Western Digital Corporation Fiscal 2018 Form 10-K Summary
Business context and reporting period
Western Digital develops and manufactures data-storage devices and solutions across Client Devices, Data Center Devices and Solutions, and Client Solutions, using HDD and flash-based technologies. The filing covers the 52-week fiscal year ended June 29, 2018; the source does not provide a separate “2018 Q4” filing summary, although fourth-quarter results are disclosed.
Western Digital operates as one reportable segment and markets products primarily under the HGST, SanDisk, and WD brands. Substantially all flash-memory supply is obtained through Flash Ventures, its 49.9%-owned joint ventures with Toshiba Memory Corporation (TMC).
Key financial metrics
| Metric | Fiscal 2018 | Fiscal 2017 | Change |
|---|---|---|---|
| Net revenue | $20.647 billion | $19.093 billion | Up 8% |
| Gross profit | $7.705 billion | $6.072 billion | Up 27% |
| Gross margin | 37.3% | 31.8% | Up 5.5 percentage points |
| Operating income | $3.617 billion | $1.954 billion | Up 85% |
| Operating margin | 17.5% | 10.2% | Up 7.3 percentage points |
| Net income | $675 million | $397 million | Up 70% |
| Diluted EPS | $2.20 | $1.34 | Up 64% |
| Operating cash flow | $4.205 billion | $3.437 billion | Up 22% |
Fiscal 2018 revenue by end market was approximately 49% Client Devices, 29% Data Center Devices and Solutions, and 22% Client Solutions. Exabytes shipped increased to 389 from 313. International sales represented 78% of revenue, and the top 10 customers represented 42% of revenue; no individual customer represented at least 10% of annual revenue.
Cash and cash equivalents were $5.005 billion at June 29, 2018, compared with $6.354 billion a year earlier. Working capital was $6.182 billion, compared with $6.712 billion. Total debt principal was $11.375 billion, down from $13.356 billion, and the company reported $1.75 billion of additional borrowing availability under its revolving credit facility. Long-term debt was $10.993 billion.
Net cash used in investing activities was $1.655 billion, including $835 million of capital expenditures, $742 million of net funding for Flash Ventures, and $100 million for acquisitions. Net cash used in financing activities was $3.900 billion, including $17.074 billion of debt repayments, $14.280 billion of debt issuance proceeds and revolver draws, $593 million of dividends, and $591 million of share repurchases.
Material changes versus the prior comparable period
- Revenue increased across all end markets, led by capacity enterprise HDDs, embedded flash, retail flash, and HDD products in Client Solutions.
- Gross margin expanded primarily because of favorable flash demand, greater flash and capacity-enterprise mix, and manufacturing cost improvements from technology transitions.
- Operating expenses declined modestly to $4.088 billion from $4.118 billion, while R&D expense declined 2% to $2.400 billion.
- Interest expense declined to $676 million from $847 million, but other expense included $899 million of losses on debt extinguishment related to refinancing and redemption activity.
- Fiscal 2018 included a provisional $1.57 billion tax expense for the Tax Cuts and Jobs Act’s mandatory deemed repatriation tax, partly offset by a $65 million deferred-tax remeasurement benefit. The effective tax rate increased to 68% from 48%.
- Inventory increased to $2.944 billion from $2.341 billion, and the cash conversion cycle widened to 51 days from 36 days, primarily because of higher flash and HDD inventory.
- The company refinanced substantial debt, issued $2.30 billion of 4.75% senior notes due 2026 and $1.10 billion of 1.50% convertible notes due 2024, and replaced prior credit facilities with a $5.02 billion Term Loan A-1 and a $2.25 billion revolving facility.
Fourth-quarter results disclosed in the 10-K
| Metric | Fiscal Q4 2018 | Fiscal Q4 2017 |
|---|---|---|
| Revenue | $5.117 billion | $4.842 billion |
| Gross profit | $1.852 billion | $1.681 billion |
| Operating income | $843 million | $652 million |
| Net income | $756 million | $280 million |
| Diluted EPS | $2.46 | $0.93 |
The quarterly results were affected by significant tax and other period-specific items. The filing does not provide a separate adjusted Q4 earnings measure in the supplied text.
Guidance, outlook, commentary, risks, contingencies, and unusual items
- Management expected fiscal 2019 gross margins to decline from fiscal 2018 because flash supply was expected to increase and average selling prices per gigabyte were expected to decline.
- Fiscal 2019 cash use for property, plant and equipment and net Flash Ventures notes receivable and equity-investment activity was expected to be approximately $1.50 billion to $1.90 billion.
- The company announced closure of its Kuala Lumpur HDD manufacturing facility, with substantial completion expected by the end of calendar 2019 and estimated total pre-tax charges of approximately $160 million. It recognized $56 million of employee termination benefits in fiscal 2018.
- TMC was sold on June 1, 2018 to a Bain Capital-led consortium that included SK hynix and other competitors and customers. Western Digital identified potential risks involving strategic misalignment, financing constraints, decision-making, intellectual property, and future Flash Ventures investments.
- Western Digital is obligated to purchase approximately 50% of Flash Ventures’ output or pay its share of fixed costs, and it has commitments for Flash Ventures investments and equipment. Its maximum reasonably estimable Flash Ventures exposure was $3.610 billion, including $1.223 billion of lease guarantees.
- Total disclosed contractual obligations were $26.931 billion, including $11.375 billion of debt principal, $8.298 billion of Flash Ventures and related commitments, $3.179 billion of purchase obligations, and $1.566 billion of provisional mandatory repatriation tax.
- Approximately 70% of debt was at variable interest rates. After interest-rate swaps, $5.94 billion of long-term debt remained exposed to rate changes; a one-percentage-point increase in variable rates was estimated to increase annual interest expense by $59 million.
- The IRS issued a statutory notice of deficiency seeking approximately $516 million of additional federal tax through fiscal 2009, plus interest. The company disagreed and intended to petition the U.S. Tax Court. The timing and ultimate outcome were uncertain.
- Key operating risks include flash-memory supply concentration, cyclical demand, declining ASPs, technology-transition execution, customer and supplier concentration, international operations and tariffs, foreign-exchange exposure, cybersecurity, intellectual-property litigation, product defects, and high leverage.
- The company maintained effective disclosure controls and internal control over financial reporting, according to management and KPMG LLP.
Most important facts for investors to verify
- Whether flash-memory pricing and supply conditions in fiscal 2019 produced the expected gross-margin compression.
- Progress and final costs of the Kuala Lumpur facility closure and HDD manufacturing consolidation.
- Flash Ventures’ investment requirements, wafer pricing, capacity transition to 3D NAND, and the effect of TMC’s change in ownership.
- Debt maturities, refinancing capacity, variable-rate exposure, covenant compliance, and the ability to fund dividends and repurchases while meeting Flash Ventures commitments.
- Final accounting for the Tax Cuts and Jobs Act, including the $1.57 billion provisional repatriation tax and any additional taxes associated with foreign earnings.
- The outcome of the IRS tax dispute involving approximately $516 million of proposed additional federal tax, as well as other disclosed litigation and indemnification matters.
- Inventory levels, the 51-day cash conversion cycle, customer concentration, and potential write-down exposure if demand or technology transitions change.