Business Context and Reporting Period
Western Digital Corporation develops and manufactures data-storage solutions, principally hard disk drives, along with enterprise SSDs, storage software, personal-cloud products and data-center systems under the HGST, WD and G-Technology brands. The Form 10-K covers the 53-week fiscal year ended July 3, 2015; the comparable fiscal year ended June 27, 2014 had 52 weeks. The filing also reports fourth-quarter fiscal 2015 results.
The company operated through the independent HGST and WD subsidiaries while awaiting a response from China’s MOFCOM on its request to lift post-acquisition operating restrictions. Fiscal 2015 included the March 2015 acquisition of Amplidata, an object-storage software company.
Financial Performance and Key Metrics
| Metric | Fiscal 2015 | Fiscal 2014 | Change |
|---|---|---|---|
| Net revenue | $14.572 billion | $15.130 billion | Down 4% |
| Gross profit | $4.221 billion | $4.360 billion | Down $139 million |
| Gross margin | 29.0% | 28.8% | Up 20 basis points |
| Operating income | $1.611 billion | $1.791 billion | Down 10% |
| Operating margin | 11.1% | 11.8% | Down 70 basis points |
| Net income | $1.465 billion | $1.617 billion | Down 9% |
| Diluted EPS | $6.18 | $6.68 | Down 7% |
| Operating cash flow | $2.242 billion | $2.816 billion | Down $574 million |
- HDD shipments declined to 229 million units from 249 million, primarily because of weaker client-PC demand. HDD average selling price increased to $60 from $58, reflecting product mix.
- Enterprise SSD revenue increased to $811 million from $508 million.
- Research and development expense was $1.646 billion, or 11.3% of revenue; SG&A was $773 million, or 5.3% of revenue.
- Fiscal 2015 included $176 million of employee termination, asset impairment and other charges and $15 million of Seagate-related arbitration charges. The prior year included $95 million and $52 million, respectively.
- Cash and cash equivalents totaled $5.024 billion at year-end, including $4.3 billion held outside the United States. Working capital was $5.275 billion.
- Capital expenditures were $612 million. Investing cash outflows were $953 million, including $257 million for acquisitions, net of cash acquired.
- Financing cash outflows were $1.069 billion, including $970 million of share repurchases, $396 million of dividends and $125 million of debt repayment.
- Total debt was approximately $2.567 billion, consisting of $255 million outstanding under the revolving facility and $2.312 billion under the term loan, including current portions. The company was in compliance with its credit covenants.
- Fiscal 2015 declared dividends were $1.80 per share, or $418 million. The remaining share-repurchase authorization was $2.2 billion at year-end.
Fourth-Quarter Fiscal 2015
| Metric | Q4 FY2015 | Q4 FY2014 |
|---|---|---|
| Revenue | $3.191 billion | $3.651 billion |
| Gross profit | $930 million | $1.029 billion |
| Operating income | $255 million | $352 million |
| Net income | $220 million | $317 million |
| Diluted EPS | $0.94 | $1.32 |
Material Changes Versus the Prior Comparable Period
- Revenue declined despite higher HDD ASPs because total HDD volume fell 8%; client-compute shipments fell to 136 million from 157 million.
- Non-PC HDD shipments increased modestly to 93 million from 92 million, supported by enterprise and other markets.
- Gross margin improved slightly, but lower volume and higher restructuring, impairment and termination charges reduced operating income and net income.
- Operating cash flow declined substantially, partly because working capital used $593 million versus $234 million in the prior year. Inventory increased to $1.368 billion from $1.226 billion.
- Accounts receivable declined to $1.532 billion from $1.989 billion, partly reflecting improved shipment linearity and receivables factoring.
- Long-term debt declined to $2.156 billion from $2.313 billion, while the company drew $255 million on its revolving facility and classified it as current because it intended to repay the borrowing in fiscal 2016.
- Employee count declined to 76,449 from 84,072, consistent with workforce reductions and operational realignment.
- International sales represented 79% of revenue. Hewlett-Packard accounted for 11% of revenue, and the top ten customers represented 44%.
Outlook, Commentary, Risks and Unusual Items
Management emphasized long-term growth opportunities from expanding digital content, cloud infrastructure, enterprise storage, active archive systems and enterprise SSDs. The filing does not provide a clear formal fiscal 2016 revenue or earnings guidance range. Management stated that cash, operating cash generation and available credit facilities were expected to meet working-capital, debt, dividend, repurchase and capital-expenditure needs for at least the next twelve months.
- Key operating risks include declining PC demand, SSD substitution, falling ASPs, volatile gross margins, customer concentration, demand forecasting risk and intense competition from Seagate, Toshiba, Samsung, SanDisk and semiconductor-storage providers.
- Manufacturing and supply-chain risks include reliance on concentrated facilities in Asia, sole- or limited-source suppliers, rare-earth materials, NAND supply, natural disasters, labor disruption and geopolitical or trade restrictions.
- The company remains subject to MOFCOM restrictions that limit integration of HGST and WD and may delay expected synergies.
- The company paid Seagate $773.4 million in October 2014 after the arbitration award. Seagate continued to seek approximately $29 million of additional interest; a district court ruled for Western Digital, but Seagate appealed.
- Potential German copyright-levy losses were disclosed at up to $95 million, including accrued amounts. The exact judgment amount had not been determined.
- IRS proposed adjustments could increase federal tax expense by approximately $72 million for intercompany payable matters and $723 million for transfer-pricing matters, plus interest. Western Digital disputes the adjustments.
- Unrecognized tax benefits totaled $350 million, of which $291 million could result in potential cash payments; timing was not estimable.
- Foreign tax holidays contributed an estimated $641 million, or $2.70 per diluted share, to fiscal 2015 net earnings and expire in whole or in part from 2016 through 2025.
- Undistributed foreign earnings totaled $9.4 billion and would have generated an estimated $3.1 billion U.S. tax liability if repatriated.
- Fiscal 2015 included $37 million of flood-related insurance recoveries; all related claims were closed by year-end.
- KPMG issued unqualified opinions on the financial statements and internal control over financial reporting. Management concluded that disclosure controls and internal controls were effective.
Important Facts for Investors to Verify
- Whether enterprise, cloud and SSD growth can offset continued PC-market contraction and HDD unit declines.
- The sustainability of the 29.0% gross margin amid pricing pressure, product-mix changes and technology transitions.
- Future cash generation after scheduled term-loan repayments, dividends, repurchases, capital expenditures and acquisition spending.
- The outcome and potential cash impact of the Seagate appeal, German copyright-levy proceedings and IRS tax examinations.
- Whether MOFCOM lifts the hold-separate restrictions and whether Western Digital realizes expected HGST integration synergies.
- The expiration and possible renewal of foreign tax holidays and the resulting effect on the effective tax rate.
- Customer concentration, particularly Hewlett-Packard and the top-ten-customer exposure, and the company’s ability to manage receivables and inventory.