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WDC > SEC Filings for WDC > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for WESTERN DIGITAL CORP

Form 10-Q for WESTERN DIGITAL CORP


2-Nov-2012

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This information should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in this Quarterly Report on Form 10-Q, and the audited consolidated financial statements and notes thereto and Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, contained in our Annual Report on Form 10-K for the year ended June 29, 2012.

Unless otherwise indicated, references herein to specific years and quarters are to our fiscal years and fiscal quarters. As used herein, the terms "we," "us," "our," the "Company" and "WD" refer to Western Digital Corporation and its subsidiaries.

Forward-Looking Statements

This document contains forward-looking statements within the meaning of the federal securities laws. Any statements that do not relate to historical or current facts or matters are forward-looking statements. You can identify some of the forward-looking statements by the use of forward-looking words, such as "may," "will," "could," "would," "project," "believe," "anticipate," "expect," "estimate," "continue," "potential," "plan," "forecast," and the like, or the use of future tense. Statements concerning current conditions may also be forward-looking if they imply a continuation of current conditions. Examples of forward-looking statements include, but are not limited to, statements concerning:

expectations regarding industry demand and pricing in the December quarter and the ability of the industry to support this demand;

expectations concerning the anticipated benefits of our acquisition of Viviti Technologies Ltd., until recently known as Hitachi Global Storage Technologies Holdings Pte. Ltd.;

demand for hard drives and solid-state drives in the various markets and factors contributing to such demand;

our plans to continue to develop new products and expand into new storage markets and into emerging economic markets;

emergence of new storage markets for hard drives;

emergence of competing storage technologies;

our quarterly cash dividend policy;

our share repurchase plans;

our stock price volatility;

our belief regarding our compliance with environmental laws and regulations;

our belief regarding component availability;

expectations regarding the outcome of legal proceedings in which we are involved;

our beliefs regarding the adequacy of our tax provisions and the timing of future payments, if any, relating to the unrecognized tax benefits;

contributions to our pension plans in fiscal 2013; and

our beliefs regarding the sufficiency of our cash and cash equivalents to meet our working capital, capital expenditure and other cash needs.

Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. You are urged to carefully review the disclosures we make concerning risks and other factors that may affect our business and operating results, including those made in Part II, Item 1A of this Quarterly Report on Form 10-Q, and any of those made in our other reports filed with the Securities and Exchange Commission (the "SEC"). You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document. We do not intend, and undertake no obligation, to publish revised forward-looking statements to reflect events or circumstances after the date of this document or to reflect the occurrence of unanticipated events.


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Our Company

We are an industry-leading developer and manufacturer of storage products that enable people to create, manage, experience and preserve digital content. We design and make storage devices, networking equipment and home entertainment products under the WD, HGST and G-Technology brands. We serve each of the primary markets addressing storage opportunities - enterprise and cloud data centers, client, consumer electronics, backup, the Internet and other emerging markets such as automotive and home and small office networking.

We operate our global business through two independent subsidiaries due to regulatory requirements-WD and HGST, both long-time innovators in the storage industry.

Our principal products today are hard drives, which use one or more rotating magnetic disks ("magnetic media") to store and allow fast access to data. Hard drives are today's primary storage medium for digital content. Our hard drives are used in desktop and notebook computers, multiple types of data centers including corporate and cloud data centers, home entertainment equipment and stand-alone consumer storage devices. Our other products include solid-state drives, home entertainment and networking products and applications for smart phones and tablets.

Acquisition

Hitachi Global Storage Technologies Holdings Pte. Ltd. ("HGST") Acquisition

On March 8, 2012 (the "Closing Date"), we, through Western Digital Ireland ("WDI"), our indirect wholly owned subsidiary, completed the acquisition (the "Acquisition") of all the issued and outstanding paid-up share capital of Viviti Technologies Ltd., until recently known as HGST, from Hitachi, Ltd. ("Hitachi"), pursuant to a Stock Purchase Agreement, dated March 7, 2011, among us, WDI, Hitachi and HGST. The Acquisition is intended over time, and subject to compliance with applicable regulatory conditions imposed on the Acquisition, to result in a more efficient and innovative customer-focused storage company. We do not expect to achieve significant operating expense synergies while the regulatory conditions are in effect.

The preliminary, aggregate purchase price of the Acquisition amounted to approximately $4.7 billion and is subject to a post-closing adjustment (an increase or a decrease) for changes in the working capital of HGST and certain other payments and expenses. The post-closing adjustment has not yet been determined.

Maintenance of Competitive Requirement

In connection with the regulatory approval process of the Acquisition, we agreed to certain conditions required by the Ministry of Commerce of the People's Republic of China ("MOFCOM"), including adopting measures to maintain HGST as an independent competitor until MOFCOM agrees otherwise (with the minimum period being two years). We are working closely with MOFCOM to finalize an operations plan that is expected to outline in more detail the conditions of the competitive requirement.

Toshiba Transactions

In connection with the regulatory approval process of the Acquisition, we announced on May 15, 2012 that we had closed a transaction with Toshiba Corporation ("Toshiba") to divest certain 3.5-inch hard drive assets and to purchase Toshiba Storage Device (Thailand) Company Limited, a wholly-owned subsidiary of Toshiba that manufactured hard drives prior to the recent Thailand flooding. The net impact of these two transactions was immaterial to our condensed consolidated financial statements.

First Quarter Overview

In accordance with U.S. generally accepted accounting principles ("U.S. GAAP"), operating results for HGST prior to the date of the Acquisition are not included in our operating results, affecting our discussion of changes in our revenues and expenses for the periods prior to the Acquisition as compared to the periods after the Acquisition.


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For the three months ended September 28, 2012, we believe that overall hard drive industry shipments totaled approximately 139 million units, down 21% from the prior-year period and down 11% sequentially from the June quarter as a result of a softer demand environment.

The following table sets forth, for the periods presented, selected summary information from our condensed consolidated statements of income by dollars and percentage of net revenue (in millions, except percentages):

                                                   Three Months Ended
                                           Sept. 28,                Sept. 30,
                                             2012                     2011
           Net revenue                $ 4,035       100.0 %    $ 2,694       100.0 %
           Gross margin                 1,193        29.6          541        20.1
           Total operating expenses       601        14.9          282        10.5
           Operating income               592        14.7          259         9.6
           Net income                     519        12.9          239         8.9

The following is a summary of our financial performance for the first quarter of 2013:

Consolidated net revenue totaled $4.0 billion.

44% of our hard drive revenue was derived from non-compute and enterprise markets, which include CE products, enterprise applications, and branded products, as compared to 36% in the prior-year period.

Hard drive unit shipments increased by 8% from the prior-year period to 62.5 million units.

Gross margin increased to 29.6%, compared to 20.1% for the prior-year period.

Operating income, including $26 million of employee termination benefits and other charges, was $592 million, an increase of $333 million from the prior-year period.

We generated $936 million in cash flow from operations in the first quarter of fiscal 2013, and we ended the quarter with $3.5 billion in cash and cash equivalents.

For the quarter ending December 28, 2012, we expect overall hard drive industry shipments to remain flat with the September quarter. In addition, we expect our revenue in the December quarter to decrease from the September quarter reflecting a muted demand environment, a seasonal reduction in our gaming business and a planned reduction in the shipment of 3.5-inch hard drives to Toshiba in connection with our divestiture agreement with Toshiba.

Results of Operations

Net Revenue



                                                 Three Months
                                                    Ended
  (in millions, except percentages and    Sept. 28,        Sept. 30,        Percentage
  average selling price)                    2012             2011             Change
  Net revenue                            $     4,035      $     2,694                50 %
  Average selling price (per unit)*      $        62      $        46                35
  Revenues by Geography (%)
  Americas                                        23 %             19 %
  Europe, Middle East and Africa                  18               22
  Asia                                            59               59
  Revenues by Channel (%)
  OEM                                             63 %             53 %
  Distributors                                    24               29
  Retailers                                       13               18
  Unit Shipments*
  Compute                                       42.7             41.2
  Non-compute                                   13.8             14.2
  Enterprise                                     6.0              2.4

  Total units shipped                           62.5             57.8                 8 %

* Based on sales of hard drive units only.


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For the quarter ended September 28, 2012, net revenue was $4.0 billion, an increase of 50% from the prior-year period. Total hard drive shipments increased to 62.5 million units for the quarter ended September 28, 2012 as compared to 57.8 million units in the prior-year period. The increase in net revenue resulted primarily from an increase in average selling price ("ASP") and the contribution of the acquired operations of HGST. For the quarter ended September 28, 2012, ASP increased by $16, from $46 to $62. This increase in ASP relates to product mix, as well as the continued effects of the Thailand flooding in October 2011.

Changes in revenue by geography and channel generally reflect normal fluctuations in market demand and competitive dynamics. However, in the three months ended September 28, 2012, our revenue by channel mix reflects a heavier weighting toward OEM as result of the Acquisition. In addition, for the three months ended September 28, 2012, no customer accounted for 10% or more of our net revenue.

In accordance with standard industry practice, we have sales incentive and marketing programs that provide customers with price protection and other incentives or reimbursements that are recorded as a reduction to gross revenue. For the three months ended September 28, 2012 and September 30, 2011, these programs represented 8% and 9% of gross revenues, respectively. These amounts generally vary according to several factors, including industry conditions, seasonal demand, competitor actions, channel mix and overall availability of product.

Gross Margin



                                               Three Months
                                                  Ended
                                        Sept. 28,        Sept. 30,        Percentage
   (in millions, except percentages)      2012             2011             Change
   Net revenue                         $     4,035      $     2,694                50 %
   Gross margin                              1,193              541               121
   Gross margin %                             29.6 %           20.1 %

For the three months ended September 28, 2012, gross margin as a percentage of revenue increased to 29.6% as compared to 20.1% for the prior-year period. This increase was primarily a result of a higher ASP due to product mix and the continued effects of the Thailand flooding, offset by $38 million for amortization of intangibles related to the Acquisition.

Operating Expenses



                                                            Three Months
                                                                Ended
                                                     Sept. 28,         Sept. 30,         Percentage
(in millions, except percentages)                      2012              2011              Change
R&D expense                                         $       396       $       193                105 %
SG&A expense                                                179                89                101
Employee termination benefits and other charges              26                -

Total operating expenses                            $       601       $       282

Research and development ("R&D") expense was $396 million for the three months ended September 28, 2012, an increase of $203 million from the prior-year period. The increase was primarily due to the continued investment in product development to support new programs, as well as the inclusion of a full quarter of HGST's R&D activities. As a percentage of net revenue, R&D expense increased to 9.8% in the three months ended September 28, 2012, compared to 7.2% in the prior-year period. Selling, general and administrative ("SG&A") expense was $179 million for the three months ended September 28, 2012, an increase of $90 million over the prior-year period. The increase was primarily due to the expansion of sales and marketing to support new products and growing markets, the inclusion of a full quarter of SG&A expense from HGST and $11 million for amortization of intangibles related to the Aquisition. SG&A expense as a percentage of net revenue increased to 4.4% in the three months ended September 28, 2012, compared to 3.3% in the comparative prior-year period.


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In the first quarter of fiscal 2012, we recorded $25 million of employee termination benefits and $1 million of contract and other termination costs in order to realign our production with anticipated market demand.

Other Income (Expense)

Interest income for the three months ended September 28, 2012 decreased $1 million as compared to the prior-year period primarily due to a lower average daily invested cash balance for the period. Interest and other expense for the three months ended September 28, 2012 increased $12 million as compared to the prior-year period primarily due to interest on an increased debt balance.

Income Tax Provision

Our income tax provision for the three months ended September 28, 2012 was $59 million as compared to $19 million in the prior-year period. The differences between the effective tax rate and the U.S. Federal statutory rate are primarily due to tax holidays in Malaysia, the Philippines, Singapore and Thailand that expire at various dates from 2013 through 2025 and the current year generation of income tax credits.

In the three months ended September 28, 2012, we recorded a net decrease of $4 million in our liability for unrecognized tax benefits. As of September 28, 2012, we had a recorded liability for unrecognized tax benefits of approximately $276 million. Interest and penalties recognized on such amounts were not material.

The Internal Revenue Service ("IRS") has completed its field examination of the federal income tax returns for fiscal years 2006 and 2007 for us. We have also received Revenue Agent Reports ("RARs") from the IRS that seek adjustments to income before income taxes of approximately $970 million in connection with unresolved issues related primarily to transfer pricing and certain other intercompany transactions. We disagree with the proposed adjustments. In May 2011, we filed a protest with the IRS Appeals Office regarding the proposed adjustments. Meetings with the Appeals Office began in February 2012. In January 2012, the IRS commenced an examination of our fiscal years 2008 and 2009 and of the 2007 fiscal period ended September 5, 2007 of Komag, Incorporated, which was acquired by us on September 5, 2007.

We believe that adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in our tax audits are resolved in a manner not consistent with management's expectations, we could be required to adjust our provision for income taxes in the period such resolution occurs. As of September 28, 2012, we believe it is reasonably possible that our liability for unrecognized tax benefits will decrease by $54 million within the next twelve months. Any significant change in the amount of our liability for unrecognized tax benefits would most likely result from additional information or settlements relating to the examination of our uncertain tax positions.

Arbitration Award

As disclosed above in Part I, Item 1, Note 5 in the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, on November 18, 2011, a sole arbitrator ruled against us in an arbitration in Minnesota. The arbitration involves claims brought by Seagate Technology LLC ("Seagate") against us and a now former employee, alleging misappropriation of confidential information and trade secrets. The arbitrator issued an interim award against us in the amount of $525 million plus pre-award interest. On January 23, 2012, the arbitrator issued a final award adding pre-award interest in the amount of $105.4 million, for a total award of $630.4 million. On January 23, 2012, we filed a petition in the District Court of Hennepin County, Minnesota to have the final arbitration award vacated, and a hearing on the petition to vacate was held on March 1, 2012. On October 12, 2012, the District Court of Hennepin County, Minnesota vacated, in full, the $630.4 million final arbitration award and ordered that a rehearing be held concerning certain trade secret claims before a new arbitrator agreed upon by the parties and that if by November 2, 2012 the parties are unable to reach agreement, then the Court will appoint a new arbitrator. On October 30, 2012, Seagate initiated an appeal of the Court's decision with the Minnesota Court of Appeals. We strongly believe that the Court's decision was correct and intend to vigorously oppose Seagate's efforts to appeal the decision. Nevertheless, we cannot be certain we will be successful in a new arbitration of the trade secret claims or in Seagate's efforts to appeal the decision. In the event Seagate is successful in its efforts to appeal the Court's decision, the original arbitration award could be reinstated, and payment of the award, including interest (which would apply at the statutory rate of 10% from the date of the original arbitration award), would adversely affect our financial condition, results of operations and cash flows.


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Liquidity and Capital Resources

We ended the first quarter of fiscal 2013 with total cash and cash equivalents
of $3.5 billion. The following table summarizes our statements of cash flows (in
millions):



                                                       Three Months Ended
                                                  Sept. 28,          Sept. 30,
                                                     2012              2011
      Net cash flow provided by (used in):
      Operating activities                        $      936        $       352
      Investing activities                              (391 )             (134 )
      Financing activities                              (216 )              (33 )

      Net increase in cash and cash equivalents   $      329        $       185

Our investment policy is to manage our investment portfolio to preserve principal and liquidity while maximizing return through the full investment of available funds. In connection with our Acquisition, we entered into a five-year credit agreement (the "Credit Facility"), which provides for a $500 million revolving credit facility. In addition, we may elect to expand the Credit Facility by up to an additional $500 million if existing or new lenders provide additional term or revolving commitments. We believe our current cash, cash equivalents and cash generated from operations as well as our available credit facilities will be sufficient to meet our working capital, debt, dividend, stock repurchase and capital expenditure needs for at least the next twelve months. Our ability to sustain our working capital position is subject to a number of risks that we discuss in Part II, Item 1A of this Quarterly Report on Form 10-Q.

A total of $2.7 billion and $1.7 billion of our cash and cash equivalents was held outside of the United States at September 28, 2012 and June 29, 2012, respectively. Substantially all of the amounts held outside of the United States are intended to be indefinitely reinvested in foreign operations. On September 13, 2012, our Board of Directors approved a capital allocation plan which includes repurchases of our common stock and the adoption of a quarterly cash dividend policy. Our current plans do not anticipate that we will need funds generated from foreign operations to fund our domestic operations or capital allocation plan for at least the next twelve months. In the event funds from foreign operations are needed in the United States, any repatriation could result in the accrual and payment of additional U.S. income tax.

Operating Activities

Net cash provided by operating activities was $936 million during the three months ended September 28, 2012. Cash flow from operating activities consists of net income, adjusted for non-cash charges, plus or minus working capital changes. This represents our principal source of cash. Net cash provided by working capital changes was $77 million for the three months ended September 28, 2012 as compared to net cash used to fund working capital changes of $71 million in the prior-year period.

Our working capital requirements primarily depend on the effective management of our cash conversion cycle, which measures how quickly we can convert our products into cash through sales. The cash conversion cycles were as follows:

                                               Three Months Ended
                                          Sept. 28,           Sept. 30,
                                            2012                2011
             Days sales outstanding               44                  46
             Days in inventory                    42                  27
             Days payables outstanding           (82 )               (72 )

             Cash conversion cycle                 4                   1

For the three months ended September 28, 2012, our average days sales outstanding ("DSOs") decreased by 2 days, days in inventory ("DIOs") increased by 15 days, and days payable outstanding ("DPOs") increased by 10 days compared to the prior year period. Changes in average DSOs and DIOs are generally related to linearity of shipments and the timing of inventory builds, respectively. Changes in DPOs are generally related to production volume and the timing of purchases during the period. From time to time, we modify the timing of payments to our vendors. We make modifications primarily to manage our vendor relationships and to manage our cash flows, including our cash balances. Generally, we make the payment modifications through negotiations with our vendors or by granting to, or receiving from, our vendors' payment term accommodations.


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Investing Activities

Cash used in investing activities for the three months ended September 28, 2012 was $391 million as compared to $134 million for the prior-year period. For the three months ended September 28, 2012, cash used in investing activities consisted of $382 million of capital expenditures and $9 million related to an acquisition compared to $134 million of capital expenditures for the prior-year period. This increase in capital expenditures primarily relates to the inclusion of HGST's activities and flood-related recovery capital spending.

Our cash equivalents are invested in highly liquid money market funds that are invested in U.S. Treasury securities and U.S. Treasury bills. We also have $14 million of auction-rate securities, which are classified as available-for-sale securities.

Financing Activities

Net cash used in financing activities for the three months ended September 28, 2012 was $216 million as compared to $33 million in the prior-year period. Net cash used in financing activities for the three months ended September 28, 2012 consisted of $58 million used to repay long-term debt, $218 million used to repurchase shares of our common stock and a net $60 million provided by employee stock plans. Net cash used in financing activities for the three months ended September 30, 2011 consisted of $31 million used to repay long-term debt and a net $2 million related to employee stock plans.

Off-Balance Sheet Arrangements . . .

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