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WDC > SEC Filings for WDC > Form 10-Q on 31-Jan-2014All Recent SEC Filings

Show all filings for WESTERN DIGITAL CORP

Form 10-Q for WESTERN DIGITAL CORP


31-Jan-2014

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 28, 2013.
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," and the "Company" 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 March quarter and the ability of the industry to support this demand;

expectations concerning the anticipated benefits of our acquisitions;

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

our position in the industry;

our belief regarding our ability to capitalize on the expansion in, and our expectations regarding the growth and demand of, digital data;

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;

expectations regarding our external and internal supply base;

our belief regarding component availability;

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


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

contributions to our pension plans in fiscal 2014; 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. Our Company

We are a leading developer and manufacturer of data storage solutions that enable consumers, businesses, governments and other organizations to create, manage, experience and preserve digital content. Our principal products are hard drives. Our product portfolio also includes solid-state drives ("SSDs"). Hard drives are today's primary storage medium for digital data, with solid-state storage products growing rapidly. Our products are marketed under the HGST, WD and G-Technology brand names. We currently operate our global business through two independent subsidiaries due to regulatory requirements - HGST and WD. Acquisitions
Acquisition of Virident Systems, Inc. ("Virident") On October 17, 2013, we acquired Virident, a provider of server-side flash storage solutions for virtualization, database, cloud computing and webscale applications. Virident was fully integrated into our HGST subsidiary and became our wholly owned indirect subsidiary. The purchase price of the acquisition was approximately $613 million, consisting of $598 million which was funded with available cash and $15 million related to the fair value of stock options assumed. The acquisition is expected to further HGST's strategy to address the rapidly changing needs of enterprise customers by delivering intelligent storage solutions that maximize application performance by leveraging the tightly coupled server, storage and network resources of today's converged datacenter infrastructures. The acquisition of Virident did not have a material impact on our condensed consolidated financial statements for the three months ended December 27, 2013.
Acquisition of sTec, Inc. ("sTec")

On September 12, 2013, we completed the acquisition of sTec, a provider of enterprise SSDs. As a result of the acquisition, sTec was fully integrated into our HGST subsidiary and became our wholly owned indirect subsidiary. The acquisition is intended to augment HGST's existing solid-state storage capabilities. The purchase price of the acquisition was approximately $336 million, consisting of $325 million which was funded with available cash and $11 million related to the fair value of stock options and RSUs assumed. The acquisition of sTec did not have a material impact on our condensed consolidated financial statements for the three and six months ended December 27, 2013. Acquisition of VeloBit, Inc. ("VeloBit") On July 10, 2013, we acquired VeloBit, a privately held provider of high-performance storage I/O optimization software. As a result of the acquisition, VeloBit was fully integrated into our HGST subsidiary and became our wholly owned indirect subsidiary. The acquisition is intended to build on HGST's strategy to enhance the overall value of datacenter storage by integrating HGST SSDs with software. The acquisition was not material to our condensed consolidated financial statements. Second Quarter Overview
In accordance with accounting principles generally accepted in the United States ("U.S. GAAP"), operating results for Virident, which was acquired on October 17, 2013, sTec, which was acquired on September 12, 2013, and VeloBit, which was acquired on July 10, 2013, are included in our operating results only after the dates of acquisition.
For the quarter ended December 27, 2013, we believe that overall hard drive industry shipments totaled approximately 142 million units, up 5% from the prior-year period and up 1% from the September quarter.


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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                       Six Months Ended
                           December 27,        December 28,        December 27,        December 28,
                               2013                2012                2013                2012
Net revenue              $ 3,972   100.0 %   $ 3,824   100.0 %   $ 7,776   100.0 %   $ 7,859   100.0 %
Gross profit               1,141    28.7       1,059    27.7       2,229    28.7       2,252    28.7
Total operating expenses     663    16.7         581    15.2       1,209    15.5       1,182    15.0
Operating income             478    12.0         478    12.5       1,020    13.1       1,070    13.6
Net income                   430    10.8         335     8.8         925    11.9         854    10.9

The following is a summary of our financial performance for the second quarter of fiscal 2014:
Consolidated net revenue totaled $4.0 billion.

54% of our net revenue was derived from non-PC (personal computer) markets, which include enterprise applications, branded products and CE (consumer electronics) products, as compared to 49% in the prior-year period.

Net revenue derived from enterprise SSDs was $155 million as compared to $89 million in the prior-year period.

Hard drive unit shipments increased 7% from the prior-year period to 63.1 million units.

Gross margin increased to 28.7%, compared to 27.7% for the prior-year period.

Operating income was $478 million, flat with the prior-year period.

We generated $727 million in cash flow from operations in the second quarter of fiscal 2014, and we ended the quarter with $4.7 billion in cash and cash equivalents.

For the quarter ending March 28, 2014, we expect overall hard drive industry shipments and our revenue to decrease slightly from the December quarter as a result of seasonality.

Results of Operations
Net Revenue
                                   Three Months                                             Six Months
                                       Ended                                                   Ended
(in millions, except
percentages and            December 27,     December 28,                           December 27,     December 28,     Percentage
average selling price)         2013             2012         Percentage Change         2013             2012           Change
Net revenue               $      3,972     $      3,824             4  %          $      7,776     $      7,859         (1 )%
Average selling price
(per unit)*               $         60     $         62            (3 )%          $         59     $         62         (5 )%
Revenues by Geography (%)
Americas                            25 %             27 %                                   26 %             25 %
Europe, Middle East and
Africa                              23               23                                     21               20
Asia                                52               50                                     53               55
Revenues by Channel (%)
OEM                                 62 %             61 %                                   63 %             62 %
Distributors                        24               24                                     24               24
Retailers                           14               15                                     13               14
Unit Shipments*
PC                                39.5             39.0                                   79.7             81.7
Non-PC                            23.6             20.2                                   46.0             40.0
      Total units shipped         63.1             59.2             7  %                 125.7            121.7          3  %

* Based on sales of hard drive units only.

For the quarter ended December 27, 2013, net revenue was $4.0 billion, an increase of 4% from the prior-year period. Total hard drive shipments increased to 63.1 million units for the quarter ended December 27, 2013 as compared to 59.2 million units in the prior-year period. For the six months ended December 27, 2013, net revenue was $7.8 billion, a decrease of 1% from the


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prior year period. Total hard drive shipments increased to 125.7 million units for the six months ended December 27, 2013, as compared to 121.7 million units in the prior-year period. For the quarter ended December 27, 2013, average selling price ("ASP") decreased by $2 from the prior-year period, from $62 to $60. For the six months ended December 27, 2013, ASP decreased by $3 from the prior-year period, from $62 to $59. These decreases in ASP were primarily driven by a competitive pricing environment.
Changes in revenue by geography and channel generally reflect normal fluctuations in market demand and competitive dynamics. For the three and six months ended December 27, 2013, Hewlett-Packard Company accounted for approximately 11% and 12% of our net revenue, respectively. For the three and six months ended December 28, 2012, no customer accounted for 10% or more of our net revenue.
Consistent 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 and six months ended December 27, 2013, these programs represented 7% of gross revenues, as compared to 9% and 8% in the respective prior-year periods. 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                                       Six Months
                                  Ended                                             Ended
(in millions, except  December 27,     December 28,     Percentage      December 27,     December 28,     Percentage
percentages)              2013             2012           Change            2013             2012           Change
Net revenue          $      3,972     $      3,824           4 %       $      7,776     $      7,859          (1 )%
Gross profit                1,141            1,059           8 %              2,229            2,252          (1 )%
Gross margin                 28.7 %           27.7 %                           28.7 %           28.7 %

For the three months ended December 27, 2013, gross margin as a percentage of revenue increased to 28.7% as compared to 27.7% for the prior-year period. This increase was primarily a result of cost improvements due to operational efficiencies. For the six months ended December 27, 2013, gross margin as a percentage of revenue remained flat at 28.7%.

Operating Expenses
                                  Three Months                                        Six Months
                                     Ended                                               Ended
(in millions, except     December 27,      December 28,      Percentage     December 27,      December 28,      Percentage
percentages)                 2013              2012            Change           2013              2012            Change
R&D expense            $        421       $         378          11 %      $         822     $         774          6 %
SG&A expense                    229                 162          41 %                361               341          6 %
Charges related to
arbitration award                13                   -                               26                 -
Employee termination
benefits and other
charges                           -                  41                                -                67
Total operating
expenses               $        663       $         581                    $       1,209     $       1,182

Research and development ("R&D") expense was $421 million for the three months ended December 27, 2013, an increase of $43 million from the prior-year period. For the six months ended December 27, 2013, R&D expense was $822 million, an increase of $48 million from the prior-year period. These increases were primarily due to the inclusion of Virident and sTec's R&D expenses from the dates of acquisition as well as expense related to adjustments to market value on our stock appreciation rights ("SARs"). As a percentage of net revenue, R&D expense increased to 10.6% in both the three and six months ended December 27, 2013, respectively, compared to 9.9% and 9.8% in the respective prior-year periods.
Selling, general and administrative ("SG&A") expense was $229 million for the three months ended December 27, 2013, an increase of $67 million from the prior-year period. For the six months ended December 27, 2013, SG&A expense was $361 million, an increase of $20 million from the prior-year period. These increases were primarily due to the inclusion of Virident and sTec's SG&A expenses from the dates of acquisition as well as expense related to adjustments to market value on our SARs. SG&A expense as a percentage of net revenue increased to 5.8% and 4.6% in the three and six months ended December 27, 2013, compared to 4.2% and 4.3% in the respective prior-year periods.
During the three and six months ended December 27, 2013, we recorded $13 million and $26 million, respectively, of interest charges related to an arbitration award for claims brought against us and a now former employee of ours by Seagate


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Technology LLC ("Seagate"), alleging misappropriation of confidential information and trade secrets. For further details see the "Arbitration Award" section below.
During the three months ended December 28, 2012, we recorded charges of $41 million consisting of $26 million of employee termination benefits, $12 million of asset impairments and $3 million of contract and other termination costs in order to realign our operations with anticipated market demand. During the six months ended December 28, 2012, we recorded charges of $67 million consisting of $51 million of employee termination benefits, $12 million of asset impairments and $4 million of contract and other termination costs in order to realign our operations with anticipated market demand.

Other Income (Expense)
Interest income for the three months ended December 27, 2013 remained flat with the prior-year period. Interest income for the six months ended December 27, 2013 increased $1 million as compared to the prior-year period primarily due to a higher average daily invested cash balance for the period. Interest and other expense for the three months ended December 27, 2013 increased $1 million as compared to the prior-year period primarily due to interest on an increased weighted average debt balance as a result of borrowings under the revolving credit facility. Interest and other expense for the six months ended December 27, 2013 decreased $2 million as compared to the prior-year period primarily due to interest on a decreased weighted average debt balance. Income Tax Provision
Our income tax provision for the three months ended December 27, 2013 was $37 million as compared to $133 million in the prior-year period. Our income tax provision for the six months ended December 27, 2013 was $74 million as compared to $192 million in the prior-year period. We recorded an $88 million charge to reduce our previously recognized California deferred tax assets in the six months ended December 28, 2012 as a result of the enactment of California Proposition 39. 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 2014 through 2025 and the current year generation of income tax credits. In the three months ended December 27, 2013, we recorded a net increase of $13 million in our liability for unrecognized tax benefits. In the six months ended December 27, 2013, we recorded a net increase of $23 million in our liability for unrecognized tax benefits. In addition, we recorded a $3 million increase related to the Virident and sTec acquisitions in the six months ended December 27, 2013. As of December 27, 2013, we had a recorded liability for unrecognized tax benefits of approximately $263 million. Interest and penalties recognized on such amounts were not material to the condensed consolidated financial statements during the three and six months ended December 27, 2013. The Internal Revenue Service ("IRS") completed its field examination of our federal income tax returns for fiscal years 2006 and 2007 and issued Revenue Agent Reports that proposed adjustments to income before income taxes of approximately $970 million primarily related to transfer pricing and intercompany payable balances. We disagreed with the proposed adjustments and filed a protest with the IRS Appeals Office. In June 2013, we reached an agreement with the IRS to resolve the transfer pricing issue. This agreement resulted in a decrease in the amount of net operating loss and tax credits realized, but did not have an impact on our consolidated statements of income. The proposed adjustment relating to intercompany payable balances for fiscal years 2006 and 2007 will be addressed in conjunction with the IRS's examination of our fiscal years 2008 and 2009, which commenced in January 2012. In addition, in January 2012, the IRS commenced an examination of the 2007 fiscal period ended September 5, 2007 of Komag, Incorporated, which was acquired by us on September 5, 2007. In February 2013, the IRS commenced an examination of calendar years 2010 and 2011 of HGST, which was acquired by us on March 8, 2012. 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 December 27, 2013, it is not possible to estimate the amount of change, if any, in the unrecognized tax benefits that is reasonably possible 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 tax returns. 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 against us and a now former employee, alleging misappropriation of confidential


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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. On October 30, 2012, Seagate initiated an appeal of the District Court's decision with the Minnesota Court of Appeals. On July 22, 2013, the Minnesota Court of Appeals reversed the District Court's decision and remanded for entry of an order and judgment confirming the arbitration award. We strongly disagree with the decision of the Court of Appeals and believe that the District Court's decision was correct. On August 20, 2013, we filed a petition for review with the Minnesota Supreme Court and, on October 15, 2013, we were informed that the Minnesota Supreme Court granted our petition. The appeal before the Minnesota Supreme Court has been fully briefed, and oral argument is scheduled for February 5, 2014. We will continue to vigorously defend ourselves in this matter. In light of uncertainties with respect to this matter, we recorded an accrual of $681 million for this matter in our financial statements for the three months ended June 28, 2013. This amount was in addition to the $25 million previously accrued in the fourth quarter of fiscal 2011. In the three and six months ended December 27, 2013, we recorded an additional $13 million and $26 million, respectively, for interest related to the arbitration award. As a result, the total amount accrued of $732 million represents the amount of the final arbitration award, plus interest accrued on the initial arbitration award at the statutory rate of 10% from January 24, 2012 through December 27, 2013. Liquidity and Capital Resources
We ended the first quarter of fiscal 2014 with total cash and cash equivalents of $4.7 billion. The following table summarizes our statements of cash flows (in millions):

                                                 Six Months Ended
                                           December 27,     December 28,
                                               2013             2012
Net cash flow provided by (used in):
Operating activities                      $      1,406     $      1,708
Investing activities                            (1,125 )           (670 )
Financing activities                                65             (430 )
Net increase in cash and cash equivalents $        346     $        608

Our investment policy is to manage our investment portfolio to preserve principal and liquidity while maximizing return through the full investment of available funds. On January 9, 2014 (the "Closing Date"), the outstanding balance on the existing credit facility entered into on March 8, 2012 (the "Credit Facility") was repaid, the Credit Facility was terminated, and Western Digital Corporation, Western Digital Technologies, Inc. ("WDT") and Western Digital Ireland, Ltd. ("WDI") entered into a new credit agreement with JPMorgan Chase Bank, N.A., as administrative agent, and the lenders party thereto (the "Credit Agreement"). The Credit Agreement provides for $4.0 billion of unsecured loan facilities consisting of a $2.5 billion term loan facility to WDT, and a $1.5 billion revolving credit facility to WDT and WDI. Subject to certain conditions, a Borrower may also elect to expand the credit facilities by, or obtain incremental term loans of, up to $1.0 billion if existing or new lenders provide additional term or revolving commitments. For additional information on the Credit Facility and the Credit Agreement, See Part I, Item 1, Notes 4 and 14, respectively, of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. 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 $4.0 billion and $2.8 billion of our cash and cash equivalents was held outside of the United States at December 27, 2013 and June 28, 2013, respectively. Substantially all of the amounts held outside of the United States . . .

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