WESTERN DIGITAL CORPORATION The following discussion and analysis contains forward-looking statements within the meaning of the federal securities laws, and should be read in conjunction with the disclosures we make concerning risks and other factors that may affect our business and operating results. You should read this information 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 included in Part II, Item 8 of our Annual Report on Form 10K for the fiscal year endedJuly 3, 2020 . See also "Forward-Looking Statements" immediately prior to Part I, Item 1 in this Quarterly Report on Form 10-Q. 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 toWestern Digital Corporation and its subsidiaries.
Our Company
We are a leading developer, manufacturer and provider of data storage devices
and solutions that address the evolving needs of the information technology
("IT") industry and the infrastructure that enables the proliferation of data in
virtually every other industry. We create environments for data to thrive. We
drive the innovation needed to help customers capture, preserve, access and
transform an ever-increasing diversity of data. Everywhere data lives, from
advanced data centers to mobile sensors to personal devices, our
industry-leading solutions deliver the possibilities of data.
Our broad portfolio of technology and products address the following key end markets: Client Devices; Data Center Devices and Solutions; and Client Solutions. We also generate license and royalty revenue from our extensive intellectual property ("IP"), which is included in each of these three end market categories.
Our fiscal year ends on the Friday nearest toJune 30 and typically consists of 52 weeks. Approximately every five to six years, we report a 53-week fiscal year to align the fiscal year with the foregoing policy. Fiscal year 2021, which ends onJuly 2, 2021 , will be comprised of 52 weeks, with all quarters presented consisting of 13 weeks. Fiscal year 2020, which ended onJuly 3, 2020 , was comprised of 53 weeks, with the first quarter consisting of 14 weeks and the remaining quarters consisting of 13 weeks each.
Key Developments
Business Structure
Late in the first quarter of fiscal 2021, we announced a decision to reorganize
our business by forming two separate product business units: flash-based
products and hard disk drive ("HDD"). The new structure is intended to provide
each business unit with focus and responsibility for identifying current and
future customer requirements while driving the strategy, roadmap, pricing and
overall profitability for their respective product areas. Beginning in the
second fiscal quarter, we are in the process of transitioning to this new
operating model and discrete information has not yet been established to align
with the new business structure. We are developing new reporting processes to
support the new business structure and evaluating the impact of these changes on
our discussion and analysis of our financial condition and results of operations
in the future.
COVID-19 Pandemic
As a result of the ongoing COVID-19 pandemic, governments and other authorities
around the world, including federal, state and local authorities in the United
States , have imposed measures intended to reduce its spread, including
restrictions on freedom of movement and business operations such as travel bans,
border closings, business limitations and closures (subject to exceptions for
essential operations and businesses), quarantines and shelter-in-place orders.
Although some of these governmental restrictions have since been lifted or
scaled back, periodic surges of COVID-19 infections have resulted in the
re-imposition of certain restrictions and may lead to other restrictions being
re-implemented in response to efforts to reduce the spread of COVID-19. These
measures may remain in place for a significant amount of time, and the effects
of ongoing vaccination efforts and the emergence of new strains of the virus
remain uncertain. In light of these events, we have taken actions to protect the
health and safety of our employees while continuing to serve our global
customers as an essential business. We have implemented more thorough sanitation
practices as outlined by health organizations and instituted social distancing
policies at our locations around the world, including working from home,
limiting the number of employees attending meetings, reducing the number of
people in our sites at any one time, and suspending employee travel. In
addition, the responses to COVID-19 taken by others in the supply chain have
impacted our operations. As a result, we have incurred
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charges of approximately $61 million during the six months ended January 1,
2021 , primarily related to higher logistics costs, which were recorded in cost
of revenue.
As an essential business, we continue to provide products and solutions that
enable the proliferation of data and facilitate the sharing of information
remotely, which has become more critical as much of the world is interacting
from areas of self-isolation. Generally, demand for our products remains solid.
During the six months ended January 1, 2021 , we experienced lower sales in some
of our capacity enterprise and Client Devices products as customers absorbed
purchases made in recent quarters, but we also experienced increased sales in
retail as COVID-19 restrictions eased, more brick and mortar businesses resumed
operations, the work and learn from home trend increased hard drive demand for
desktops and notebooks, and gaming increased. Looking forward, we see positive
indications of the progression of 5G ramp and the growth of gaming. We also
currently expect retail demand to be solid in the near term and HDD to improve
as customers absorb recent purchases and we ramp sales of new products. However,
the COVID-19 environment remains dynamic and we cannot predict the duration of
the pandemic and how demand may change as it develops.
We will continue to actively monitor the situation and may take further actions
altering our business operations that we determine are in the best interests of
our employees, customers, partners, suppliers, and stakeholders, or as required
by federal, state, or local authorities. See "The COVID-19 pandemic could
adversely affect our business, results of operations and financial condition" in
Part I, Item 1A, Risk Factors, of our Annual Report on Form 10-K for the fiscal
year ended July 3, 2020 for more information regarding the risks we face as a
result of the COVID-19 pandemic.
Through our three business ventures withKioxia Corporation ("Kioxia"), referred to as "Flash Ventures ", we and Kioxia operate flash-based memory wafer manufacturing facilities inJapan . We are obligated to pay for variable costs incurred in producing our share ofFlash Ventures' flash-based memory wafer supply, based on our three-month forecast, which generally equals 50% ofFlash Ventures' output. In addition, we are obligated to pay for half ofFlash Ventures' fixed costs regardless of the output we choose to purchase. We are also obligated to fund 49.9% to 50% of eachFlash Ventures entity's capital investments to the extent thatFlash Ventures entity's operating cash flow is insufficient to fund these investments. We also co-develop flash technologies (including process technology and memory design) with Kioxia and contribute IP forFlash Ventures' use. Since its inception,Flash Ventures' primary manufacturing site has been located in Yokkaichi,Japan , which currently includes five wafer fabrication facilities. Production levels at the Yokkaichi site were temporarily reduced as a result of an unexpected power outage incident that occurred in the Yokkaichi region onJune 15, 2019 . The power outage incident impacted the facilities and process tools and resulted in damage to flash wafers in production. The incident resulted in a reduction of our flash wafer availability by approximately 4 exabytes. As a result of this power outage incident, we incurred aggregate charges of$68 million recorded in Cost of revenue in the six months endedJanuary 3, 2020 , which primarily consisted of unabsorbed manufacturing overhead costs. During the six months endedJanuary 1, 2021 , we recovered$75 million related to this incident from our insurance carriers, which was recorded in Cost of revenue. InMay 2019 , we entered into additional agreements with Kioxia to extendFlash Ventures to a new wafer fabrication facility, known as "K1," located in Kitakami,Japan . The primary purpose of K1 is to provide clean room space to continue the transition of existing flash-based wafer capacity to newer technology nodes. K1 is now fully operational. In connection with the start-up of this facility, we agreed to prepay an aggregate of approximately$360 million over a 3-year period beginning in the first half of fiscal year 2020 toward K1 building depreciation, to be credited against future wafer charges. As ofJanuary 1, 2021 , remaining committed prepayments totaled$149 million . InOctober 2020 , Kioxia announced the start of construction of the shell for a new fabrication facility in Yokkaichi,Japan , referred to as "Y7 ". We expect to continueFlash Ventures investments intoY7 in due course, following the completion of agreements with Kioxia governing the construction and operation of the new facility and according to then-prevailing market trends. 37 -------------------------------------------------------------------------------- Table of Contents Results of Operations
Second Quarter and First Half Overview
The following table sets forth, for the periods presented, selected summary information from our Condensed Consolidated Statements of Operations by dollars and percentage of net revenue(1):
Three Months Ended
January 1, January 3,
2021 2020 $ Change % Change
($ in millions)Revenue, net$ 3,943 100.0 %$ 4,234 100.0 %$ (291) (7) % Cost of revenue 2,983 75.7 3,299 77.9 (316) (10) Gross profit 960 24.3 935 22.1 25 3 Operating Expenses: Research and development 535 13.6 578 13.7 (43) (7) Selling, general and administrative 265 6.7 298 7.0 (33) (11) Employee termination, asset impairment, and other charges 2 0.1 9 0.2 (7) (78) Total operating expenses 802 20.3 885 20.9 (83) (9) Operating income 158 4.0 50 1.2 108 216 Interest and other income (expense): Interest income 2 0.1 8 0.2 (6) (75) Interest expense (81) (2.1) (105) (2.5) 24 (23) Other income, net 6 0.2 7 0.2 (1) (14) Total interest and other expense, net (73) (1.9) (90) (2.1) 17 (19) Income (loss) before taxes 85 2.2 (40) (0.9) 125 (313) Income tax expense 23 0.6 99 2.3 (76) (77) Net income (loss)$ 62 1.6$ (139) (3.3) 201 (145)
(1) Percentages may not total due to rounding.
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Six Months Ended
January 1, January 3,
2021 2020 $ Change % Change
($ in millions)
Revenue, net $ 7,865 100.0 % $ 8,274 100.0 % $ (409) (5) %
Cost of revenue 6,001 76.3 6,581 79.5 (580) (9)
Gross profit 1,864 23.7 1,693 20.5 171 10
Operating Expenses:
Research and development 1,090 13.9 1,152 13.9 (62) (5)
Selling, general and administrative 521 6.6 603 7.3 (82) (14)
Employee termination, asset impairment,
and other charges 25 0.3 17 0.2 8 47
Total operating expenses 1,636 20.8 1,772 21.4 (136) (8)
Operating income (loss) 228 2.9 (79) (1.0) 307 (389)
Interest and other income (expense):
Interest income 4 0.1 20 0.2 (16) (80)
Interest expense (165) (2.1) (227) (2.7) 62 (27)
Other income, net 15 0.2 9 0.1 6 67
Total interest and other expense, net (146) (1.9) (198) (2.4) 52 (26)
Income (loss) before taxes 82 1.0 (277) (3.3) 359 (130)
Income tax expense 80 1.0 138 1.7 (58) (42)
Net income (loss) $ 2 - $ (415) (5.0) 417 (100)
The following table sets forth, for the periods presented, summary information
regarding our revenue:
Three Months Ended Six Months Ended
January 1, January 3, January 1, January 3,
2021 2020 2021 2020
(in millions)
Revenue by Product
HDD $ 1,909 $ 2,396 $ 3,753 $ 4,804
Flash-based 2,034 1,838 4,112 3,470
Total Revenue $ 3,943 $ 4,234 $ 7,865 $ 8,274
Revenue by End Market
Client Devices $ 2,131 $ 1,797 $ 4,077 $ 3,413
Data Center Devices & Solutions 807 1,489 1,936 3,021
Client Solutions 1,005 948 1,852 1,840
Total Revenue $ 3,943 $ 4,234 $ 7,865 $ 8,274
Revenue by Geography
Americas $ 945 $ 1,296 $ 2,024 $ 2,609
Europe, Middle East and Africa 725 811 1,354 1,590
Asia 2,273 2,127 4,487 4,075
Total Revenue $ 3,943 $ 4,234 $ 7,865 $ 8,274
39-------------------------------------------------------------------------------- Table of Contents Net Revenue Net revenue decreased 7% for the three months endedJanuary 1, 2021 compared to the three months endedJanuary 3, 2020 , which reflects an approximate 11 percentage point decline in revenue related to pricing per gigabyte of memory for both HDD and flash products and an approximate 6 percentage point decline in exabyte volume of HDD memory sold, primarily in Data Center Devices and Solutions as discussed further below. These declines were largely offset by higher volumes of flash memory sold. Client Devices revenue increased 19% year over year. Higher volumes of flash memory contributed 28 percentage points of growth, as work-, school- and game-from-home trends continued to drive demand for our solutions for notebook and desktop applications.Western Digital's industry leading NVMe-based client SSDs and strong relationships with major PC OEMs drove a record level of exabyte shipments. These increases were slightly offset, in relatively equal portions, by lower average pricing per gigabyte of memory on both HDD and flash products and lower volumes of HDD. Data Center Devices and Solutions revenue declined 46% year over year due to ongoing cloud digestion, one ongoing qualification delay andChina shipment restrictions. Revenue from both capacity enterprise hard drives and enterprise SSDs were down year over year. We believe cloud digestion is abating and are seeing stabilization of OEM demand. Should these demand trends continue, we believe capacity enterprise hard drive revenue bottomed in the second quarter and anticipate a rebound in the third quarter. Within our enterprise SSD product line, we completed the qualification process at a cloud titan for our second-generation product and began shipping to this customer in the third quarter.
Client Solutions revenue increased 6% year over year with approximately 12 percentage points driven by volume growth. The work-, school- and gaming-from-home trends benefited both hard drive and flash-based products. This growth was partially offset by more competitive pricing.
Net revenue decreased 5% for the six months endedJanuary 1, 2021 from the comparable period in the prior year, reflecting an approximate 11 percentage point decline related to pricing per gigabyte of memory for both HDD and flash products and an approximate 8 percentage point decline in HDD memory sold, primarily in Data Center Devices and Solutions. These declines were largely offset by higher volumes of memory, predominantly in flash products. Client Devices revenue increased 19% year over year, with approximately 25 percentage points of growth coming from higher volumes of memory, driven by growth in flash products for the same reasons noted above for the quarter. This increase was partially offset by lower average selling prices per gigabyte of memory in both flash and HDD products. Revenue for Data Center Devices and Solutions declined 36% year over year, which also reflects the drivers noted for the quarter above. Client Solutions revenue was essentially flat year over year, with relatively stable retail demand and pricing in both HDD and flash products. The changes in net revenue by geography reflect an increase inAsia due to our increased sales of mobility products to manufacturers in theAsia region, and a decrease in theAmericas driven by lower sales of capacity enterprise products. Our top 10 customers accounted for 43% and 41% of our net revenue for the three and six months endedJanuary 1, 2021 , respectively, and 44% and 43% for the three and six months endedJanuary 3, 2020 , respectively. For the three and six months endedJanuary 1, 2021 andJanuary 3, 2020 , no single 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 endedJanuary 1, 2021 andJanuary 3, 2020 , these programs represented 20% and 19% and 17% and 16%, respectively, of gross revenues, and adjustments to revenue due to changes in accruals for these programs have generally averaged less than 1% of gross revenue year over year. The increase in adjustments year over year reflects the current competitive environment. The amounts attributed to our sales incentive and marketing programs generally vary according to several factors including industry conditions, list pricing strategies, seasonal demand, competitor actions, channel mix and overall availability of products. Changes in future customer demand and market conditions may require us to adjust our incentive programs as a percentage of gross revenue.
Gross Profit and Gross Margin
Gross profit increased by$25 million for the three months endedJanuary 1, 2021 from the comparable period in the prior year, which reflects a$48 million decrease in charges in the current year related to amortization expense on acquired intangible assets and the$45 million insurance recovery in the current year related to the power outage incident, partially offset by lower revenues. 40 -------------------------------------------------------------------------------- Table of Contents Gross margin increased approximately 3 percentage points for the three months endedJanuary 1, 2021 from the comparable period in the prior year, substantially all of which is attributed to the impacts of the lower charges for amortization of acquired intangible assets and the insurance recovery noted above. Gross profit increased by$171 million for the six months endedJanuary 1, 2021 from the comparable period in the prior year, which reflects the power outage charges of$68 million incurred in the prior year compared to the$75 million partial recovery in the current year, a$67 million decrease in charges in the current year related to amortization expense on acquired intangible assets and reduced manufacturing costs. Gross margin increased approximately 10 percentage points for the six months endedJanuary 1, 2021 from the comparable period in the prior year, substantially all of which is attributed to the impacts of the charges related to the power outage incident in the prior year, the insurance recovery in the current year and the lower charges for amortization of acquired intangible assets noted above. Over the near term, we expect flash gross margin to benefit from improved pricing and cost reductions while HDD gross margin is expected to be constrained by the pricing environment for 16-terabyte drives, but we expect improved gross margins over the longer term as we ramp production on higher capacity drives.
Operating Expenses
Research and development ("R&D") expense decreased $43 million for the three
months ended January 1, 2021 from the comparable period in the prior year. The
decrease was driven, in comparable amounts, by lower compensation costs, lower
travel and entertainment expenses due to the COVID-19 restrictions, and a
decline in outside services. R&D expense decreased $62 million for the six
months ended January 1, 2021 from the comparable period in the prior year,
reflecting the drivers noted above for the quarter, as well as the impact of
additional expense in the prior year for the additional week in the prior year.
Selling, general and administrative ("SG&A") expense decreased $33 million for
the three months ended January 1, 2021 from the comparable period in the prior
year. The decrease was driven, in comparable amounts, by lower compensation
costs, lower travel and entertainment as a result of COVID-19 restrictions and
lower consulting and marketing expenses due to event cancellations. SG&A expense
decreased $82 million for the six months ended January 1, 2021 from the
comparable period in the prior year. Similar to the quarter, the decline was
driven, in comparable amounts, by lower compensation costs, lower travel and
entertainment as a result of COVID-19 restrictions and lower consulting and
marketing expenses due to event cancellations, as well as approximately $10
million of additional expense in the prior year related to the additional week.
Employee termination, asset impairment and other charges increased from the
comparable period in the prior year as we initiated incremental actions to align
our operations with current market demand. For information regarding employee
termination, asset impairment and other charges, see Part I, Item 1, Note 14,
Employee Termination, Asset Impairment and Other Charges, of the Notes to
Condensed Consolidated Financial Statements included in this Quarterly Report on
Form 10-Q.
Interest and Other Income (Expense)
The decreases in total interest and other expense, net for the three and six months endedJanuary 1, 2021 reflect lower interest expense resulting from lower index rates and the pay-down of principal on our debt. 41
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Income Tax Expense
The Tax Cuts and Jobs Act (the "2017 Act") includes a broad range of tax reform proposals affecting businesses. We completed our accounting for the tax effects of the enactment of the 2017 Act during the second quarter of fiscal 2019. However, theU.S. Treasury and the Internal Revenue Service ("IRS") have issued tax guidance on certain provisions of the 2017 Act since the enactment date, and we anticipate the issuance of additional regulatory and interpretive guidance. We applied a reasonable interpretation of the 2017 Act along with the then-available guidance in finalizing our accounting for the tax effects of the 2017 Act. Any additional regulatory or interpretive guidance would constitute new information, which may require further refinements to our estimates in future periods.
The following table sets forth income tax information from our Condensed Consolidated Statements of Operations by dollar and effective tax rate:
Three Months Ended Six Months Ended
January 1, January 3, January 1, January 3,
2021 2020 2021 2020
($ in millions)
Income (loss) before taxes $ 85 $ (40) $ 82 $ (277)
Income tax expense 23 99 80 138
Effective tax rate 27 % (248) % 98 % (50) %
The primary drivers of the difference between the effective tax rate for the
three and six months ended January 1, 2021 and the U.S. Federal statutory rate
of 21% are the relative mix of earnings and losses by jurisdiction, the
deduction for foreign derived intangible income, credits, and tax holidays in
Malaysia , the Philippines and Thailand that will expire at various dates during
fiscal years 2021 through 2030. In addition, the effective tax rate for the
three and six months ended January 1, 2021 includes the discrete effects of
favorable adjustments proposed by tax authorities of $8 million . The effective
tax rate for the six months ended January 1, 2021 also includes the discrete
effects of net tax deficiencies from shortfalls of $12 million related to the
vesting of stock-based awards and additional tax expense of $10 million from the
re-measurement of deferred tax liabilities due to restructuring activities,
which have no impact on the amount of income taxes paid by us.
The primary driver of the difference between the effective tax rate for the
three and six months ended January 3, 2020 and the U.S. Federal statutory rate
of 21% are the relative mix of earnings and losses by jurisdiction, the
deduction for foreign derived intangible income, credits, and tax holidays in
Malaysia , Philippines and Thailand that expired or will expire at various dates
during fiscal years 2020 through 2030.
Our future effective tax rate is subject to future regulatory developments and
changes in the mix of our U.S. earnings compared to foreign earnings. Our total
tax expense in future fiscal years may also vary as a result of discrete items
such as excess tax benefits or deficiencies.
For additional information regarding Income tax expense (benefit), see Part I, Item 1, Note 12, Income Tax Expense, of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.
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