Western Digital Beats 1Q Estimates

Western Digital Corp. (WDC - Analyst Report) posted first quarter 2013 adjusted earnings per share (EPS) of $2.36, beating the Zacks Consensus Estimate of $2.31.

Revenues

Revenues during the quarter increased 49.8% year over year to $4.04 billion and came slightly above the company’s revised guidance range and the Zacks Consensus Estimate of $4.0 billion. Hard drive shipments were 62.5 million units during the quarter, up from 57.8 million in the year-ago quarter. Average selling price (ASP) increased to $62 from $46 in the year-ago quarter. But both volume and ASP dropped on a sequential basis.

Western Digital recorded 63% of revenues from original equipment manufacturer (OEM) sales (53% in the year-ago quarter); distribution channel sales were 24% of total revenue (29% in the year-ago quarter), while retail sales were 13% (18% in the year-ago quarter). The top 10 customers of the company constituted 44.0% of total revenue, down from 49% in the year-ago quarter.

Operating Results

Gross margin in the reported quarter was 29.6% versus 20.1% in the year-ago quarter. Gross margin exceeded the company’s estimate on the back of higher shipments and ASP.

Operating margin for the quarter was 14.7%, up from 9.6% reported in the year-ago quarter. Total operating expense shot up 113.1% on higher research and development (R&D) and selling, general and administrative (SG&A) expense.

Net income for the quarter was $519.0 million or $2.06 per share, up from $239.0 million or $1.01 in the year-ago quarter. Excluding amortization of intangibles related to the acquisition of HGST, employee termination benefits and other charges, non-GAAP/adjusted net income was $594.0 million or $2.36 per share versus $260.0 million or $1.10 in the year ago quarter.

Balance Sheet & Cash Flow

The company generated $936.0 million in cash from operations in the first quarter, down from $1.13 billion in the year-ago quarter. Cash and cash equivalents were $3.54 billion versus $3.21 billion in the previous quarter.

Capital spending and depreciation and amortization for the first quarter totaled $382.0 million and $313.0 million, respectively. The company has a debt balance of $1.41 billion, down from $1.95 billion reported in the previous quarter.

The company’s conversion cycle was a positive 4 days. This consisted of 44 days of receivables, 42 days of inventory, or 9 turns, and 82 days payables.

Western Digital bought back 5.2 million shares worth $218.0 million. The board declared the first quarterly dividend of 25 cents per share, which was paid on October 15 to shareholders of record as of September 28.

Guidance

Western Digital provided a cautious guidance for the second quarter 2013 keeping in view the dampening macroeconomic environment and its adverse impact on near-term demand, slowing PC demand and normalizing hard disk drive supply. Revenue is expected to be within $3.55 billion and $3.70 billion and total operating expenses are expected to be $525.0 million. Total addressable market is expected to be 140 million.

Assuming a gross margin of 28.0% and diluted shares outstanding of 248 million, Western Digital expects non-GAAP EPS in the range of $1.65–$1.85.

Management asserted that the company is well-positioned to achieve long-term growth in storage and digital content management. The management also thinks that new product launches, further cost optimization, strategic allocation of capital and efficient execution will drive customers. Hence, the company expects to achieve EPS of $10 in fiscal 2013.

The company would continue to invest in growth opportunities while at the same time, return approximately 50% of the free cash flow to shareholders.

Our Take

The company’s first quarter results exceeded our expectations, with EPS and revenue beating the Zacks Consensus Estimates. Year-over-year comparisons were also encouraging. The benefits achieved from higher ASPs due to tight supply of hard disk drives (HDDs) resulting from disruption caused by Thailand flood, are exhausting. This is due to normalization of supply/demand metrics. This has been reflected in the company’s second quarter guidance, which is sequentially weak. But management brought in some comfort with its commentary of cost reduction and efficient execution.

We believe that the Hitachi deal will strengthen its foothold in the data storage business. Although the company has been able to handle competition efficiently, bigger players like Seagate Technology plc (STX - Analyst Report), Fujitsu Ltd, Samsung and Toshiba pose considerable challenges.

Currently, Western Digital has a Zacks #3 Rank (implying a short-term Hold rating).