QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2021
Or
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 1-8703
WESTERN DIGITAL CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
Delaware
33-0956711
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
5601 Great Oaks Parkway
San Jose,
California
95119
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (408) 717-6000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading symbol(s)
Name of each exchange on which registered
Common Stock, $0.01 Par Value Per Share
WDC
The Nasdaq Stock Market LLC
(Nasdaq Global Select Market)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes☒ No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes☒ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
☒
☐
☐
☐
☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ý
As of the close of business on January 27, 2022, 312,917,687 shares of common stock, par value $0.01 per share, were outstanding.
WESTERN DIGITAL CORPORATION
INDEX
PAGE NO.
PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements (unaudited)
Condensed Consolidated Balance Sheets — As of December 31, 2021 and July 2, 2021
Unless otherwise indicated, references herein to specific years and quarters are to our fiscal years and fiscal quarters, and references to financial information are on a consolidated basis. As used herein, the terms “we,” “us,” “our,” the “Company,” “WDC” and “Western Digital” refer to Western Digital Corporation and its subsidiaries, unless we state, or the context indicates, otherwise.
WDC, a Delaware corporation, is the parent company of our data storage business. Our principal executive offices are located at 5601 Great Oaks Parkway, San Jose, California 95119. Our telephone number is (408) 717-6000.
Western Digital, the Western Digital logo, G-Technology, SanDisk and WD are registered trademarks or trademarks of Western Digital or its affiliates in the U.S. and/or other countries. All other trademarks, registered trademarks and/or service marks, indicated or otherwise, are the property of their respective owners.
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 the effects of the COVID-19 pandemic and measures intended to reduce its spread; expectations regarding supply chain conditions and constraints; expectations regarding demand trends and market conditions for our products and expected future financial performance; expectations regarding our product momentum and product development and technology plans; expectations regarding capital expenditure plans and investments, including relating to our Flash Ventures joint venture with Kioxia Corporation (“Kioxia”), and sources of funding for those expenditures; and our beliefs regarding the sufficiency of our available liquidity to meet our working capital, debt and capital expenditure needs.
These forward-looking statements are based on management’s current expectations, represent the most current information available to the Company as of the date of this Quarterly Report on Form 10-Q and are subject to a number of risks, uncertainties and other factors that could cause actual results or performance to differ materially from those expressed in the forward-looking statements.These risks and uncertainties include, but are not limited to:
•future responses to and effects of the COVID-19 pandemic;
•volatility in global economic conditions;
•impact of business and market conditions;
•impact of competitive products and pricing;
•our development and introduction of products based on new technologies and expansion into new data storage markets;
•risks associated with cost saving initiatives, restructurings, acquisitions, divestitures, mergers, joint ventures and our strategic relationships;
•difficulties or delays in manufacturing or other supply chain disruptions;
•hiring and retention of key employees;
•our substantial level of debt and other financial obligations;
•changes to our relationships with key customers;
•disruptions in operations from cyberattacks or other system security risks;
•actions by competitors;
•risks associated with compliance with changing legal and regulatory requirements and the outcome of legal proceedings; and
•the other risks and uncertainties disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended July 2, 2021 (the “2021 Annual Report on Form 10-K”).
You are urged to carefully review the disclosures we make concerning these risks and review the additional disclosures we make concerning material risks and other factors that may affect the outcome of our forward-looking statements and our business and operating results, including those made in Part I, Item 1A of our 2021 Annual Report on Form 10-K and any of those made in our other reports filed with the Securities and Exchange Commission, including under “Risk Factors” in Item 1A of subsequent Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q that may from time to time amend, supplement or supersede the risks and uncertainties disclosed in the 2021 Annual Report on Form 10-K. You are cautioned not to place undue reliance on the forward-looking statements included in this Quarterly Report on Form 10-Q, which speak only as of the date of this document. We do not intend, and undertake no obligation, to update or revise these forward-looking statements to reflect new information or events after the date of this document or to reflect the occurrence of unanticipated events, except as required by law.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Organization and Basis of Presentation
Western Digital Corporation (“Western Digital” or the “Company”) is 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. The Company creates environments for data to thrive. The Company is driving 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, the Company’s industry-leading solutions deliver the possibilities of data.
The accounting policies followed by the Company are set forth in Part II, Item 8, Note 1, Organization and Basis of Presentation, of the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10‑K for the fiscal year ended July 2, 2021. In the opinion of management, all adjustments necessary to fairly state the Condensed Consolidated Financial Statements have been made. All such adjustments are of a normal, recurring nature. Certain information and footnote disclosures normally included in the Consolidated Financial Statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto included in the Company’s Annual Report on Form 10‑K for the fiscal year ended July 2, 2021. The results of operations for interim periods are not necessarily indicative of results to be expected for the full year.
Fiscal Year
The Company’s fiscal year ends on the Friday nearest to June 30 and typically consists of 52 weeks. Approximately every five to six years, the Company reports a 53-week fiscal year to align the fiscal year with the foregoing policy. Fiscal years 2022, which ends on July 1, 2022, and 2021, which ended on July 2, 2021, are each comprised of 52 weeks, with all quarters presented consisting of 13 weeks.
Use of Estimates
Company management has made estimates and assumptions relating to the reporting of certain assets and liabilities in conformity with U.S. GAAP. These estimates and assumptions have been applied using methodologies that are consistent throughout the periods presented with consideration given to the potential impacts of the ongoing COVID-19 pandemic. However, actual results could differ materially from these estimates and be significantly affected by the severity and duration of the COVID-19 pandemic, the extent of actions to contain or treat COVID-19, the timing, distribution, efficacy and public acceptance of vaccines around the world, additional surges of COVID-19, including the emergence of more contagious or vaccine-resistant variants, and how quickly and to what extent normal economic and operating activity can resume.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 2. Recent Accounting Pronouncements
Accounting Pronouncements Recently Adopted
In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes” (“ASU 2019-12”). ASU 2019-12 removes certain exceptions for recognizing deferred taxes for investments, performing intraperiod allocation and calculating income taxes in interim periods. The ASU also adds guidance to reduce complexity in certain areas, including recognizing deferred taxes for tax goodwill and allocating taxes to members of a consolidated group. The Company adopted this ASU on July 3, 2021, which is the beginning of fiscal 2022, and its adoption did not have a material impact on the Company’s Condensed Consolidated Financial Statements.
Recently Issued Accounting Pronouncements Not Yet Adopted
In August 2020, the FASB issued ASU No. 2020-06, “Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity” (“ASU 2020-06”). ASU 2020-06 reduces the number of accounting models for convertible debt instruments and convertible preferred stock and results in fewer instruments with embedded conversion features being separately recognized from the host contract as compared with current standards. Those instruments that do not have a separately recognized embedded conversion feature will no longer recognize a debt issuance discount related to such a conversion feature and would recognize less interest expense on a periodic basis. Additionally, the ASU amends the calculation of the share dilution impact related to a conversion feature and eliminates the treasury method as an option. For instruments that do not have a component mandatorily settled in cash, the change will likely result in a higher amount of share dilution in the calculation of earnings per share. The Company expects to adopt this ASU in the first quarter of fiscal 2023, and is currently assessing the impact of adoption.
In November 2021, the FASB issued ASU No. 2021-10, “Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance” (“ASU 2021-10”). ASU 2021-10 increases the transparency of government assistance received by requiring most business entities to disclose information about government assistance received, including (1) the types of assistance, (2) the entity’s accounting for the assistance, and (3) the effect of the assistance on an entity’s financial statements. This ASU is effective for fiscal years (and interim periods within those fiscal years) beginning after December 15, 2021, which for the Company is the first quarter of fiscal 2023. Early adoption is permitted. The Company is currently assessing the impact and timing of adoption of this ASU.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 3. Segment Information
The Company manufactures, markets, and sells data storage devices and solutions in the U.S. and in foreign countries through its sales personnel, dealers, distributors, retailers, and subsidiaries. Historically, the Company had been managed and reported under a single operating segment. Late in the first quarter of fiscal 2021, the Chief Executive Officer, who is the Company’s Chief Operating Decision Maker (“CODM”), announced a decision to reorganize the Company’s business by forming two separate product business units: hard disk drives (“HDD”) and flash-based products (“Flash”). To align with the new operating model and business structure, the Company made management organizational changes and implemented new reporting modules and processes to provide discrete information to manage the business. Effective July 3, 2021, the Company’s management finalized its assessment of the Company’s operating segments and concluded that the Company now has two reportable segments: HDD and Flash.
The CODM evaluates performance of the Company and makes decisions regarding allocation of resources based on each operating segment’s net revenue and gross margin, which are summarized below. Because of the integrated nature of the Company’s production and distribution activities, separate segment asset measures are not available or reviewed by the CODM to evaluate the performance of or to allocate resources to the segments.
The following table summarizes the operating performance of the Company’s reportable segments:
Three Months Ended
Six Months Ended
December 31, 2021
January 1, 2021
December 31, 2021
January 1, 2021
Net revenue:
HDD
$
2,213
$
1,909
$
4,774
$
3,753
Flash
2,620
2,034
5,110
4,112
Total net revenue
$
4,833
$
3,943
$
9,884
$
7,865
Gross profit:
HDD
$
677
$
488
$
1,469
$
971
Flash
946
551
1,867
1,099
Total gross profit for segments
1,623
1,039
3,336
2,070
Unallocated corporate items:
Amortization of acquired intangible assets
(26)
(109)
(65)
(254)
Stock-based compensation expense
(14)
(15)
(23)
(27)
Charges related to a power outage incident and related recovery
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Disaggregated Revenue
The Company’s broad portfolio of technology and products address multiple end markets. In the fiscal first quarter of 2022, the Company refined the end markets it reports to be Cloud, Client and Consumer. Cloud represents a large and growing end market comprised primarily of products for public or private cloud environments and end customers, which the Company believes it is uniquely positioned to address as the only provider of both hard drive and flash products. Through the Client end market, the Company provides its original equipment manufacturer (“OEM”) and channel customers a broad array of high-performance flash and hard drive solutions across personal computer, mobile, gaming, automotive, virtual reality headsets, at-home entertainment, and industrial spaces. The Consumer end market is highlighted by the Company’s broad range of retail and other end-user products, which capitalize on the strength of the Company’s product brand recognition and vast points of presence around the world.
The Company’s disaggregated revenue information is as follows:
Three Months Ended
Six Months Ended
December 31, 2021
January 1, 2021
December 31, 2021
January 1, 2021
(in millions)
Revenue by End Market
Cloud
$
1,920
$
1,014
$
4,145
$
2,305
Client
1,854
1,869
3,707
3,619
Consumer
1,059
1,060
2,032
1,941
Total Revenue
$
4,833
$
3,943
$
9,884
$
7,865
Revenue by Geography
Americas
$
1,407
$
945
$
3,021
$
2,024
Europe, Middle East and Africa
816
725
1,578
1,354
Asia
2,610
2,273
5,285
4,487
Total Revenue
$
4,833
$
3,943
$
9,884
$
7,865
The Company’s top 10 customers accounted for 46% and 44% of its net revenue for the three and six months ended December 31, 2021, respectively, and 43% and 41% of its net revenue for the three and six months ended January 1, 2021, respectively. For the three and six months ended December 31, 2021 and January 1, 2021, no single customer accounted for 10% or more of the Company’s net revenue.
Goodwill
In connection with the Company’s determination of its reportable segments, effective July 3, 2021, the Company allocated its goodwill between its segments based on the estimated relative fair values of the business units. In addition, management performed a goodwill impairment assessment for each segment and concluded there were no impairment indicators as of both the beginning and end of the six months ended December 31, 2021. The following table provides a summary of goodwill activity for the period:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 4. Revenues
Contract assets represent the Company’s rights to consideration where performance obligations are completed but the customer payments are not due until another performance obligation is satisfied. The Company did not have any contract assets as of either December 31, 2021 or July 2, 2021.
The Company incurs sales commissions and other direct incremental costs to obtain sales contracts. The Company has applied the practical expedient to recognize the direct incremental costs of obtaining contracts as an expense when incurred if the amortization period is expected to be one year or less or the amount is not material, with these costs charged to Selling, general and administrative expenses. Other direct incremental costs to obtain contracts that have an expected benefit of greater than one year are amortized over the period of expected cash flows from the related contracts, and the amortization expense is recorded as a reduction to revenue. Total capitalized contract costs as of December 31, 2021 and July 2, 2021 as well as the related amortization for the three and six months ended December 31, 2021 and January 1, 2021 were not material.
Contract liabilities relate to customers’ payments in advance of performance under the contract and primarily relate to remaining performance obligations under support and maintenance contracts. As of December 31, 2021 and July 2, 2021, contract liabilities were not material.
The Company applies the practical expedients and does not disclose transaction price allocated to the remaining performance obligations for (i) arrangements that have an original expected duration of one year or less, which mainly consist of the support and maintenance contracts, and (ii) variable consideration amounts for sale-based or usage-based royalties for intellectual property (“IP”) license arrangements, which typically range longer than one year. Remaining performance obligations are mainly attributed to right-to-access patent license arrangements and customer support and service contracts, which will be recognized over the remaining contract period. The transaction price allocated to the remaining performance obligations as of December 31, 2021 was $51 million, which is mainly attributable to the functional IP license and service arrangements. The Company expects to recognize this amount as revenue as follows: $20 million during the remainder of fiscal 2022, $30 million in fiscal 2023, and $1 million in fiscal 2024 and thereafter.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 5. Supplemental Financial Statement Data
Accounts receivable, net
From time to time, in connection with factoring agreements, the Company sells trade accounts receivable without recourse to third party purchasers in exchange for cash. The Company did not sell any trade accounts receivable during the six months ended December 31, 2021. During the six months ended January 1, 2021, the Company sold trade accounts receivable for cash proceeds of $173 million. The discounts on the trade accounts receivable sold were not material and were recorded within Other income, net in the Condensed Consolidated Statements of Operations. There were no factored receivables outstanding as of December 31, 2021 and July 2, 2021.
Inventories
December 31, 2021
July 2, 2021
(in millions)
Inventories:
Raw materials and component parts
$
1,685
$
1,623
Work-in-process
1,013
1,088
Finished goods
949
905
Total inventories
$
3,647
$
3,616
Property, plant and equipment, net
December 31, 2021
July 2, 2021
(in millions)
Property, plant and equipment:
Land
$
273
$
278
Buildings and improvements
1,870
1,854
Machinery and equipment
8,287
7,860
Computer equipment and software
466
440
Furniture and fixtures
53
51
Construction-in-process
486
476
Property, plant and equipment, gross
11,435
10,959
Accumulated depreciation
(8,068)
(7,771)
Property, plant and equipment, net
$
3,367
$
3,188
Intangible assets
December 31, 2021
July 2, 2021
(in millions)
Finite-lived intangible assets
$
5,508
$
5,508
In-process research and development
80
80
Accumulated amortization
(5,288)
(5,146)
Intangible assets, net
$
300
$
442
As part of prior acquisitions, the Company recorded at the time of the acquisition acquired in-process research and development (“IPR&D”) for projects in progress that had not yet reached technological feasibility. IPR&D is initially accounted for as an indefinite-lived intangible asset. Once a project reaches technological feasibility, the Company reclassifies the balance to existing technology and begins to amortize the intangible asset over its estimated useful life.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Product warranty liability
Changes in the warranty accrual were as follows:
Three Months Ended
Six Months Ended
December 31, 2021
January 1, 2021
December 31, 2021
January 1, 2021
(in millions)
Warranty accrual, beginning of period
$
370
$
391
$
363
$
408
Charges to operations
36
24
76
59
Utilization
(28)
(24)
(51)
(55)
Changes in estimate related to pre-existing warranties
(27)
(25)
(37)
(46)
Warranty accrual, end of period
$
351
$
366
$
351
$
366
The current portion of the warranty accrual is classified in Accrued expenses and the long-term portion is classified in Other liabilitiesas noted below:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Accumulated other comprehensive income (loss)
Accumulated other comprehensive income (loss) (“AOCI”), net of tax refers to expenses, gains and losses that are recorded as an element of shareholders’ equity but are excluded from net income. The following table illustrates the changes in the balances of each component of AOCI:
Actuarial Pension Gains (Losses)
Foreign Currency Translation Adjustment
Unrealized Gains (Losses) on Derivative Contracts
Total Accumulated Comprehensive Income (Loss)
(in millions)
Balance at July 2, 2021
$
(35)
$
(38)
$
(124)
$
(197)
Other comprehensive income (loss) before reclassifications
1
(41)
(71)
(111)
Amounts reclassified from accumulated other comprehensive income (loss)
—
—
94
94
Income tax expense related to items of other comprehensive income (loss)
—
—
(3)
(3)
Net current-period other comprehensive income (loss)
1
(41)
20
(20)
Balance at December 31, 2021
$
(34)
$
(79)
$
(104)
$
(217)
During the three and six months ended December 31, 2021, the amounts reclassified out of AOCI were losses related to foreign exchange contracts and interest rate swap contracts. Losses reclassified out of AOCI related to foreign exchange contracts were $32 million and $69 million, respectively, and were substantially charged to Cost of revenue in the Condensed Consolidated Statements of Operations. Losses reclassified out of AOCI related to interest rate swap contracts were $12 million and $25 million, respectively, and were charged to Interest expense in the Condensed Consolidated Statements of Operations.
As of December 31, 2021, the amount of existing net losses related to cash flow hedges recorded in AOCI included $5 million related to the Company’s interest rate swaps that is expected to be reclassified to earnings after twelve months. In addition, as of December 31, 2021, the Company did not have any foreign exchange forward contracts with credit-risk-related contingent features.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 6. Fair Value Measurements and Investments
Financial Instruments Carried at Fair Value
Financial assets and liabilities that are remeasured and reported at fair value at each reporting period are classified and disclosed in one of the following three levels:
Level 1. Quoted prices in active markets for identical assets or liabilities.
Level 2. Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3. Inputs that are unobservable for the asset or liability and that are significant to the fair value of the assets or liabilities.
The following tables present information about the Company’s financial assets and liabilities that are measured at fair value on a recurring basis as of December 31, 2021 and July 2, 2021, and indicate the fair value hierarchy of the valuation techniques utilized to determine such values:
December 31, 2021
Level 1
Level 2
Level 3
Total
(in millions)
Assets:
Cash equivalents - Money market funds
$
71
$
—
$
—
$
71
Foreign exchange contracts
—
22
—
22
Total assets at fair value
$
71
$
22
$
—
$
93
Liabilities:
Foreign exchange contracts
$
—
$
86
$
—
$
86
Interest rate swap contracts
—
48
—
48
Total liabilities at fair value
$
—
$
134
$
—
$
134
July 2, 2021
Level 1
Level 2
Level 3
Total
(in millions)
Assets:
Cash equivalents - Money market funds
$
1,283
$
—
$
—
$
1,283
Foreign exchange contracts
—
14
—
14
Total assets at fair value
$
1,283
$
14
$
—
$
1,297
Liabilities:
Foreign exchange contracts
$
—
$
65
$
—
$
65
Interest rate swap contracts
—
80
—
80
Total liabilities at fair value
$
—
$
145
$
—
$
145
During the three and six months ended December 31, 2021 and January 1, 2021, the Company had no transfers of financial assets and liabilities between levels and there were no changes in valuation techniques or the inputs used in the fair value measurement.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Financial Instruments Not Carried at Fair Value
For financial instruments where the carrying value (which includes principal adjusted for any unamortized issuance costs, and discounts or premiums) differs from fair value (which is based on quoted market prices), the following table represents the related carrying value and fair value for each of the Company’s outstanding financial instruments. Each of the financial instruments presented below was categorized as Level 2 for all periods presented, based on the frequency of trading immediately prior to the end of the second quarter of fiscal 2022 and the fourth quarter of fiscal 2021, respectively.
December 31, 2021
July 2, 2021
Carrying Value
Fair Value
Carrying Value
Fair Value
(in millions)
Variable interest rate Term Loan A-1 maturing 2023
$
2,998
$
3,006
$
4,327
$
4,346
Variable interest rate Term Loan B-4 maturing 2023
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 7. Derivative Instruments and Hedging Activities
As of December 31, 2021, the Company had outstanding foreign exchange forward contracts that were designated as either cash flow hedges or non-designated hedges. Substantially all of the contract maturity dates of these foreign exchange forward contracts do not exceed 12 months. In addition, the Company had outstanding pay-fixed interest rate swaps that were designated as cash flow hedges of variable rate interest payments on a portion of its term loans through February 2023.
Changes in fair values of the non-designated foreign exchange contracts are recognized in Other income, net and are largely offset by corresponding changes in the fair values of the foreign currency denominated monetary assets and liabilities. For each of the three and six months ended December 31, 2021 and January 1, 2021, total net realized and unrealized transaction and foreign exchange contract currency gains and losses were not material to the Company’s Condensed Consolidated Financial Statements.
Unrealized gains or losses on designated cash flow hedges are recognized in AOCI. For more information regarding cash flow hedges, see Part I, Item1, Note 5. Supplemental Information - Accumulated other comprehensive income (losses), of the Notes to the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.
Netting Arrangements
Under certain provisions and conditions within agreements with counterparties to the Company’s foreign exchange forward contracts, subject to applicable requirements, the Company has the right of offset associated with the Company’s foreign exchange forward contracts and is allowed to net settle transactions of the same currency with a single net amount payable by one party to the other. As of December 31, 2021 and July 2, 2021, the effect of rights of offset was not material and the Company did not offset or net the fair value amounts of derivative instruments in its Condensed Consolidated Balance Sheets.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 8. Debt
Debt consisted of the following as of December 31, 2021 and July 2, 2021:
December 31, 2021
July 2, 2021
(in millions)
Variable interest rate Term Loan A-1 maturing 2023
$
3,000
$
4,332
Variable interest rate Term Loan B-4 maturing 2023
—
1,093
1.50% convertible notes due 2024
1,100
1,100
4.75% senior unsecured notes due 2026
2,300
2,300
2.85% senior unsecured notes due 2029
500
—
3.10% senior unsecured notes due 2032
500
—
Total debt
7,400
8,825
Issuance costs and debt discounts
(92)
(100)
Subtotal
7,308
8,725
Less current portion of long-term debt
(251)
(251)
Long-term debt
$
7,057
$
8,474
In December 2021, the Company issued $500 million aggregate principal amount of 2.850% senior unsecured notes due February 1, 2029 (the “2029 Notes”) and issued $500 million aggregate principal amount of 3.100% senior unsecured notes due February 1, 2032 (the “2032 Notes”) pursuant to the terms of an indenture, dated as of December 10, 2021 (the “Base Indenture”) between the Company and U.S. Bank National Association, as trustee (the “Trustee”), as supplemented by the first supplemental indenture dated as of December 10, 2021 (the “First Supplemental Indenture”) between the Company and the Trustee. As used herein, “Indenture” means the Base Indenture, as supplemented by the First Supplemental Indenture. The Indenture contains certain restrictive covenants which are subject to a number of limitations and exceptions. Interest for both the 2029 Notes and 2032 Notes is payable on February 1 and August 1 of each year. The Company is not required to make principal payments on either the 2029 Notes or 2032 Notes prior to their maturity dates. Issuance costs and discounts are amortized to interest expense over their respective terms and as of December 31, 2021, unamortized issuance costs and discounts were $5 million for the 2029 Notes and $6 million for the 2032 Notes.
During the six months ended December 31, 2021, the Company voluntarily paid $1.09 billion to prepay the remaining principal balance of its Term Loan B-4 in accordance with its terms. In addition, during the three months ended December 31, 2021, the Company repaid $1.27 billion of the outstanding principal balance on its Term Loan A-1 in accordance with its terms to reduce the remaining outstanding principal balance to $3.0 billion using proceeds from the issuance of the 2029 Notes and the 2032 Notes and using cash on hand.
Subsequent to the end of the second quarter of fiscal 2022, on January 7, 2022, the Company entered into a restatement agreement (“Restatement Agreement”) to amend and restate the Loan Agreement, originally dated as of April 29, 2016 (including subsequent amendments and the Restatement Agreement, collectively, the “Loan Agreement”), to provide for, among other things, (i) the issuance of a new $3.0 billion Term Loan A-2 maturing in January 2027 (the “Term Loan A-2”) to replace our previously existing Term Loan A-1; and (ii) the availability of a new $2.25 billion revolving credit facility maturing in January 2027 (the “2027 Revolving Facility”) to replace our previously existing $2.25 billion revolving credit facility and (iii) additional covenant flexibility and other modifications. The obligations under the Loan Agreement will be the senior unsecured obligations of the Company and will not benefit from any collateral or subsidiary guarantees.
The Term Loan A-2 Loan bears interest, at the Company’s option, at a per annum rate equal to either (x) the Adjusted Term Secured Overnight Financing Rate (“SOFR”) (as defined in the Loan Agreement) plus an applicable margin varying from 1.125% to 2.000% or (y) a base rate plus an applicable margin varying from 0.125% to 1.000%, in each case depending on the corporate family ratings of the Company from at least two of Standard & Poor’s Ratings Services (“S&P”), Moody’s Investors Service, Inc. (“Moody’s”) and Fitch Ratings, Inc. (“Fitch”), with an initial interest rate of Adjusted Term SOFR plus 1.375%. The Term Loan A-2 will amortize in equal quarterly installments of (i) 0.625% per quarter during the first through the fourth
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
full fiscal quarters following the date of the Restatement Agreement (the “Restatement Effective Date”) and (ii) 1.25% per quarter for the fifth through the nineteenth full fiscal quarters following the Restatement Effective Date, with the remaining balance payable on the date that is five years after the Restatement Effective Date.
Loans under the 2027 Revolving Facility bear interest at a per annum rate, at the Company’s option, equal to either (x) the Adjusted Term SOFR Rate (as defined in the Loan Agreement) plus an applicable margin varying from 1.125% to 2.000% or (y) a base rate plus an applicable margin varying from 0.125% to 1.000%, in each case depending on the corporate family ratings of the Company from at least two of S&P, Moody’s and Fitch, with an initial rate of Adjusted Term SOFR plus 1.375%. The Company will also pay an unused commitment fee on the 2027 Revolving Facility ranging from 0.120% to 0.350% based on the corporate family ratings of the Company from at least two of S&P, Moody’s and Fitch, with an initial unused commitment fee of 0.200%.
Prior to its restatement on January 7, 2022, the Loan Agreement required the Company to comply with certain financial covenants, consisting of a leverage ratio and an interest coverage ratio. As of December 31, 2021, the Company was in compliance with these financial covenants. Following its restatement on January 7, 2022, the covenants under the Loan Agreement were simplified and the interest coverage ratio requirement was removed.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 9. Pension and Other Post-Retirement Benefit Plans
The Company has pension and other post-retirement benefit plans in various countries. The Company’s principal pension plans are in Japan, Thailand and the Philippines. All pension and other post-retirement benefit plans outside of the Company’s Japan, Thailand and Philippines defined benefit pension plans (the “Pension Plans”) are immaterial to the Condensed Consolidated Financial Statements. The expected long-term rate of return on the Pension Plans assets is 2.5%.
Obligations and Funded Status
The following table presents the unfunded status of the benefit obligations for the Pension Plans:
December 31, 2021
July 2, 2021
(in millions)
Benefit obligation at end of period
$
353
$
359
Fair value of plan assets at end of period
223
227
Unfunded status
$
130
$
132
The following table presents the unfunded amounts related to the Pension Plans as recognized on the Company’s Condensed Consolidated Balance Sheets:
December 31, 2021
July 2, 2021
(in millions)
Current liabilities
$
1
$
1
Non-current liabilities
129
131
Net amount recognized
$
130
$
132
Net periodic benefit costs were not material for the three and six months ended December 31, 2021.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 10. Related Parties and Related Commitments and Contingencies
Flash Ventures
The Company’s business ventures with Kioxia Corporation (“Kioxia”) consist of three separate legal entities: Flash Partners Ltd. (“Flash Partners”), Flash Alliance Ltd. (“Flash Alliance”), and Flash Forward Ltd. (“Flash Forward”), collectively referred to as “Flash Ventures”.
The following table presents the notes receivable from, and equity investments in, Flash Ventures as of December 31, 2021 and July 2, 2021:
December 31, 2021
July 2, 2021
(in millions)
Notes receivable, Flash Partners
$
92
$
191
Notes receivable, Flash Alliance
161
213
Notes receivable, Flash Forward
694
561
Investment in Flash Partners
194
199
Investment in Flash Alliance
284
293
Investment in Flash Forward
128
129
Total notes receivable and investments in Flash Ventures
$
1,553
$
1,586
During the three and six months ended December 31, 2021 and during the three and six months ended January 1, 2021, the Company made net payments to Flash Ventures of $1.11 billion and $2.30 billion, and $1.21 billion and $2.19 billion, respectively, for purchased flash-based memory wafers and net loans.
The Company makes, or will make, loans to Flash Ventures to fund equipment investments for new process technologies and additional wafer capacity. The Company aggregates its Flash Ventures’ notes receivable into one class of financing receivables due to the similar ownership interest and common structure in each Flash Venture entity. For all reporting periods presented, no loans were past due and no loan impairments were recorded. The Company’s notes receivable from each Flash Ventures entity, denominated in Japanese yen, are secured by equipment owned by that Flash Ventures entity.
As of December 31, 2021 and July 2, 2021, the Company had Accounts payable balances due to Flash Ventures of $389 million and $398 million, respectively.
The Company’s maximum reasonably estimable loss exposure (excluding lost profits) as a result of its involvement with Flash Ventures, based upon the Japanese yen to U.S. dollar exchange rate at December 31, 2021, is presented below. Investments in Flash Ventures are denominated in Japanese yen, and the maximum estimable loss exposure excludes any cumulative translation adjustment due to revaluation from the Japanese yen to the U.S. dollar.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The Company is obligated to pay for variable costs incurred in producing its share of Flash Ventures’ flash-based memory wafer supply, based on its three-month forecast, which generally equals 50% of Flash Ventures’ output. In addition, the Company is obligated to pay for half of Flash Ventures’ fixed costs regardless of the output the Company chooses to purchase. The Company is not able to estimate its total wafer purchase commitment obligation beyond its rolling three-month purchase commitment because the price is determined by reference to the future cost of producing the semiconductor wafers. In addition, the Company is committed to fund 49.9% to 50.0% of each Flash Ventures entity’s capital investments to the extent that each Flash Ventures entity’s operating cash flow is insufficient to fund these investments.
In June 2019, an unexpected power outage incident occurred at the flash-based memory manufacturing facilities operated in Yokkaichi, Japan. The power outage incident impacted the facilities and process tools and resulted in damage to flash wafers in production and a reduction in the Company’s flash wafer availability. During the three and six months ended January 1, 2021, the Company recovered $45 million and $75 million, respectively, related to this incident from its insurance carriers, which was recorded in Cost of revenue.
Inventory Purchase Commitments with Flash Ventures. Purchase orders placed under Flash Ventures for up to three months are binding and cannot be canceled.
Research and Development Activities. The Company participates in common research and development (“R&D”) activities with Kioxia and is contractually committed to a minimum funding level. R&D commitments are immaterial to the Condensed Consolidated Financial Statements.
Off-Balance Sheet Liabilities
Flash Ventures sells to and leases back from a consortium of financial institutions a portion of its tools and has entered into equipment lease agreements of which the Company guarantees half or all of the outstanding obligations under each lease agreement. The lease agreements are subject to customary covenants and cancellation events related to Flash Ventures and each of the guarantors. The occurrence of a cancellation event could result in an acceleration of Flash Ventures’ obligations and a call on the Company’s guarantees.
The following table presents the Company’s portion of the remaining guarantee obligations under the Flash Ventures’ lease facilities in both Japanese yen and U.S. dollar-equivalent, based upon the Japanese yen to U.S. dollar exchange rate as of December 31, 2021.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following table details the breakdown of the Company’s remaining guarantee obligations between the principal amortization and the purchase option exercise price at the end of the term of the Flash Ventures lease agreements, in annual installments as of December 31, 2021 in U.S. dollars, based upon the Japanese yen to U.S. dollar exchange rate as of December 31, 2021:
Annual Installments
Payment of Principal Amortization
Purchase Option Exercise Price at Final Lease Terms
Guarantee Amount
(in millions)
Remaining six months of 2022
$
304
$
—
$
304
2023
507
63
570
2024
353
113
466
2025
161
103
264
2026
124
156
280
Thereafter
15
65
80
Total guarantee obligations
$
1,464
$
500
$
1,964
The Company and Kioxia have agreed to mutually contribute to, and indemnify each other and Flash Ventures for, environmental remediation costs or liability resulting from Flash Ventures’ manufacturing operations in certain circumstances. The Company has not made any indemnification payments, nor recorded any indemnification receivables, under any such agreements. As of December 31, 2021, no amounts have been accrued in the Condensed Consolidated Financial Statements with respect to these indemnification agreements.
Unis Venture
The Company has a joint venture with Unisplendour Corporation Limited and Unissoft (Wuxi) Group Co. Ltd. (“Unis”), referred to as the “Unis Venture”, to market and sell the Company’s products in China and to develop data storage systems for the Chinese market in the future. The Unis Venture is 49% owned by the Company and 51% owned by Unis. The Company accounts for its investment in the Unis Venture under the equity method of accounting. Revenue on products distributed by the Unis Venture is recognized upon sell through to third-party customers. For both the three and six months ended December 31, 2021, the Company recognized approximately 4% of its consolidated revenue on products distributed by the Unis Venture. For both the three and six months ended January 1, 2021, the Company recognized approximately 3% of its consolidated revenue on products distributed by the Unis Venture. The outstanding accounts receivable due from the Unis Venture were 7% and 6% of Accounts receivable, net as of December 31, 2021 and July 2, 2021, respectively.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 11. Leases and Other Commitments
Leases
The Company leases certain domestic and international facilities and data center space under long-term, non-cancelable operating leases that expire at various dates through 2034. These leases include no material variable or contingent lease payments. Operating lease assets and liabilities are recognized based on the present value of the remaining lease payments discounted using the Company’s incremental borrowing rate. Operating lease assets also include prepaid lease payments minus any lease incentives. Extension or termination options present in the Company’s lease agreements are included in determining the right-of-use asset and lease liability when it is reasonably certain the Company will exercise those options. Lease expense is recognized on a straight-line basis over the lease term. The following table summarizes supplemental balance sheet information related to operating leases as of December 31, 2021:
Lease Amounts
Minimum lease payments by fiscal year:
($ in millions)
Remaining six months of 2022
$
27
2023
47
2024
46
2025
43
2026
42
Thereafter
188
Total future minimum lease payments
393
Less: Imputed Interest
58
Present value of lease liabilities
335
Less: Current portion (included in Accrued expenses)
42
Long-term operating lease liabilities (included in Other liabilities)
$
293
Operating lease right-of-use assets (included in Other non-current assets)
$
318
Weighted average remaining lease term in years
8.7
Weighted average discount rate
3.4
%
The following table summarizes supplemental disclosures of operating cost and cash flow information related to operating leases:
Three Months Ended
Six Months Ended
December 31, 2021
January 1, 2021
December 31, 2021
January 1, 2021
(in millions)
Cost of operating leases
$
14
$
12
$
27
$
25
Cash paid for operating leases
12
14
24
26
Operating lease assets obtained in exchange for operating lease liabilities
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Purchase Agreements and Other Commitments
In the normal course of business, the Company enters into purchase orders with suppliers for the purchase of components used to manufacture its products. These purchase orders generally cover forecasted component supplies needed for production during the next quarter, are recorded as a liability upon receipt of the components, and generally may be changed or canceled at any time prior to shipment of the components. The Company also enters into long-term agreements with suppliers that contain fixed future commitments, which are contingent on certain conditions such as performance, quality and technology of the vendor’s components. As of December 31, 2021, the Company had the following minimum long-term commitments:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 12. Shareholders’ Equity
Stock-based Compensation Expense
The following tables present the Company’s stock-based compensation for equity-settled awards by type (i.e., stock options, restricted stock units (“RSUs”), restricted stock unit awards with performance conditions or market conditions (“PSUs”), and rights to purchase shares of common stock under the Company’s Employee Stock Purchase Plan (“ESPP”)) and financial statement line as well as the related tax benefit included in the Company’s Condensed Consolidated Statements of Operations:
Three Months Ended
Six Months Ended
December 31, 2021
January 1, 2021
December 31, 2021
January 1, 2021
(in millions)
RSUs and PSUs
$
78
$
72
$
145
$
139
ESPP
9
8
18
17
Total
$
87
$
80
$
163
$
156
Three Months Ended
Six Months Ended
December 31, 2021
January 1, 2021
December 31, 2021
January 1, 2021
(in millions)
Cost of revenue
$
14
$
15
$
23
$
27
Research and development
43
40
83
79
Selling, general and administrative
30
25
57
50
Subtotal
87
80
163
156
Tax benefit
(13)
(9)
(28)
(20)
Total
$
74
$
71
$
135
$
136
Windfall tax benefits and tax deficiencies for shortfalls related to the vesting and exercise of stock-based awards, which are recognized as a component of the Company’s Income tax expense, were not material for the periods presented.
Compensation cost related to unvested stock options, RSUs, PSUs, and rights to purchase shares of common stock under the ESPP will generally be amortized on a straight-line basis over the remaining average service period. The following table presents the unamortized compensation cost and weighted average service period of all unvested outstanding awards as of December 31, 2021:
Unamortized Compensation Costs
Weighted Average Service Period
(in millions)
(years)
RSUs and PSUs (1)
$
664
2.5
ESPP
81
1.7
Total unamortized compensation cost
$
745
(1) Weighted average service period assumes the performance metrics are met for the PSUs.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Plan Activities
Stock Options
The following table summarizes stock option activity under the Company’s incentive plans. All outstanding options were exercisable at December 31, 2021:
Number of Shares
Weighted Average Exercise Price Per Share
Weighted Average Remaining Contractual Life
Aggregate Intrinsic Value
(in millions)
(in years)
(in millions)
Options outstanding at July 2, 2021
1.5
$
72.84
1.2
$
15
Exercised
(0.1)
43.57
2
Canceled or expired
(0.4)
98.85
Options outstanding at December 31, 2021
1.0
66.15
1.0
9
RSUs and PSUs
The following table summarizes RSU and PSU activity under the Company’s incentive plans:
Number of Shares
Weighted Average Grant Date Fair Value
Aggregate Intrinsic Value at Vest Date
(in millions)
(in millions)
RSUs and PSUs outstanding at July 2, 2021
16.1
$
50.12
Granted
5.1
63.39
Vested
(4.6)
53.93
$
285
Forfeited
(1.2)
51.71
RSUs and PSUs outstanding at December 31, 2021
15.4
53.32
RSUs and PSUs are generally settled in an equal number of shares of the Company’s common stock at the time of vesting of the units.
Stock Repurchase Program
The Company’s Board of Directors has authorized a stock repurchase program for the repurchase of up to $5.00 billion of the Company’s common stock, which authorization is effective through July 25, 2023. The Company did not make any stock repurchases during the six months ended December 31, 2021 and has not repurchased any shares of its common stock pursuant to its stock repurchase program since the first quarter of fiscal 2019. The remaining amount available to be repurchased under the Company’s current stock repurchase program as of December 31, 2021 was $4.50 billion. Repurchases under the stock repurchase program may be made in the open market or in privately negotiated transactions and may be made under a Rule 10b5-1 plan. The Company expects stock repurchases to be funded principally by operating cash flows.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 13. Income Tax Expense
The Tax Cuts and Jobs Act (the “2017 Act”), enacted on December 22, 2017, includes a broad range of tax reform proposals affecting businesses. The Company completed its accounting for the tax effects of the enactment of the 2017 Act during the second quarter of fiscal 2019. However, the U.S. Treasury and the Internal Revenue Service (“IRS”) have issued tax guidance on certain provisions of the 2017 Act since the enactment date, and the Company anticipates the issuance of additional regulatory and interpretive guidance. The Company applied a reasonable interpretation of the 2017 Act along with the then-available guidance in finalizing its accounting for the tax effects of the 2017 Act. Any additional regulatory or interpretive guidance would constitute new information, which may require further refinements to the Company’s estimates in future periods.
The following table presents the Company’s Income tax expense and the effective tax rate:
Three Months Ended
Six Months Ended
December 31, 2021
January 1, 2021
December 31, 2021
January 1, 2021
($ in millions)
Income before taxes
$
646
$
85
$
1,350
$
82
Income tax expense
82
23
176
80
Effective tax rate
13
%
27
%
13
%
98
%
The primary drivers of the difference between the effective tax rate for the three and six months ended December 31, 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 2024 through 2031. In addition, the effective tax rate for the three and six months ended December 31, 2021 includes the discrete effect of an increase to unrecognized tax benefits as a result of ongoing discussions with various taxing authorities of $8 million and $25 million, respectively.
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, Philippines and Thailand. In addition, the effective tax rate for the six months ended January 1, 2021 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 certain deferred tax liabilities due to restructuring activities. The discrete items had no impact on the amount of income taxes paid by the Company.
As previously disclosed, the IRS issued statutory notices of deficiency with respect to adjustments relating to transfer pricing with the Company’s foreign subsidiaries and intercompany payable balances for fiscal years 2008 through 2012. The Company filed petitions with the U.S. Tax Court with respect to these notices. Through January 2022, the IRS has filed various Amendments to Answer with the U.S. Tax Court which (i) assert adjustments relating to transfer pricing with the Company’s foreign subsidiaries for fiscal years 2008 through 2012 that would result in additional federal income tax liabilities totaling approximately $1.26 billion for fiscal years 2008 through 2012, and (ii) assert penalties totaling $340 million on the proposed adjustments relating to transfer pricing with respect to fiscal years 2008 through 2012. In addition, the IRS proposed adjustments relating to transfer pricing with the Company’s foreign subsidiaries and intercompany payable balances for fiscal years 2013 through 2015 that, if sustained, would result in additional federal income tax liabilities totaling approximately $343 million for those fiscal years. In March 2021, the IRS asserted penalties totaling $109 million on the proposed adjustments relating to transfer pricing with respect to fiscal years 2013 through 2015. The Company disagrees with the proposed adjustments relating to transfer pricing and related penalties, and continues to believe that its tax positions are properly supported and will vigorously contest the position taken by the IRS. Also in March 2021, the Company and the IRS tentatively reached a basis for resolving the intercompany payable balances matter for all fiscal years at issue and the impact was not material to the Consolidated Financial Statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The Company believes that adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax examinations cannot be predicted with certainty. If any issues addressed in the Company’s tax examinations are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs. As of December 31, 2021, it was 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 the Company’s liability for unrecognized tax benefits would most likely result from additional information or settlements relating to the examination of the Company’s tax returns.
As of December 31, 2021, the liability for unrecognized tax benefits (excluding accrued interest and penalties) was approximately $772 million. Accrued interest and penalties related to unrecognized tax benefits as of December 31, 2021 was approximately $135 million. Of these amounts, approximately $772 million could result in potential cash payments. The Company is not able to provide a reasonable estimate of the timing of future tax payments related to these obligations.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 14. Net Income Per Common Share
The following table presents the computation of basic and diluted income per common share:
Three Months Ended
Six Months Ended
December 31, 2021
January 1, 2021
December 31, 2021
January 1, 2021
(in millions, except per share data)
Net income
$
564
$
62
$
1,174
$
2
Weighted average shares outstanding:
Basic
312
305
311
304
Employee stock options, RSUs, PSUs and ESPP
3
2
4
1
Basic and diluted
315
307
315
305
Income per common share:
Basic
$
1.81
$
0.20
$
3.77
$
0.01
Diluted
$
1.79
$
0.20
$
3.73
$
0.01
Anti-dilutive potential common shares excluded
5
8
3
10
The Company computes basic income per common share using Net income and the weighted average number of common shares outstanding during the period. Diluted income per common share is computed using Net income and the weighted average number of common shares and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares include dilutive outstanding employee stock options, RSUs and PSUs, and rights to purchase shares of common stock under the Company’s ESPP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 15. Employee Termination, Asset Impairment, and Other Charges
Business Realignment
The Company periodically incurs charges as part of the integration process of recent acquisitions and to realign its operations with anticipated market demand, primarily consisting of organization rationalization designed to streamline its business, reduce its cost structure and focus its resources. The Company recorded the following charges related to these actions:
Three Months Ended
Six Months Ended
December 31, 2021
January 1, 2021
December 31, 2021
January 1, 2021
(in millions)
Employee termination benefits
$
3
$
2
$
18
$
25
Asset impairments and losses (gains) on disposal of assets
(1)
—
2
—
Total employee termination, asset impairment, and other charges
$
2
$
2
$
20
$
25
The following table presents an analysis of the components of these activities against the reserve during the six months ended December 31, 2021:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 16. Legal Proceedings
Tax
For disclosures regarding statutory notices of deficiency issued by the IRS on June 28, 2018 and December 10, 2018, petitions filed by the Company with the U.S. Tax Court in September 2018 and March 2019, additional penalties asserted by the IRS in March 2021 and a tentative resolution with respect to certain matters, see Note 13, Income Tax Expense.
Other Matters
In the normal course of business, the Company is subject to legal proceedings, lawsuits and other claims. Although the ultimate aggregate amount of probable monetary liability or financial impact with respect to these other matters is subject to many uncertainties, management believes that any monetary liability or financial impact to the Company from these matters, individually and in the aggregate, would not be material to the Company’s financial condition, results of operations or cash flows. However, any monetary liability and financial impact to the Company from these matters could differ materially from the Company’s expectations.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 10‑K for the fiscal year ended July 2, 2021. 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 to Western 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 information technology (“IT”) and the infrastructure that enables the proliferation of data in virtually every industry. We create environments for data to thrive. We are driving 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 fiscal year ends on the Friday nearest to June 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 years 2022, which ends on July 1, 2022, and 2021, which ended on July 2, 2021, are each comprised of 52 weeks, with all quarters presented consisting of 13 weeks.
Key Developments
Financing Activities
In the second quarter of fiscal 2022, we continued to execute on our commitment to reduce our overall debt levels and fully repaid our Term Loan B-4. In December 2021, Fitch Ratings, Inc. raised our Company credit rating to investment grade. We then initiated a series of transactions to further reduce our debt levels and better stagger the maturities of our debt. In December 2021, we issued $500 million aggregate principal amount of 2.850% senior unsecured notes due February 1, 2029 (the “2029 Notes”) and issued $500 million aggregate principal amount of 3.100% senior unsecured notes due February 1, 2032 (the “2032 Notes”). We used the proceeds from these notes offerings and available cash to voluntarily repay $1.21 billion of our Term Loan A-1 and reduce its principal amount to $3.0 billion as of December 31, 2021. In January 2022, we amended and restated our existing loan agreement to provide for, among other things: (i) the issuance of a new $3.0 billion Term Loan A-2 maturing in January 2027 to replace our previously existing Term Loan A-1; (ii) the availability of a new $2.25 billion revolving credit facility maturing in January 2027 to replace our previously existing $2.25 billion revolving credit facility; and (iii) additional covenant flexibility and other modifications. Upon completion of these transactions, over 85% of the principal amount of our debt is now due in 2026 or later. We believe this new debt structure gives us greater financial stability and flexibility to manage our business over the longer term.
Additional information regarding our indebtedness, including the principal repayment terms, interest rates, covenants and other key terms of our outstanding indebtedness, is included in Part I, Item 1, Note 8, Debt, of the Notes to Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q and in Part II, Item 8, Note 6, Debt, of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended July 2, 2021.
Historically, our company had been managed and reported under a single operating segment. Late in the first quarter of fiscal 2021, the Chief Executive Officer, who is our Chief Operating Decision Maker, announced a decision to reorganize our business by forming two separate product business units: hard disk drives (“HDD”) and flash-based products (“Flash”). 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. To align with the new operating model and business structure, we made management organizational changes and implemented new reporting modules and processes to provide discrete information to manage the business. Effective July 3, 2021, management finalized its assessment of our operating segments and concluded that we now have two reportable segments: HDD and Flash.
Our broad portfolio of technology and products address multiple end markets. In the fiscal first quarter of 2022, we refined the end markets we report to be “Cloud”, “Client” and “Consumer”. Cloud represents a large and growing end market comprised primarily of products for public or private cloud environments and end customers, which we believe we are uniquely positioned to address as the only provider of both hard drive and flash products. Through the Client end market, we provide our original equipment manufacturer (“OEM”) and channel customers a broad array of high-performance flash and hard drive solutions across personal computer, mobile, gaming, automotive, virtual reality headsets, at-home entertainment, and industrial spaces. The Consumer end market is highlighted by our broad range of retail and other end-user products, which capitalize on the strength of our product brand recognition and vast points of presence around the world.
The discussion and analysis included under Results of Operations below reflects our new business unit structure and end markets discussed above.
COVID-19 Pandemic and Operational Update
As the ongoing COVID-19 pandemic has evolved, we have implemented and maintained more thorough sanitation practices as outlined by health organizations and supported vaccination efforts. As we begin to phase in a return to site for more employees, we are monitoring and adopting practices recommended by health organizations to ensure the continued safety of our employees and business partners. In addition, the responses to COVID-19 taken by others in the supply chain have increased the costs of their services which have in turn impacted our operations. We incurred incremental charges primarily related to logistics, absorption and other factory-related costs of approximately $70 million and $126 million, and $33 million and $61 million during the three and six months ended December 31, 2021 and January 1, 2021, respectively, which were recorded in Cost of revenue.
The technology hardware and semiconductor industries continued to face supply chain disruptions during the quarter that negatively impacted both our customers’ ability to ship products, and our ability to build products. In order to meet our end customers’ demand, we are incurring increased component costs in addition to COVID-related expenses, which we expect to weigh primarily on our hard drive gross margins through the first half of calendar year 2022. While these supply disruptions may continue for the near term, we ultimately expect that they will be transitory as demand for our products has remained solid during the COVID-19 pandemic, with work-from-home, distance learning, and at home entertainment driving demand for cloud environments, new devices, and retail products.
The COVID-19 environment remains dynamic and 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 negatively affect our business” and “We are dependent on a limited number of qualified suppliers who provide critical services, materials or components, and a disruption in our supply chain could negatively affect our business” in Part I, Item 1A, Risk Factors, of our Annual Report on Form 10-K for the fiscal year ended July 2, 2021 for more information regarding the risks we face as a result of the COVID-19 pandemic and supply chain disruptions.
Flash Ventures
In October 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 continue Flash Ventures investments into Y7 in due course.
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
December 31, 2021
January 1, 2021
$ Change
% Change
($ in millions)
Revenue, net
$
4,833
100.0
%
$
3,943
100.0
%
$
890
23
%
Cost of revenue
3,250
67.2
2,983
75.7
267
9
Gross profit
1,583
32.8
960
24.3
623
65
Operating Expenses:
Research and development
575
11.9
535
13.6
40
7
Selling, general and administrative
279
5.8
265
6.7
14
5
Employee termination, asset impairment, and other charges
The increases in consolidated net revenue for the three and six months ended December 31, 2021 from the comparable periods in the prior year reflect increases in exabytes of HDD and Flash sold as further discussed below. The revenue increases driven by exabyte growth were partially offset by declines in the average price per gigabyte of storage for both HDD and Flash as product mix shifted.
HDD revenue increased 16% for the three months ended December 31, 2021 from the comparable period in the prior year, primarily driven by a 27% increase in exabytes sold, partially offset by a decline in the average price per gigabyte as noted above. The increase in exabytes sold was due to continued demand for our latest generation energy assisted drives among our public and private cloud customers. The strong demand in Cloud was partly offset by a decline in HDD exabytes sold in our Client and Consumer end markets due to pressure in the commercial channel related to component issues impacting our customers’ ability to ship product and greater component sourcing constraints within our own operations, and customers transitioning to client SSD. HDD revenue increased 27% for the six months ended December 31, 2021 from the comparable period in the prior year, primarily driven by a 40% increase in exabytes sold, partially offset by a decline in the average price per gigabyte as noted above. The increase in exabytes for the six-month period was largely attributable to the same factors noted above for the three-month period.
Flash revenue increased 29% for the three months ended December 31, 2021 from the comparable period in the prior year, primarily driven by a 37% increase in exabytes sold, partially offset by a decline in the average price per gigabyte as noted above. The higher exabytes sold was due to strong demand in Cloud for our latest generation of enterprise SSD products and the ramp of new 5G-based mobile phones incorporating our latest BiCS5 flash solutions in the Client market. Higher volume was also driven by strong demand in gaming along with a growing brand recognition of WD_Black based products in our Consumer market. Flash revenue increased 24% for the six months ended December 31, 2021 from the comparable period in the prior year, primarily driven by a 33% increase in exabytes sold, partially offset by a decline in the average price per gigabyte as noted above. The increase in exabytes for the six-month period was largely attributable to the same factors noted above for the three-month period.
The increase in Cloud revenue for the three months ended December 31, 2021 from the comparable period in the prior year was led by demand for HDD capacity enterprise drives, including growth in our 18-terabyte capacity drives and enterprise SSDs, as we continued to ramp sales of our latest generation products. However, the supply chain disruptions previously noted contributed to a decline in exabyte shipments and a decline in revenues compared to the first quarter of fiscal 2022. In Client, the slight decrease in revenues for the three months ended December 31, 2021 from the comparable period in the prior year reflected declines in both client SSD and client HDD revenue, as a result of the supply chain disruptions noted previously, partially offset by the ramp of 5G phones. In Consumer, revenue for the three months ended December 31, 2021 was relatively flat with the comparable period in the prior year with a shift in mix from HDD to flash reflecting stronger demand in gaming along with a growing brand recognition of WD_Black.
The increase in Cloud revenue for the six months ended December 31, 2021 from the comparable period in the prior year primarily reflects the same drivers noted above for the three-month period. In Client, the slight increase in revenues for the six months ended December 31, 2021 from the comparable period in the prior year reflected growth in mobile (led by 5G growth), and growth in gaming, automotive, IOT, and industrial applications in the first quarter of fiscal 2022, partially offset by declines in both client SSD and client HDD revenue, as a result of the supply chain disruptions noted previously. In Consumer, the increase in revenue for the six months ended December 31, 2021 from the comparable period in the prior year primarily reflected stronger demand in gaming along with a growing brand recognition of WD_Black.
The changes in net revenue by geography for both the three and six months ended December 31, 2021 from the comparable periods in the prior year reflect routine variations in the mix of business.
Our top 10 customers accounted for 46% and 44% of our net revenue for the three and six months ended December 31, 2021, respectively, compared to 43% and 41% of our net revenue for the three and six months ended January 1, 2021, respectively. For each of the three and six months ended December 31, 2021 and January 1, 2021, 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. These programs represented 18% of gross revenues for both the three and six months ended December 31, 2021, and 20% and 19% of gross revenues for the three and six months ended January 1, 2021, respectively. Adjustments due to changes in accruals for these programs have generally averaged less than 1% of gross revenue year over year. 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.
We believe we have made significant progress in strengthening our product portfolio. We have qualified our enterprise SSD products at three cloud titans and two OEMs, and commenced commercial shipments of 20 terabyte hard drives based on OptiNAND technology. Additionally, we are seeing an increase in customer interest in adopting SMR technology and expect multiple cloud titans to deploy SMR drives in higher volume later in this calendar year. In client SSD, we plan to launch new products in the fiscal third quarter and enterprise SSD products later in the year, both based on BiCS5 technology. For our next generation 3D-flash, we began initial commercial shipment of consumer flash devices based on our 162-layer BiCS6. Furthermore, we qualified and commenced revenue shipment of client SSDs based on QLC and BiCS5 technology in the fiscal second quarter. While still early in its evolution, we believe our next generation BiCS6 node will play an important role in the adoption of QLC in the future. We expect these developments to contribute to further revenue growth as supply chain disruptions begin to abate.
Gross Profit and Gross Margin
Consolidated gross profit increased by $623 million for the three months ended December 31, 2021 from the comparable period in the prior year, which reflects the increase in revenue in both HDD and Flash and reduced costs as we ramped production on newer products, as well as an $83 million decrease in charges in the current period related to amortization expense on acquired intangible assets, some of which became fully amortized. Consolidated gross margin increased 8.5 percentage points for the three months ended December 31, 2021 from the comparable period in the prior year, which reflects cost reductions as we ramped production on newer products, the lower charges for amortization of acquired intangible assets noted above, and a shift in product mix to higher-margin flash drives. HDD and Flash gross margin increased by 5.0 and 9.0 percentage points year over year, respectively, reflecting cost reductions as we ramped production on newer products.
Consolidated gross profit increased by $1.38 billion for the six months ended December 31, 2021 from the comparable period in the prior year, which reflects the increase in revenue in both HDD and Flash, as well as a $189 million decrease in charges in the current period related to amortization expense on acquired intangible assets, some of which became fully amortized. Consolidated gross margin increased 9.2 percentage points for the six months ended December 31, 2021 from the comparable period in the prior year, which reflects higher gross margin in both HDD and Flash, the lower charges for amortization of acquired intangible assets noted above, and a shift in product mix to higher-margin flash drives. HDD and Flash gross margin increased by 4.9 and 9.8 percentage points year over year, respectively, reflecting cost reductions as we ramped production on newer products.
Operating Expenses
Research and development (“R&D”) expense increased $40 million for the three months ended December 31, 2021 from the comparable period in the prior year. The primary increases include approximately $20 million in employee compensation costs due to merit increases and increased headcount and approximately $10 million of higher engineering-related costs due to timing of projects. R&D expense increased $63 million for the six months ended December 31, 2021 from the comparable period in the prior year and primarily reflected higher employee compensation costs due to merit increases, increased headcount and higher variable compensation.
Selling, general and administrative (“SG&A”) expense increased $14 million for the three months ended December 31, 2021 from the comparable period in the prior year. The increase primarily reflected small increases in employee compensation costs due to merit increases as well as a small increase in professional services. SG&A expense increased $49 million for the six months ended December 31, 2021 from the comparable period in the prior year. The increase primarily reflected approximately $25 million related to higher professional services and approximately $20 million of higher employee compensation cost due to merit increases and higher variable compensation.
Employee termination, asset impairment and other charges were relatively flat for both the three and six month periods compared to the prior year and reflect minor actions taken in each period. For information regarding Employee termination, asset impairment and other charges, see Part I, Item 1, Note 15, Employee Termination, Asset Impairment, and Other Charges of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.
Total interest and other expense, net for the three and six months ended December 31, 2021 increased slightly compared to the prior year, reflecting higher foreign exchange losses partially offset by lower interest expense resulting from the pay-down of principal on our debt.
Income Tax Expense
The Tax Cuts and Jobs Act (the “2017 Act”) includes a broad range of tax reform proposals affecting businesses. We completed our accounting for the tax effects of the enactment of the 2017 Act during the second quarter of fiscal 2019. However, the U.S. Treasury and the Internal Revenue Service (“IRS”) have issued tax guidance on certain provisions of the 2017 Act since the enactment date, and we anticipate the issuance of additional regulatory and interpretive guidance. We applied a reasonable interpretation of the 2017 Act along with the then-available guidance in finalizing our accounting for the tax effects of the 2017 Act. Any additional regulatory or interpretive guidance would constitute new information, which may require further refinements to our estimates in future periods.
The following table sets forth income tax information from our Condensed Consolidated Statements of Operations by dollar and effective tax rate:
Three Months Ended
Six Months Ended
December 31, 2021
January 1, 2021
December 31, 2021
January 1, 2021
($ in millions)
Income before taxes
$
646
$
85
$
1,350
$
82
Income tax expense
82
23
176
80
Effective tax rate
13
%
27
%
13
%
98
%
The primary drivers of the difference between the effective tax rate for the three and six months ended December 31, 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 2024 through 2031. In addition, the effective tax rate for both the three and six months ended December 31, 2021 includes the discrete effect of an increase to unrecognized tax benefits as a result of ongoing discussions with various taxing authorities of $8 million and $25 million, respectively.
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, Philippines and Thailand. In addition, the effective tax rate for the three and six months ended January 1, 2021 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 certain deferred tax liabilities due to restructuring activities. The discrete items had no impact on the amount of income taxes paid.
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, see Part I, Item 1, Note 13, Income Tax Expense, of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.
The following table summarizes our statements of cash flows:
Six Months Ended
December 31, 2021
January 1, 2021
(in millions)
Net cash provided by (used in):
Operating activities
$
1,187
$
788
Investing activities
(569)
(436)
Financing activities
(1,456)
(450)
Effect of exchange rate changes on cash
(1)
6
Net decrease in cash and cash equivalents
$
(839)
$
(92)
We believe our cash, cash equivalents and cash generated from operations as well as our available credit facilities will be sufficient to meet our working capital, debt 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 I, Item 1A, Risk Factors, in our Annual Report on Form 10-K for the fiscal year ended July 2, 2021.
As further explained under Key Developments- Financing Activities above, we have taken recent actions to reduce our overall debt levels and extend the average maturity. Following these actions, we have reduced the outstanding principal amount of our debt by approximately $1.43 billion since October 1, 2021 and over 85% of the principal amount is now due in 2026 or later. We also have an existing a shelf registration statement (the “Shelf Registration Statement”) filed with the Securities and Exchange Commission that expires in August 2024, which allows us to offer and sell shares of common stock, preferred stock, warrants, and debt securities. We used the Shelf Registration Statement to complete our offering of $1.00 billion aggregate principal amount of senior unsecured notes in December 2021, and we may use the Shelf Registration Statement or other capital sources, including other offerings of equity or debt securities or the credit markets, to satisfy future financing needs, including planned or unanticipated capital expenditures, investments, debt repayments or other expenses. Any such additional financing will be subject to market conditions and may not be available on terms acceptable to us or at all.
During fiscal 2022, we expect expenditures for property, plant and equipment for our company plus our portion of the capital expenditures by our Flash Ventures joint venture with Kioxia for its operations to aggregate approximately $3.0 billion. After consideration of the Flash Ventures’ lease financing of its capital expenditures and net operating cash flow, we now expect net cash used for our purchases of property, plant and equipment and net activity in notes receivable relating to Flash Ventures to be a cash outflow of approximately $1.5 billion during fiscal 2022. The total expected cash to be used could vary depending on the timing and completion of various capital projects and the availability, timing and terms of related financing.
A total of $1.84 billion and $1.97 billion of our Cash and cash equivalents was held outside of the U.S. as of December 31, 2021 and January 1, 2021, respectively. There are no material tax consequences that were not previously accrued for on the repatriation of this cash.
Cash flow from operating activities primarily consists of net income, adjusted for non-cash charges, plus or minus changes in operating assets and liabilities. This represents our principal source of cash. Net cash used for changes in operating assets and liabilities was $715 million for the six months ended December 31, 2021, as compared to $78 million for the six months ended January 1, 2021. Changes in our operating assets and liabilities are largely affected by our working capital requirements, which are dependent on the effective management of our cash conversion cycle as well as timing of payments for taxes. Our cash conversion cycle measures how quickly we can convert our products into cash through sales. The cash conversion cycles were as follows (in days):
Three Months Ended
December 31, 2021
January 1, 2021
Days sales outstanding
52
42
Days in inventory
102
109
Days payables outstanding
(68)
(71)
Cash conversion cycle
86
80
Changes in days sales outstanding (“DSO”) are generally due to the timing of shipments. Changes in days in inventory (“DIO”) are generally related to the timing of inventory builds and staging of inventory to meet expected future demand. Changes in days payables outstanding (“DPO”) are generally related to production volume and the timing of purchases during the period. From time to time, we negotiate to modify the timing of payments to our vendors to manage our vendor relationships and to manage our cash flows, including our cash balances.
For the three months ended December 31, 2021, DSO increased by 10 days from the comparable period in the prior year, primarily reflecting the timing of shipments and customer collections. We have seen no significant deterioration in our receivables as a result of COVID-19. DIO and DPO decreased by 7 days and 3 days, respectively, from the comparable period in the prior year primarily reflecting improved supply chain management in the HDD business, as well as routine variations in the timing of purchases and payments during the period.
Investing Activities
Net cash used in investing activities for the six months ended December 31, 2021 primarily consisted of $551 million in capital expenditures and a $17 million net increase in notes receivable issuances to Flash Ventures to fund its capital expansion. Net cash used in investing activities for the six months ended January 1, 2021 primarily consisted of $576 million in capital expenditures, partially offset by a $94 million net decrease in notes receivable issuances to Flash Ventures to fund its capital expansion.
Our cash equivalents are primarily invested in money market funds that invest in U.S. Treasury securities and U.S. Government agency securities. In addition, from time to time, we also invest directly in certificates of deposit, asset backed securities and corporate and municipal notes and bonds.
Financing Activities
During the six months ended December 31, 2021, net cash used in financing activities primarily consisted of $2.43 billion for repayment of debt, which included $1.09 billion to voluntarily repay our Term Loan B-4 in full, scheduled principal payments of $126 million and a voluntary prepayment of $1.21 billion on our Term Loan A-1, as well as $80 million for taxes paid on vested stock awards under employee stock plans offset by net proceeds of $989 million from the issuance of new debt, which was used to fund a portion of the voluntary prepayment on Term Loan A-1, and $60 million from the issuance of stock under employee stock plans. Net cash used in financing activities for the six months ended months ended January 1, 2021 primarily consisted of $461 million for the repayment of our debt, which included a $300 million voluntary prepayment on our Term Loan B-4.
Other than the commitments related to Flash Ventures incurred in the normal course of business and certain indemnification provisions (see “Short and Long-term Liquidity-Contractual Obligations and Commitments” below), we do not have any other material off-balance sheet financing arrangements or liabilities, guarantee contracts, retained or contingent interests in transferred assets, or any other obligation arising out of a material variable interest in an unconsolidated entity. We do not have any majority-owned subsidiaries that are not included in the Condensed Consolidated Financial Statements. Additionally, with the exception of Flash Ventures and our joint venture with Unisplendour Corporation Limited and Unissoft (Wuxi) Group Co. Ltd., we do not have an interest in, or relationships with, any variable interest entities. For additional information regarding our off-balance sheet arrangements, see Part I, Item 1, Note 10, Related Parties and Related Commitments and Contingencies, of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.
The following is a summary of our known contractual cash obligations and commercial commitments as of December 31, 2021:
Total
Remaining six months of 2022
2023-2024
2025-2026
Beyond 2026
(in millions)
Long-term debt, including current portion(1)
$
7,400
$
126
$
3,974
$
2,300
$
1,000
Interest on debt
831
103
376
278
74
Flash Ventures related commitments(2)
6,049
2,105
2,587
1,136
221
Operating leases
393
27
93
85
188
Purchase obligations and other commitments
3,770
2,215
1,217
168
170
Mandatory Deemed Repatriation Tax
819
—
284
535
—
Total
$
19,262
$
4,576
$
8,531
$
4,502
$
1,653
(1)Principal portion of debt, excluding discounts and issuance costs.
(2)Includes reimbursement for depreciation and lease payments on owned and committed equipment, funding commitments for loans and equity investments and payments for other committed expenses, including R&D and building depreciation. Funding commitments assume no additional operating lease guarantees. Additional operating lease guarantees can reduce funding commitments.
Debt
Following the transactions described under Key Developments- Financing Activities, we have outstanding $3.3 billion aggregate principal amount of senior unsecured notes with maturities between 2026 and 2032, $3.0 billion principal amount of a new Term Loan A-2 that will mature in January 2027 and $1.1 billion of 1.5% convertible notes due 2024. In addition to our existing debt, we have $2.25 billion available for borrowing under our revolving credit facility until January 2027, subject to customary conditions under the loan agreement. See Key Developments- Financing Activities above for further information. Additional information regarding our indebtedness, including information about availability under our revolving credit facility and the principal repayment terms, interest rates, covenants and other key terms of our outstanding indebtedness, is included in Part I, Item 1, Note 8, Debt, of the Notes to Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q and in Part II, Item 8, Note 6, Debt, of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended July 2, 2021.
We may issue additional debt securities in the future that may be guaranteed by our 100% owned domestic subsidiary, Western Digital Technologies, Inc. (“Guarantor” and, together with Western Digital Corporation, the “Obligor Group”). Such guarantees may be full and unconditional, joint and several, on a secured or unsecured, subordinated or unsubordinated basis, and may be subject to certain customary guarantor release conditions. We conduct operations almost entirely through our subsidiaries. Accordingly, the Obligor Group’s cash flow and ability to service any guaranteed registered debt securities will depend on the earnings of our subsidiaries and the distribution of those earnings to the Obligor Group, including the earnings of the non-guarantor subsidiaries, whether by dividends, loans or otherwise. Holders of such guaranteed registered debt securities would have a direct claim only against the Obligor Group.
The following tables include summarized financial information for the Obligor Group. The information for the Obligor Group is presented on combined basis, excluding intercompany balances and transactions between the Company and the Guarantor and excluding investments in and equity in the earnings of non-guarantor subsidiaries. The Obligor Group’s amounts due from, amounts due to, and transactions with non-guarantor subsidiaries have been presented in separate line items in the tables below.
The assets and liabilities of the Obligor Group include the following:
December 31, 2021
July 2, 2021
(in millions)
Current assets (excluding net intercompany receivable from non-guarantor subsidiaries)
$
2,429
$
2,898
Non-current assets
1,848
1,903
Net intercompany payable to non-guarantor subsidiaries
1,110
463
Current liabilities
2,379
2,325
Non-current liabilities
8,289
9,726
The operating results and transactions with non-guarantor subsidiaries of the Obligor Group include the following:
Six Months Ended
Year Ended
December 31, 2021
July 2, 2021
(in millions)
Net sales
$
4,253
$
12,378
Gross profit
1,124
1,861
Operating income
77
142
Net income (loss)
(15)
377
Intercompany revenue
1,234
5,190
Net intercompany interest expense (income)
(22)
23
Intercompany dividends
105
528
Flash Ventures
Flash Ventures sells to and leases back from a consortium of financial institutions a portion of its tools and has entered into equipment lease agreements of which we guarantee half or all of the outstanding obligations under each lease agreement. The leases are subject to customary covenants and cancellation events that relate to Flash Ventures and each of the guarantors. The occurrence of a cancellation event could result in an acceleration of the lease obligations and a call on our guarantees. As of December 31, 2021, we were in compliance with all covenants under these Japanese lease facilities. See Part I, Item 1, Note 10, Related Parties and Related Commitments and Contingencies, of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for information regarding Flash Ventures.
In the normal course of business, we enter into purchase orders with suppliers for the purchase of components used to manufacture our products. These purchase orders generally cover forecasted component supplies needed for production during the next quarter, are recorded as a liability upon receipt of the components, and generally may be changed or canceled at any time prior to shipment of the components. We also enter into long-term agreements with suppliers that contain fixed future commitments, which are contingent on certain conditions such as performance, quality and technology of the vendor’s components. These arrangements are included under “Purchase obligations and other commitments” in the table above.
Mandatory Deemed Repatriation Tax
The following is a summary of our estimated mandatory deemed repatriation tax obligations that are payable in the following fiscal years (in millions):
December 31, 2021
2023
$
106
2024
178
2025
238
2026
297
Total
$
819
For additional information regarding our estimate of the total tax liability for the mandatory deemed repatriation tax, see Part II, Item 8, Note 14, Income Tax Expense, of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended July 2, 2021.
Unrecognized Tax Benefits
As of December 31, 2021, the liability for unrecognized tax benefits (excluding accrued interest and penalties) was approximately $772 million. Accrued interest and penalties related to unrecognized tax benefits as of December 31, 2021 was approximately $135 million. Of these amounts, approximately $772 million could result in potential cash payments. We are not able to provide a reasonable estimate of the timing of future tax payments related to these obligations.
Foreign Exchange Contracts
We purchase foreign exchange contracts to hedge the impact of foreign currency fluctuations on certain underlying assets, liabilities and commitments for Operating expenses and product costs denominated in foreign currencies. For a description of our current foreign exchange contract commitments, see Part I, Item 1, Note 7, Derivative Instruments and Hedging Activities, of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.
Indemnifications
In the ordinary course of business, we may provide indemnifications of varying scope and terms to customers, vendors, lessors, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of our breach of agreements, products or services to be provided by us, environmental compliance or from intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and certain of our officers that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. We maintain director and officer insurance, which may cover certain liabilities arising from our obligation to indemnify our directors and officers in certain circumstances.
It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Such indemnification agreements may not be subject to maximum loss clauses. Historically, we have not incurred material costs as a result of obligations under these agreements.
Our Board of Directors has authorized a stock repurchase program for the repurchase of up to $5.0 billion of our common stock, which authorization is effective through July 25, 2023. We did not make any stock repurchases during the six months ended December 31, 2021 and have not repurchased any shares of our common stock pursuant to our stock repurchase program since the first quarter of fiscal 2019. Although we will reevaluate the repurchasing of our common stock when appropriate, there can be no assurance if, when or at what level we may resume such activity. The remaining amount available to be repurchased under our current stock repurchase program as of December 31, 2021 was $4.50 billion. Repurchases under the stock repurchase program may be made in the open market or in privately negotiated transactions and may be made under a Rule 10b5-1 plan.
Recent Accounting Pronouncements
For a description of recently issued and adopted accounting pronouncements, including the respective dates of adoption and expected effects on our results of operations and financial condition, see Part I, Item 1, Note 2, Recent Accounting Pronouncements, of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.
Critical Accounting Policies and Estimates
We have prepared the accompanying unaudited Condensed Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States (U.S. GAAP). The preparation of the financial statements requires the use of judgments and estimates that affect the reported amounts of revenues, expenses, assets, liabilities and shareholders’ equity. We have adopted accounting policies and practices that are generally accepted in the industry in which we operate. If these estimates differ significantly from actual results, the impact to the Condensed Consolidated Financial Statements may be material.
There have been no material changes in our critical accounting policies and estimates from those disclosed in our Annual Report on Form 10‑K for the fiscal year ended July 2, 2021. Please refer to Part II, Item 7 of our Annual Report on Form 10‑K for the fiscal year ended July 2, 2021 for a discussion of our critical accounting policies and estimates.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Except as disclosed below, there have been no material changes to our market risk during the three months ended December 31, 2021. See Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risks in our Annual Report on Form 10-K for the fiscal year ended July 2, 2021 for further information about our exposure to market risk.
Foreign Currency Risk
We performed sensitivity analyses as of December 31, 2021 and July 2, 2021 using a modeling technique that measures the change in the fair values arising from a hypothetical 10% adverse movement in the levels of foreign currency exchange rates relative to the U.S. dollar, with all other variables held constant. The analyses cover all of our foreign currency derivative contracts used to offset the underlying exposures. The foreign currency exchange rates used in performing the sensitivity analyses were based on market rates in effect at December 31, 2021 and July 2, 2021. The sensitivity analyses indicated that a hypothetical 10% adverse movement in foreign currency exchange rates relative to the U.S. dollar would result in a foreign exchange fair value loss of $294 million and $183 million at December 31, 2021 and July 2, 2021, respectively.
Interest Rate Risk
We have generally held a balance of fixed and variable rate debt. As of December 31, 2021, we had reduced the amount of variable rate debt to $3.0 billion from $5.43 billion as of July 2, 2021. As of December 31, 2021, a one percent increase in the variable rate of interest would increase annual interest expense by $30 million. We currently have pay-fixed interest rate swaps on $2.00 billion notional amount, which would help mitigate the impact of fluctuations in variable interest rates through February 2023.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15(b) promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, our disclosure controls and procedures were effective.
Changes in Internal Controls over Financial Reporting
There has been no change in our internal control over financial reporting during the second quarter of fiscal 2022 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
See Note 13, Income Tax Expense, of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for disclosures regarding statutory notices of deficiency issued by the IRS on June 28, 2018 and December 10, 2018, petitions filed by the Company with the U.S. Tax Court in September 2018 and March 2019, additional penalties asserted by the IRS in March 2021 and a tentative resolution with respect to certain matters.
Item 1A.Risk Factors
We have described under the heading “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended July 2, 2021 risks and uncertainties that could cause our actual results of operations and financial condition to vary materially from past, or from anticipated future, results of operations and financial condition. There have been no material changes from these risk factors previously described in our Annual Report on Form 10-K for the fiscal year ended July 2, 2021. These risks and uncertainties are not the only risks facing us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also adversely affect our business, financial condition, results of operations or the market price of our common stock.
Item 5. Other Information
Disclosure Pursuant to Section 13(r) of the Securities Exchange Act of 1934
On March 2, 2021, the U.S. government designated the Russian Federal Security Service (the “FSB”) as a blocked party under Executive Order 13382; however, on the same day, the U.S. Department of the Treasury’s Office of Foreign Assets Control issued General License No. 1B (the “OFAC General License”), which generally authorizes U.S. companies to engage in certain transactions and dealings with the FSB necessary and ordinarily incident to requesting or obtaining licenses, permits, certifications or notifications issued or registered by the FSB for the importation, distribution or use of information technology products in the Russian Federation.
In the normal course of business, as permitted and authorized by the OFAC General License, the Company or its subsidiaries file notifications with, or apply for import licenses and permits from, the FSB as required pursuant to Russian encryption product import controls for the purpose of enabling the Company or its subsidiaries or their channel partners to import and distribute certain products in the Russian Federation. There are no gross revenues or net profits directly associated with these activities, and the Company and its subsidiaries do not distribute or sell products or provide services to the FSB. The Company expects that we or our subsidiaries will continue to file notifications with and apply for import licenses and permits from the FSB to qualify our products for importation and distribution in the Russian Federation if and as permitted by applicable U.S. law, including the OFAC General License.
Entry into Separation Agreement
On February 1, 2022, we entered into a Separation and General Release Agreement with Robert K. Eulau, Executive Vice President and Chief Financial Officer (the “Separation Agreement”). Mr. Eulau has agreed to continue in an advisory capacity through May 1, 2022 to assist with the transition of his duties and responsibilities. Pursuant to the Separation Agreement, Mr. Eulau will receive the Tier I severance benefits to which he is entitled pursuant to the terms and conditions of our Amended and Restated Executive Severance Plan, the material terms of which have been previously disclosed and a copy previously filed with the SEC (the “Separation Benefits”). Mr. Eulau’s receipt of the Separation Benefits is subject to his non-revocation of a general release of claims included in the Separation Agreement and compliance with the terms of the Separation Agreement, including certain non-solicitation and cooperation provisions.
The exhibits listed in the Exhibit Index below are filed with, or incorporated by reference in, this Quarterly Report on Form 10-Q, as specified in the Exhibit List, from exhibits previously filed with the Securities and Exchange Commission. Certain agreements listed in the Exhibit Index that we have filed or incorporated by reference may contain representations and warranties by us or our subsidiaries. These representations and warranties have been made solely for the benefit of the other party or parties to such agreements and (i) may have been qualified by disclosures made to such other party or parties, (ii) were made only as of the date of such agreements or such other date(s) as may be specified in such agreements and are subject to more recent developments, which may not be fully reflected in our public disclosures, (iii) may reflect the allocation of risk among the parties to such agreements and (iv) may apply materiality standards different from what may be viewed as material to investors. Accordingly, these representations and warranties may not describe the actual state of affairs at the date hereof and should not be relied upon.
Amended and Restated Certificate of Incorporation of Western Digital Corporation, as amended to date (Filed as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q (File No. 1-08703) with the Securities and Exchange Commission on February 8, 2006)
Amended and Restated By-Laws of Western Digital Corporation, as amended effective as of February 10, 2021 (Filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K (File No. 1-08703) with the Securities and Exchange Commission on February 12, 2021)
Indenture, dated as of December 10, 2021, between Western Digital Corporation and U.S. Bank National Association, as trustee (Filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K (File No. 1-08703) with the Securities and Exchange Commission on December 10, 2021)
First Supplemental Indenture (including Form of 2.850% Senior Notes due 2029 and Form of 3.100% Senior Notes due 2032), dated as of December 10, 2021, between Western Digital Corporation and U.S. Bank National Association, as trustee (Filed as Exhibit 4.2 to the Company’s Current Report on Form 8-K (File No. 1-08703) with the Securities and Exchange Commission on December 10, 2021)
Western Digital Corporation 2021 Long-Term Incentive Plan, adopted as of August 18, 2021 (Filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K (File No. 1-08703) with the Securities and Exchange Commission on November 18, 2021)*
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002**
101.INS
XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
Cover Page Interactive Data File - formatted in Inline XBRL and contained in Exhibit 101
† Filed with this report.
* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to applicable rules of the Securities and Exchange Commission.
** Furnished with this report.
#As permitted by Regulation S-K, Item 601(b)(10)(iv) of the Securities Exchange Act of 1934, as amended, certain confidential portions of this exhibit have been redacted from the publicly filed document.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized.
WESTERN DIGITAL CORPORATION
By:
/s/ Gene Zamiska
Gene Zamiska
Senior Vice President, Global Accounting and Chief Accounting Officer
