Western Digital Beats, View Cautious

Zacks

Western Digital Corp. (WDC) posted second quarter 2013 adjusted earnings per share (EPS) of $2.09, comprehensively beating the Zacks Consensus Estimate of $1.82. The quarter’s result also increased 38.4% from the year-ago quarter. The Expected Surprise Prediction or ESP (Read: Zacks Earnings ESP: A Better Method) was +3.3%.

Revenues

Revenues during the quarter increased 91.7% year over year to $3.82 billion and came above the company’s guidance range and the Zacks Consensus Estimate of $3.68 billion. Hard drive shipments were 59.2 million units during the quarter, up from 28.5 million in the year-ago quarter. This was partially offset by average selling price (ASP) of $62.0, which decreased from $69.0 in the year-ago quarter. Sequentially, volume dropped but ASP remained flat. Industry-wide volume shipment decreased slightly due to inventory corrections at the original equipment manufacturers and distributors.

Western Digital recorded 61.0% of revenues from original equipment manufacturer (:OEM) sales (59.0% in the year-ago quarter); distribution channel sales were 24.0% of total revenue (25.0% in the year-ago quarter), while retail sales were 15.0% (16.0% in the year-ago quarter). The top 10 customers of the company constituted 45.0% of total revenue, down from 51.0% in the year-ago quarter.

Operating Results

Gross margin in the reported quarter was 27.7% versus 32.5% in the year-ago quarter.

Operating margin for the quarter was 12.5%, up from 8.1% reported in the year-ago quarter. Total operating expense increased 19.5% due to higher research and development (R&D) and selling, general and administrative (SG&A) expense, but partially offset by lower one-time expenses.

Net income for the quarter was $335.0 million or $1.36 per share, up from $145.0 million or 61 cents in the year-ago quarter. Excluding amortization of intangibles related to the acquisition of HGST, employee termination benefits and other charges, non-GAAP/adjusted net income was $513.0 million or $2.09 per share versus $358.0 million or $1.51 in the year ago quarter.

Balance Sheet & Cash Flow

The company generated $772.0 million in cash from operations in the second quarter, down from $936.0 million in the year-ago quarter. Cash and cash equivalents were $3.82 billion versus $3.54 billion in the previous quarter.

Capital spending and depreciation and amortization for the second quarter totaled $246.0 million and $382.0 million, respectively. The company’s debt balance of $2.13 billion remained flat sequentially.

The company’s conversion cycle was a positive 9 days. This consisted of 41 days of receivables, 40 days of inventory, or 9 turns, and 72 days payables.

Western Digital bought back 4.2 million shares worth $146.0 million. The board declared the second quarterly dividend of 25 cents per share, which was paid on Dec 26.

Guidance

Western Digital provided a cautious guidance for the third quarter of 2013, keeping in view the dampening macroeconomic environment and its adverse impact on near-term demand, slowing PC demand and normalizing hard disk drive supply. Hence, it expects the second half of calendar year 2013 to be better in comparison to a challenging first half. The company predicts a better second half considering new product launches, slow recovery in the macro environment and demand for high capacity storage devices.

Revenues are expected to be within a range of $3.55 billion to $3.65 billion and total operating expenses are expected to be $540.0 million. Total addressable market is expected to be flat to slightly down sequentially. Assuming a gross margin of 28.0%, tax rate of 7.0% and diluted shares outstanding of 244 million, Western Digital expects non-GAAP EPS in the range of $1.65–$1.80.

Our Take

The company’s second quarter results exceeded our expectations, with EPS and revenue beating the Zacks Consensus Estimates. Year-over-year comparisons were also encouraging but the results were down sequentially due to continued soft industry demand due to macroeconomic uncertainty, weak PC demand, and inventory rebalancing by the customers.

The benefits achieved from higher ASPs due to tight supply of hard disk drives (HDDs) resulting from disruption caused by the Thailand floods are exhausting. This is due to normalization of supply/demand metrics. This has been reflected in the company’s third quarter guidance, which is sequentially weak. But management brought in some comfort with its commentary of cost reduction and efficient execution.

We are also encouraged by Western Digital’s growing exposure in the small and medium business (SMB) space. Recently, the company expanded its SMB product suite. Increasing IT spending expected from the SMBs is a good sign and we believe that the company is well-positioned to capitalize on the opportunity.

Currently, Western Digital has a Zacks Rank #3 Rank (Hold). Its archrival Seagate Technology plc (STX), which is going to report its second quarter earnings on Jan 28, also has a Zacks Rank #3 with an ESP of +2.4%.

You can also consider other technology stocks that are going to report soon.

Geospace Technologies Corp.(GEOS) has a Zacks Rank #2 (Buy) with an ESP of +21.2%. Interdigital Inc. (IDCC) has a Zacks Rank #2 (Buy) with an ESP of +350.0%.

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Read the Full Research Report on IDCC

Read the Full Research Report on GEOS

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