Edgar Filing: WESTERN DIGITAL CORP

WDC-03/28/14-10Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 28, 2014



¨	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.)

3355 Michelson Drive, Suite 100 Irvine, California	92612
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (949) 672-7000

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 ý No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes ý No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer	ý	Accelerated filer	¨
Non-accelerated filer	¨ (Do not check if a smaller reporting company)	Smaller reporting company	¨

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 April 23, 2014, 235,068,588 shares of common stock, par value $.01 per share, were outstanding.

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WESTERN DIGITAL CORPORATION

INDEX



	PAGE NO.
PART I. FINANCIAL INFORMATION	3

Item 1. Financial Statements (unaudited)	3

Condensed Consolidated Balance Sheets — March 28, 2014 and June 28, 2013	3

Condensed Consolidated Statements of Income — Three and Nine Months Ended March 28, 2014 and March 29, 2013	4

Condensed Consolidated Statements of Comprehensive Income — Three and Nine Months Ended March 28, 2014 and March 29, 2013	5

Condensed Consolidated Statements of Cash Flows — Nine Months Ended March 28, 2014 and March 29, 2013	6

Notes to Condensed Consolidated Financial Statements	7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	23

Item 3. Quantitative and Qualitative Disclosures About Market Risk	33

Item 4. Controls and Procedures	34

PART II. OTHER INFORMATION	34

Item 1. Legal Proceedings	34

Item 1A. Risk Factors	35

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	51

Item 6. Exhibits	52

Our fiscal year ends on the Friday nearest to June 30 and typically consists of 52 weeks. Approximately every six years, we report a 53-week fiscal year to align our fiscal year with the foregoing policy. Our fiscal third quarters ended March 28, 2014 and March 29, 2013 both consisted of 13 weeks. Fiscal year 2013 was comprised of 52 weeks and ended on June 28, 2013. Fiscal year 2014 will be comprised of 52 weeks and will end on June 27, 2014. Fiscal year 2015 will be comprised of 53 weeks, with the first quarter consisting of 14 weeks and the second, third and fourth quarters consisting of 13 weeks each. 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 storage business, which operates under two independent subsidiaries – HGST and WD. Our principal executive offices are located at 3355 Michelson Drive, Suite 100, Irvine, California 92612. Our telephone number is (949) 672-7000 and our Web site is www.westerndigital.com. The information on our Web site is not incorporated in this Quarterly Report on Form 10-Q.

Western Digital, WD and the WD logo are trademarks of Western Digital Technologies, Inc. and/or its affiliates. All other trademarks mentioned are the property of their respective owners.

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PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

WESTERN DIGITAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in millions, except par values; unaudited)



	March 28, 2014			June 28, 2013
ASSETS
Current assets:
Cash and cash equivalents	$	4,569		$	4,309
Short-term investments	296			—
Accounts receivable, net	1,802			1,793
Inventories	1,277			1,188
Other current assets	362			308
Total current assets	8,306			7,598
Property, plant and equipment, net	3,406			3,700
Goodwill	2,558			1,954
Other intangible assets, net	539			605
Other non-current assets	523			179
Total assets	$	15,332		$	14,036
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,902		$	1,990
Accrued arbitration award	745			706
Accrued expenses	455			480
Accrued compensation	409			453
Accrued warranty	111			114
Current portion of long-term debt	125			230
Total current liabilities	3,747			3,973
Long-term debt	2,344			1,725
Other liabilities	473			445
Total liabilities	6,564			6,143
Commitments and contingencies (Notes 4 and 5)
Shareholders’ equity:
Preferred stock, $.01 par value; authorized — 5 shares; issued and outstanding — none	—			—
Common stock, $.01 par value; authorized — 450 shares; issued — 261 shares; outstanding — 235 and 237 shares, respectively	3			3
Additional paid-in capital	2,314			2,188
Accumulated other comprehensive loss	(4		)	(35		)
Retained earnings	7,845			6,749
Treasury stock — common shares at cost; 26 and 24 shares, respectively	(1,390		)	(1,012		)
Total shareholders’ equity	8,768			7,893
Total liabilities and shareholders’ equity	$	15,332		$	14,036

The accompanying notes are an integral part of these condensed consolidated financial statements.

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WESTERN DIGITAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(in millions, except per share amounts; unaudited)



	Three Months Ended						Nine Months Ended
	March 28, 2014			March 29, 2013			March 28, 2014			March 29, 2013
Revenue, net	$	3,703		$	3,764		$	11,479		$	11,623
Cost of revenue	2,643			2,703			8,190			8,310
Gross profit	1,060			1,061			3,289			3,313
Operating expenses:
Research and development	426			396			1,248			1,170
Selling, general and administrative	202			185			563			526
Charges related to arbitration award	13			—			39			—
Employee termination benefits and other charges	—			63			—			130
Total operating expenses	641			644			1,850			1,826
Operating income	419			417			1,439			1,487
Other income (expense):
Interest income	4			3			10			8
Interest and other expense	(17		)	(14		)	(44		)	(43		)
Total other expense, net	(13		)	(11		)	(34		)	(35		)
Income before income taxes	406			406			1,405			1,452
Income tax provision	31			15			105			207
Net income	$	375		$	391		$	1,300		$	1,245
Income per common share:
Basic	$	1.60		$	1.64		$	5.51		$	5.14
Diluted	$	1.55		$	1.60		$	5.37		$	5.02
Weighted average shares outstanding:
Basic	235			239			236			242
Diluted	242			245			242			248

The accompanying notes are an integral part of these condensed consolidated financial statements.

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WESTERN DIGITAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in millions; unaudited)



	Three Months Ended				Nine Months Ended
	March 28, 2014		March 29, 2013		March 28, 2014		March 29, 2013
Net income	$	375	$	391	$	1,300	$	1,245
Other comprehensive income (loss), net of tax:
Net unrealized gain on foreign exchange contracts	45		5		31		32
Net actuarial pension gain	—		6		—		7
Translation loss	—		—		—		(4		)
Other comprehensive income	45		11		31		35
Total comprehensive income	$	420	$	402	$	1,331	$	1,280

The accompanying notes are an integral part of these condensed consolidated financial statements.

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WESTERN DIGITAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions; unaudited)



	Nine Months Ended
	March 28, 2014			March 29, 2013
Cash flows from operating activities
Net income	$	1,300		$	1,245
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization	936			931
Stock-based compensation	125			107
Deferred income taxes	(66		)	59
Gain from insurance recovery	(65		)	—
Loss on disposal of assets	33			—
Non-cash portion of employee termination benefits and other charges	—			16
Other non-cash operating activities, net	21			—
Changes in:
Accounts receivable, net	12			665
Inventories	(50		)	13
Accounts payable	(106		)	(434		)
Accrued arbitration award	39			—
Accrued expenses	(19		)	(120		)
Accrued compensation	(44		)	3
Other assets and liabilities	(12		)	(50		)
Net cash provided by operating activities	2,104			2,435
Cash flows from investing activities
Purchases of property, plant and equipment	(467		)	(816		)
Acquisitions, net of cash acquired	(823		)	(1		)
Purchases of investments	(470		)	—
Other investing activities, net	4			(17		)
Net cash used in investing activities	(1,756		)	(834		)
Cash flows from financing activities
Issuance of stock under employee stock plans	125			123
Taxes paid on vested stock awards under employee stock plans	(27		)	(10		)
Excess tax benefits from employee stock plans	41			39
Repurchases of common stock	(544		)	(607		)
Dividends paid to shareholders	(189		)	(121		)
Proceeds from debt, net of issuance costs	2,992			—
Repayment of debt	(2,486		)	(173		)
Net cash used in financing activities	(88		)	(749		)
Net increase in cash and cash equivalents	260			852
Cash and cash equivalents, beginning of period	4,309			3,208
Cash and cash equivalents, end of period	$	4,569		$	4,060
Supplemental disclosure of cash flow information:
Cash paid for income taxes	$	138		$	122
Cash paid for interest	$	35		$	16
Supplemental disclosure of non-cash financing activities:
Accrual of cash dividend declared	$	71		$	60

The accompanying notes are an integral part of these condensed consolidated financial statements.

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WESTERN DIGITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Basis of Presentation

The accounting policies followed by Western Digital Corporation (the “Company”) are set forth in Part II, Item 8, Note 1 of the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended June 28, 2013. In the opinion of management, all adjustments necessary to fairly state the unaudited 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”). Certain prior year amounts have been reclassified to conform to the current year presentation. These unaudited 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 year ended June 28, 2013. The results of operations for interim periods are not necessarily indicative of results to be expected for the full year.

The Company acquired Virident Systems, Inc. ("Virident") on October 17, 2013, sTec, Inc. (“sTec”) on September 12, 2013, and VeloBit, Inc. ("VeloBit") on July 10, 2013. These acquisitions are further described in Note 11 below. In connection with the acquisitions, Virident, sTec and VeloBit became indirect wholly-owned subsidiaries of the Company. Virident, sTec and VeloBit’s results of operations since the dates of acquisition are included in the condensed consolidated financial statements.

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. However, actual results could differ materially from these estimates.

2. Supplemental Financial Statement Data

Inventories; Property, Plant and Equipment; and Other Intangible Assets



	March 28, 2014			June 28, 2013
	(in millions)
Inventories:
Raw materials and component parts	$	204		$	167
Work-in-process	519			575
Finished goods	554			446
Total inventories	$	1,277		$	1,188
Property, plant and equipment:
Property, plant and equipment	$	7,991		$	7,616
Accumulated depreciation	(4,585		)	(3,916		)
Property, plant and equipment, net	$	3,406		$	3,700
Other intangible assets:
Other intangible assets	$	1,016		$	948
Accumulated amortization	(477		)	(343		)
Other intangible assets, net	$	539		$	605

Warranty

The Company records an accrual for estimated warranty costs when revenue is recognized. The Company generally warrants its products for a period of one to five years. The warranty provision considers estimated product failure rates and trends, estimated replacement costs, estimated repair costs which include scrap costs, and estimated costs for customer compensatory claims related to product quality issues, if any. A statistical warranty tracking model is used to help prepare estimates and assist the Company in exercising judgment in determining the underlying estimates. The statistical tracking model captures specific detail on hard drive reliability, such as factory test data, historical field return rates, and costs to repair by product type. Management’s judgment is subject to a greater degree of subjectivity with respect to newly introduced products because of limited field experience with those products upon which to base warranty estimates. Management reviews the warranty accrual quarterly for products shipped in prior periods and which are still under warranty. Any changes in the estimates underlying the accrual may result in adjustments that impact current period gross profit and income. Such changes are generally a result of differences between forecasted and actual return rate experience and costs to repair. If actual product return trends, costs to repair

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returned products or costs of customer compensatory claims differ significantly from estimates, future results of operations could be materially affected. Changes in the warranty accrual were as follows (in millions):



	Three Months Ended						Nine Months Ended
	March 28, 2014			March 29, 2013			March 28, 2014			March 29, 2013
Warranty accrual, beginning of period	$	190		$	211		$	187		$	260
Warranty liability assumed as a result of acquisition (see Note 11)	—			—			4			—
Charges to operations	41			44			125			134
Utilization	(56		)	(56		)	(162		)	(167		)
Changes in estimate related to pre-existing warranties	(2		)	(7		)	19			(35		)
Warranty accrual, end of period	$	173		$	192		$	173		$	192

The long-term portion of the warranty accrual classified in other liabilities was $62 million at March 28, 2014 and $73 million at June 28, 2013.

Investments

The following table summarizes, by major type, the fair value and cost basis of the Company’s investments as of March 28, 2014 (in millions):



	Cost Basis		Unrealized Gains (Losses)		Fair Value
Available-for-sale securities:
U.S. Treasury securities	$	149	$	—	$	149
U.S. Government agency securities	98		—		98
Commercial paper	170		—		170
Other	53		—		53
Auction-rate securities	14		—		14
Total	$	484	$	—	$	484

Included in short-term investments					$	296
Included in other non-current assets					188
Total					$	484

The fair value of the Company’s investments classified as available-for-sale securities at March 28, 2014, by remaining contractual maturity were as follows (in millions):



	Cost Basis		Fair Value
Due in less than one year:	$	296	$	296
Due in one to five years:	188		188
Due thereafter:	—		—
Total	$	484	$	484

The Company determined no available-for-sale securities were other-than-temporarily impaired in the three and nine months ended March 28, 2014. For more information on the Company's available-for-sale securities, see Note 7 below.

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Other Comprehensive Income (Loss)

Other comprehensive income (loss) refers to revenue, expenses, gains and losses that are recorded as an element of shareholders’ equity but are excluded from net income. The Company’s other comprehensive income (loss) is comprised of unrealized gains and losses on foreign exchange contracts, foreign currency translation gains and losses, and actuarial gains and losses related to pensions. There were no unrealized gains or losses on the Company's available-for-sale securities in the nine months ended March 28, 2014. In addition, the income tax impact on components of other comprehensive income is immaterial for all periods presented.

The following table illustrates the changes in the balances of each component of accumulated other comprehensive income for the nine months ended March 28, 2014 (in millions):



	Actuarial Pension Gain (Loss)		Foreign Currency Translation Gain (Loss)		Unrealized Gain (Loss) on Foreign Exchange Contracts			Accumulated Other Comprehensive Income (Loss)
Balance at June 28, 2013	$	11	$	—	$	(46	)	$	(35	)
Other comprehensive income before reclassifications	—		—		29			29
Amounts reclassified from accumulated other comprehensive income	—		—		2			2
Net current-period other comprehensive income	—		—		31			31
Balance at March 28, 2014	$	11	$	—	$	(15	)	$	(4	)

The following table illustrates the changes in the balances of each component of accumulated other comprehensive income for the nine months ended March 29, 2013 (in millions):



	Actuarial Pension Gain (Loss)			Foreign Currency Translation Gain (Loss)			Unrealized Gain (Loss) on Foreign Exchange Contracts			Accumulated Other Comprehensive Income (Loss)
Balance at June 29, 2012	$	(3	)	$	4		$	(16	)	$	(15	)
Other comprehensive income before reclassifications	7			—			64			71
Amounts reclassified from accumulated other comprehensive income	—			(4		)	(32		)	(36		)
Net current-period other comprehensive income	7			(4		)	32			35
Balance at March 29, 2013	$	4		$	—		$	16		$	20

3. Income per Common Share

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 certain dilutive outstanding employee stock options, rights to purchase shares of common stock under the Company’s Employee Stock Purchase Plan (“ESPP”) and restricted stock unit awards (“RSUs”).

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The following table illustrates the computation of basic and diluted income per common share (in millions, except per share data):



	Three Months Ended				Nine Months Ended
	March 28, 2014		March 29, 2013		March 28, 2014		March 29, 2013
Net income	$	375	$	391	$	1,300	$	1,245
Weighted average shares outstanding:
Basic	235		239		236		242
Employee stock options and other	7		6		6		6
Diluted	242		245		242		248
Income per common share:
Basic	$	1.60	$	1.64	$	5.51	$	5.14
Diluted	$	1.55	$	1.60	$	5.37	$	5.02
Anti-dilutive potential common shares excluded*	2		4		1		3



*	For purposes of computing diluted income per common share, certain potentially dilutive securities have been excluded from the calculation because their effect would have been anti-dilutive.

4. Debt

On March 8, 2012 (the “HGST Closing Date”), the Company, in its capacity as the parent entity and guarantor, Western Digital Technologies, Inc. (“WDT”), a wholly owned subsidiary of the Company, and Western Digital Ireland, Ltd. (“WDI”), an indirect wholly owned subsidiary of the Company, entered into a five-year credit agreement (the “Prior Credit Facility”) with Bank of America, N.A., as administrative agent, swing line lender and letter of credit issuer, and certain other participating lenders. The Prior Credit Facility provided for $2.8 billion of unsecured loan facilities consisting of a $2.3 billion term loan facility and a $500 million revolving credit facility. On January 9, 2014 (the "Closing Date”), WDI used existing cash to repay the outstanding term loan balance of $1.8 billion under the Prior Credit Facility, and subsequently, on the Closing Date, the Company, WDT and WDI, entered into a new credit agreement with JPMorgan Chase Bank, N.A., as administrative agent, and the lenders party thereto (the "Credit Agreement"); WDT paid the outstanding revolving credit facility balance of $500 million under the Prior Credit Facility; and the Company terminated the Prior Credit Facility. In connection with the repayment of the Prior Credit Facility, $4 million of debt issuance costs associated with lenders that did not enter into the Credit Agreement were written off in the three months ended March 28, 2014, and are included within interest and other expense in the condensed consolidated statements of income. The Credit Agreement provides for $4.0 billion of unsecured loan facilities consisting of a $2.5 billion term loan facility to WDT and a $1.5 billion revolving credit facility to WDT and WDI (the “Borrowers”). The revolving credit facility includes a $100 million sublimit for letters of credit and a $50 million sublimit for swing line loans. Subject to certain conditions, a Borrower may elect to expand the credit facilities by, or obtain incremental term loans of, up to $1.0 billion if existing or new lenders provide additional term or revolving commitments. The loans under the Credit Agreement have a five-year term. The obligations of the Borrowers under the Credit Agreement are guaranteed by the Company and its material domestic subsidiaries, and the obligations of WDI under the Credit Agreement are also guaranteed by WDT.

As of March 28, 2014, no amounts were outstanding under the revolving credit facility and the term loan facility had an outstanding balance of $2.5 billion and a variable interest rate of 1.66%. The Company is required to make quarterly principal payments on the term loan facility totaling $31 million for the remainder of fiscal 2014, $125 million in fiscal 2015, $156 million in fiscal 2016, $219 million in fiscal 2017, $250 million in fiscal 2018 and the remaining balance of $1.7 billion in fiscal 2019.

The Credit Agreement requires the Company to comply with a leverage ratio and an interest coverage ratio calculated on a consolidated basis for the Company and its subsidiaries. In addition, the Credit Agreement contains customary covenants, including covenants that limit or restrict the Company’s and its subsidiaries’ ability to incur liens, incur indebtedness, make certain restricted payments, merge or consolidate and enter into certain speculative hedging arrangements, and customary events of default. As of March 28, 2014, the Company was in compliance with all covenants.

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5. Legal Proceedings

When the Company becomes aware of a claim or potential claim, the Company assesses the likelihood of any loss or exposure. The Company discloses information regarding each material claim where the likelihood of a loss contingency is probable or reasonably possible. If a loss contingency is probable and the amount of the loss can be reasonably estimated, the Company records an accrual for the loss. In such cases, there may be an exposure to potential loss in excess of the amount accrued. Where a loss is not probable but is reasonably possible or where a loss in excess of the amount accrued is reasonably possible, the Company discloses an estimate of the amount of the loss or range of possible losses for the claim if a reasonable estimate can be made, unless the amount of such reasonably possible losses is not material to the Company’s financial position, results of operations or cash flows. Unless otherwise stated below, for each of the matters described below, the Company has either recorded an accrual for losses that are probable and reasonably estimable or has determined that, while a loss is reasonably possible (including potential losses in excess of the amounts accrued by the Company), a reasonable estimate of the amount of loss or range of possible losses with respect to the claim or in excess of amounts already accrued by the Company cannot be made. The ability to predict the ultimate outcome of such matters involves judgments, estimates and inherent uncertainties. The actual outcome of such matters could differ materially from management’s estimates.

Solely for purposes of this footnote, “WD” refers to Western Digital Corporation or one or more of its subsidiaries excluding HGST prior to the HGST Closing Date. HGST refers to Hitachi Global Storage Technologies Holdings Pte. Ltd. or one or more of its subsidiaries as of the HGST Closing Date, and “the Company” refers to Western Digital Corporation and all of its subsidiaries on a consolidated basis including HGST.

Intellectual Property Litigation

On June 20, 2008, plaintiff Convolve, Inc. (“Convolve”) filed a complaint in the Eastern District of Texas against WD, HGST, and one other company alleging infringement of U.S. Patent Nos. 6,314,473 and 4,916,635. The complaint sought unspecified monetary damages and injunctive relief. On October 10, 2008, Convolve amended its complaint to allege infringement of only the ‘473 patent. The ‘473 patent allegedly relates to interface technology to select between certain modes of a disk drive’s operations relating to speed and noise. A trial in the matter began on July 18, 2011 and concluded on July 26, 2011 with a verdict against WD and HGST in an amount that is not material to the Company’s financial position, results of operations or cash flows, for which the Company previously recorded an accrual. WD and HGST have filed post-trial motions challenging the verdict. On January 17, 2014, the Court denied the Company’s motion for judgment as a matter of law on invalidity. The Company will evaluate its options for appeal after the Court rules on the remaining post-trial motions. The Company intends to continue to defend itself vigorously in this matter.

On December 7, 2009, plaintiff Nazomi Communications (“Nazomi”) filed a complaint in the Eastern District of Texas against WD and seven other companies alleging infringement of U.S. Patent Nos. 7,080,362 and 7,225,436. Nazomi dismissed the Eastern District of Texas suit after filing a similar complaint in the Central District of California on February 8, 2010. The case was subsequently transferred to the Northern District of California on October 14, 2010. The complaint seeks injunctive relief and unspecified monetary damages, fees and costs. The asserted patents allegedly relate to processor cores capable of Java hardware acceleration. In August 2012, the Court dismissed WD on summary judgment for non-infringement. Nazomi filed a notice of appeal on January 16, 2013. The Federal Circuit heard oral argument on the appeal on November 4, 2013 and affirmed the Court's grant of summary judgment of non-infringement on January 10, 2014. WD intends to continue to defend itself vigorously in this matter.

On August 1, 2011, plaintiff Guzik Technical Enterprises (“Guzik”) filed a complaint in the Northern District of California against WD and various of its subsidiaries alleging infringement of U.S. Patent Nos. 6,023,145 and 6,785,085, breach of contract and misappropriation of trade secrets. The complaint seeks injunctive relief and unspecified monetary damages, fees and costs. The patents asserted by Guzik allegedly relate to devices used to test hard disk drive heads and media. On November 30, 2013, WD entered into a settlement agreement for an amount that is not material to the Company’s financial position, results of operations or cash flows, for which the Company recorded an accrual in the three months ended December 27, 2013. Guzik is disputing the enforceability of the agreement and on December 27, 2013, WD filed a motion to enforce the agreement. The Court heard oral argument on WD’s motion on January 31, 2014. The Court granted WD’s motion to enforce the settlement agreement on March 21, 2014. WD intends to continue to defend itself vigorously in this matter.

On July 9, 2012, Siemens Aktiengesellschaft (“Siemens”) filed a complaint in German court against WD, Western Digital GmbH, and Digital River International, S.a.r.l. alleging patent infringement of European patent no. EP 674769, which claims an artificial antiferromagnetic (AAF) (aka, synthetic antiferromagnetic) structure for giant magneto-resistive (GMR) sensors. On March 14-15, 2013, Western Digital GmbH filed a response of non-infringement and also filed a separate nullity action. Siemens separately served WD on July 15, 2013. On March 25, 2014, Siemens filed an extension of the complaint including WDT as a defendant. On March 28, 2014, Siemens filed its response to WD’s noninfringement submission. WD’s rejoinder and WDT’s

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response to the extension of the complaint is due on June 27, 2014. Siemens will then have until September 5, 2014 to respond to WD’s submission. The oral hearing on infringement is scheduled for October 2, 2014. The oral hearing on the nullity action to challenge the validity of the patent is scheduled for February 3, 2015. WD intends to defend itself vigorously in this matter.

On September 5, 2013, plaintiff Lake Cherokee Hard Drive Technologies, LLC (“Lake Cherokee”) filed a complaint in the Eastern District of Texas against: Marvell Asia PTE, Ltd., Samsung Semiconductor, Inc., Seagate Tech. LLC, Seagate Tech. Int’l., Toshiba Corp., Toshiba Am. Elec. Components, Toshiba Am. Inf. Sys., Inc., Toshiba Am. Inf. Equip. (Philippines), Inc., and WDT alleging infringement of US Patent Nos. 5,844,738 and 5,978,162. Lake Cherokee alleges that WDT’s hard disk drive products that contain Marvell read channel systems-on-a-chip (SOCs) infringe its ’738 and ’162 patents. The complaint seeks unspecified monetary damages, fees and costs. WDT intends to defend itself vigorously in this matter.

On September 25, 2013, plaintiff Lake Cherokee filed a complaint in the Eastern District of Texas against: Marvell Semiconductor, Inc., Marvell Asia PTE, Ltd., Dell Inc., and WDT alleging infringement of US Patent No. 5,583,706. Lake Cherokee alleges that WDT’s hard disk drive products that contain Marvell read channel systems-on-a-chip (SOCs) infringe its ’706 patent. The complaint seeks an injunction, unspecified monetary damages, fees and costs. WDT intends to defend itself vigorously in this matter.

On September 9, 2013, plaintiff Garnet Digital, LLC ("Garnet Digital") filed a complaint in the Eastern District of Texas against WDT, alleging infringement of US Patent No. 5,379,421. Garnet Digital alleges that the WD TV Live product infringes the ’421 patent. The complaint seeks unspecified monetary damages, fees and costs. On January 21, 2014, WDT and Garnet Digital reached a settlement in this matter for an amount that was not material to the Company's financial position, results of operations or cash flows. On February 4, 2014, the United States District Court for the Eastern District of Texas issued an order that all claims against WD are dismissed with prejudice.

Seagate Matter

On October 4, 2006, plaintiff Seagate Technology LLC (“Seagate”) filed an action in the District Court of Hennepin County, Minnesota, naming as defendants WD and one of its now former employees previously employed by Seagate. The complaint in the action alleged claims based on supposed misappropriation of trade secrets and sought injunctive relief and unspecified monetary damages, fees and costs. On June 19, 2007, WD’s former employee filed a demand for arbitration with the American Arbitration Association. A motion to stay the litigation as against all defendants and to compel arbitration of all Seagate’s claims was granted on September 19, 2007. On September 23, 2010, Seagate filed a motion to amend its claims and add allegations based on the supposed misappropriation of additional confidential information, and the arbitrator granted Seagate’s motion. The arbitration hearing commenced on May 23, 2011 and concluded on July 11, 2011.

On November 18, 2011, the sole arbitrator ruled in favor of WD in connection with five of the eight alleged trade secrets at issue, based on evidence that such trade secrets were known publicly at the time the former employee joined WD. Based on a determination that the employee had fabricated evidence, the arbitrator then concluded that WD had to know of the fabrications. As a sanction, the arbitrator precluded any evidence or defense by WD disputing the validity, misappropriation, or use of the three remaining alleged trade secrets by WD, and entered judgment in favor of Seagate with respect to such trade secrets. Using an unjust enrichment theory of damages, the arbitrator issued an interim award against WD in the amount of $525 million plus pre-award interest at the Minnesota statutory rate of 10% per year. In his decision with respect to these three trade secrets, the arbitrator did not question the relevance, veracity or credibility of any of WD’s ten expert and fact witnesses (other than WD’s former employee), nor the authenticity of any other evidence WD presented. On January 23, 2012, the arbitrator issued a final award adding pre-award interest in the amount of $105.4 million for a total final award of $630.4 million. On January 23, 2012, WD filed a petition in the District Court of Hennepin County, Minnesota to have the final arbitration award vacated. A hearing on the petition to vacate was held on March 1, 2012.

On October 12, 2012, the District Court of Hennepin County, Minnesota vacated, in full, the $630.4 million final arbitration award. Specifically, the Court confirmed the arbitration award with respect to each of the five trade secret claims that WD and the former employee had won at the arbitration and vacated the arbitration award with respect to the three trade secret claims that WD and the former employee had lost at the arbitration. The Court ordered that a rehearing be held concerning those three alleged trade secret claims before a new arbitrator.

On October 30, 2012, Seagate initiated an appeal of the Court’s decision with the Minnesota Court of Appeals. On July 22, 2013, the Minnesota Court of Appeals reversed the District Court’s decision and remanded for entry of an order and judgment confirming the arbitration award. The Company strongly disagrees with the decision of the Court of Appeals and believes that the District Court’s decision was correct. On August 20, 2013, the Company filed a petition for review with the Minnesota Supreme Court and, on October 15, 2013, the Company was informed that the Minnesota Supreme Court granted the Company’s petition. The appeal before the Minnesota Supreme Court was fully briefed, and oral argument was held on February 5, 2014. The Company will continue to vigorously

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defend itself in this matter. In light of uncertainties with respect to this matter, the Company recorded an accrual of $681 million for this matter in its financial statements in the fourth quarter of fiscal 2013 and recorded additional interest totaling $13 million and $39 million in the three and nine months ended March 28, 2014, respectively, which is included within charges related to arbitration award in the condensed consolidated statements of income. This amount is in addition to the $25 million previously accrued in the fourth quarter of fiscal 2011. The total amount accrued of $745 million represents the amount of the final arbitration award, plus interest accrued on the initial arbitration award at the statutory rate of 10% from January 24, 2012 through March 28, 2014.

Other Matters

In the normal course of business, the Company is subject to other 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 and is therefore not predictable with assurance, management believes that any monetary liability or financial impact to the Company from these other matters, individually and in the aggregate, would not be material to the Company’s financial condition, results of operations or cash flows. However, there can be no assurance with respect to such result, and monetary liability or financial impact to the Company from these other matters could differ materially from those projected.

6. Income Taxes

The Company’s income tax provision for the three and nine months ended March 28, 2014 was $31 million and $105 million, respectively, as compared to $15 million and $207 million in the respective prior-year periods. The Company’s income tax provision for both the three and nine months ended March 29, 2013 reflected a tax benefit of $34 million as a result of the retroactive extension of the U.S. Federal research and experimentation tax credit (“R&D credit”) that was signed into law on January 2, 2013 as part of the American Taxpayer Relief Act of 2012. The R&D credit, which had previously expired on December 31, 2011, was extended through December 31, 2013. In addition, the Company recorded an $88 million charge to reduce its previously recognized California deferred tax assets in the nine months ended March 29, 2013 as a result of the enactment of California Proposition 39. The differences between the effective tax rate and the U.S. Federal statutory rate are primarily due to tax holidays in Malaysia, the Philippines, Singapore and Thailand that expire at various dates from 2014 through 2025 and the current year generation of income tax credits.

In the three months ended March 28, 2014, the Company recorded a net increase of $6 million in its liability for unrecognized tax benefits. In the nine months ended March 28, 2014, the Company recorded a net increase of $26 million in its liability for unrecognized tax benefits. In addition, the Company recorded a $9 million increase in its liability for unrecognized tax benefits related to the Virident and sTec acquisitions in the nine months ended March 28, 2014. As of March 28, 2014, the Company had a recorded liability for unrecognized tax benefits of approximately $275 million. Interest and penalties recognized on such amounts were not material to the condensed consolidated financial statements during the three and nine months ended March 28, 2014.

The Internal Revenue Service (“IRS”) previously completed its field examination of the Company’s federal income tax returns for fiscal years 2006 and 2007 and issued Revenue Agent Reports that proposed adjustments to income before income taxes of approximately $970 million primarily related to transfer pricing and intercompany payable balances. The Company disagreed with the proposed adjustments and filed a protest with the IRS Appeals Office. In June 2013, the Company reached an agreement with the IRS to resolve the transfer pricing issue. This agreement resulted in a decrease in the amount of net operating loss and tax credits realized, but did not have an impact on the Company’s consolidated statements of income. The proposed adjustment relating to intercompany payable balances for fiscal years 2006 and 2007 will be addressed in conjunction with the IRS’s examination of the Company’s fiscal years 2008 and 2009, which commenced in January 2012. In addition, in January 2012, the IRS commenced an examination of the 2007 fiscal period ended September 5, 2007 of Komag, Incorporated, which was acquired by the Company on September 5, 2007. In February 2013, the IRS commenced an examination of calendar years 2010 and 2011 of HGST, which was acquired by the Company on March 8, 2012.

The Company believes that adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in the Company’s tax audits 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 March 28, 2014, it is not possible to estimate the amount of change, if any, in the unrecognized tax benefits that is reasonably possible within the next twelve months. Any significant change in the amount of 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.

7. Fair Value Measurements

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.

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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 table presents information about the Company’s financial assets and liabilities that are measured at fair value on a recurring basis as of March 28, 2014, and indicates the fair value hierarchy of the valuation techniques utilized to determine such value (in millions):



	Fair Value Measurements at Reporting Date Using
	Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents:
Money market funds	$	894	$	—	$	—	$	894
U.S. Treasury securities	—		25		—		25
Commercial paper	—		1		—		1
Other	—		4		—		4
Total cash equivalents	894		30		—		924
Short-term investments:
U.S. Government agency securities	—		73		—		73
Commercial paper	—		170		—		170
Other	—		53		—		53
Total short-term investments	—		296		—		296
Long-term investments:
U.S. Treasury securities	—		149		—		149
U.S. Government agency securities	—		25		—		25
Auction-rate securities	—		—		14		14
Total long-term investments	—		174		14		188
Foreign exchange contracts	—		1		—		1
Total assets at fair value	$	894	$	501	$	14	$	1,409
Liabilities:
Foreign exchange contracts	$	—	$	21	$	—	$	21
Total liabilities at fair value	$	—	$	21	$	—	$	21

The following table presents information about the Company’s financial assets and liabilities that are measured at fair value on a recurring basis as of June 28, 2013, and indicates the fair value hierarchy of the valuation techniques utilized to determine such value (in millions):



	Fair Value Measurements at Reporting Date Using
	Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents:
Money market funds	$	1,227	$	—	$	—	$	1,227
Auction-rate securities	—		—		14		14
Total assets at fair value	$	1,227	$	—	$	14	$	1,241
Liabilities:
Foreign exchange contracts	$	—	$	57	$	—	$	57
Total liabilities at fair value	$	—	$	57	$	—	$	57

Money Market Funds. The Company’s money market funds are funds that invest in U.S. Treasury and U.S. Government Agency securities and are recorded within cash and cash equivalents in the condensed consolidated balance sheets. Money market funds are valued based on quoted market prices.

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Commercial Paper. The Company’s commercial paper securities are investments issued by corporations which are held in custody by a third party with original maturities of twelve months or less and are recorded within short-term investments in the condensed consolidated balance sheets. Commercial paper securities are valued using a market approach which is based on observable inputs including market interest rates from multiple pricing sources.

U.S. Government Agency Securities. The Company’s U.S. Government agency securities are investments in fixed income securities sponsored by the U.S. Government and are held in custody by a third party and recorded within short-term investments or long term other assets in the condensed consolidated balance sheets depending on their original maturities. U.S. Government agency securities are valued using a market approach which is based on observable inputs including market interest rates from multiple pricing sources.

U.S. Treasury Securities. The Company’s U.S. Treasury securities are direct obligations of the U.S. federal government, are held in custody by a third party and are recorded within cash and cash equivalents or long-term other assets in the condensed consolidated balance sheets depending on their original maturities. U.S. Treasury securities are valued using a market approach which is based on observable inputs including market interest rates from multiple pricing sources.

Other. The Company’s other investments include certificates of deposit and bank acceptances which are held in custody by a third party and recorded within cash and cash equivalents or short-term investments in the condensed consolidated balance sheets depending on their original maturities. Certificates of deposit are valued using fixed interest rates and bank acceptances are valued using a market approach which is based on observable inputs including market interest rates from multiple pricing sources.

Auction-Rate Securities. The Company’s auction-rate securities have maturity dates through 2050, are primarily backed by insurance products and are accounted for as available-for-sale securities. These investments are classified as long-term investments and recorded within other non-current assets in the condensed consolidated balance sheets. Auction-rate securities are valued by a third party using unobservable inputs including indicative bids on similar securities.

Foreign Exchange Contracts. The Company’s foreign exchange contracts are short-term contracts to hedge the Company’s foreign currency risk. Foreign exchange contracts are classified within other current assets and liabilities in the condensed consolidated balance sheets. For contracts that have a right of offset by its individual counterparties under master netting arrangements, the Company presents its foreign exchange contracts on a net basis by counterparty in the condensed consolidated balance sheets. For more information on the Company's foreign exchange contracts, see Note 8 below. Foreign exchange contracts are valued using an income approach that is based on a present value of future cash flows model. The market-based observable inputs for the model include forward rates and credit default swap rates.

In the three and nine months ended March 28, 2014, there were no transfers between levels and no changes in Level 3 financial assets measured on a recurring basis.

The carrying amounts of cash, accounts receivable, accounts payable and accrued expenses approximate fair value for all periods presented because of the short-term maturity of these assets and liabilities. The carrying amount of debt approximates fair value because of its variable interest rate.

8. Foreign Exchange Contracts

Although the majority of the Company’s transactions are in U.S. dollars, some transactions are based in various foreign currencies. The Company purchases short-term, foreign exchange contracts to hedge the impact of foreign currency exchange fluctuations on certain underlying assets, liabilities and commitments for operating expenses and product costs denominated in foreign currencies. The purpose of entering into these hedging transactions is to minimize the impact of foreign currency fluctuations on the Company’s results of operations. These contract maturity dates do not exceed 12 months. All foreign exchange contracts are for risk management purposes only. The Company does not purchase foreign exchange contracts for trading purposes. As of March 28, 2014, the Company had outstanding foreign exchange contracts with commercial banks for British Pound Sterling, Euro, Japanese Yen, Malaysian Ringgit, Philippine Peso, Singapore Dollar and Thai Baht, which were designated as either cash flow or fair value hedges.

If the derivative is designated as a cash flow hedge, the effective portion of the change in fair value of the derivative is initially deferred in other comprehensive income (loss), net of tax. These amounts are subsequently recognized into earnings when the underlying cash flow being hedged is recognized into earnings. Recognized gains and losses on foreign exchange contracts entered into for manufacturing-related activities are reported in cost of revenue and presented within cash flow from operations. Hedge effectiveness is measured by comparing the hedging instrument’s cumulative change in fair value from inception to maturity to the underlying exposure’s terminal value. The Company determined the ineffectiveness associated with its cash flow hedges to be immaterial to the condensed consolidated financial statements for the three and nine months ended March 28, 2014 and March 29, 2013.

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A change in the fair value of fair value hedges is recognized in earnings in the period incurred and is reported as a component of operating expenses. All fair value hedges were determined to be effective. The fair value and the changes in fair value on these contracts were immaterial to the condensed consolidated financial statements during the three and nine months ended March 28, 2014 and March 29, 2013.

As of March 28, 2014, the net amount of unrealized losses with respect to the Company’s foreign exchange contracts that is expected to be reclassified into earnings within the next 12 months was $15 million. In addition, as of March 28, 2014, the Company did not have any foreign exchange contracts with credit-risk-related contingent features. The Company opened $1.0 billion and $3.7 billion and closed $1.2 billion and $3.8 billion, in foreign exchange contracts in the three and nine months ended March 28, 2014, respectively. The Company opened $2.5 billion and $3.9 billion, and closed $1.4 billion and $3.3 billion, in foreign exchange contracts in the three and nine months ended March 29, 2013, respectively. The fair value and balance sheet location of such contracts were as follows (in millions):

Asset Derivatives

Liability Derivatives

March 28, 2014

June 28, 2013

March 28, 2014

June 28, 2013

Derivatives Designated as

Hedging Instruments

Balance Sheet
Location

Fair
Value

Balance Sheet
Location

Fair
Value

Balance Sheet
Location

Fair
Value

Balance Sheet
Location

Fair
Value

Foreign exchange contracts

Other current assets

—

Accrued expenses

The following table presents the gross amounts of the Company's derivative instruments, amounts offset due to master netting arrangements with the Company's various counterparties, and the net amounts recognized in the condensed consolidated balance sheet as of March 28, 2014 (in millions):



										Gross Amounts Not Offset in the Balance Sheet
Derivatives Designated as Hedging Instruments	Gross Amounts of Recognized Assets (Liabilities)			Gross Amounts Offset in the Balance Sheet			Net Amounts of Assets (Liabilities) Presented in the Balance Sheet			Financial Instruments		Cash Collateral Received or Pledged		Net Amount
Foreign exchange contracts
Financial assets	$	2		$	(1	)	$	1		$	—	$	—	$	1
Financial liabilities	(22		)	1			(21		)	—		—		(21		)
Total derivative instruments	$	(20	)	$	—		$	(20	)	$	—	$	—	$	(20	)



										Gross Amounts Not Offset in the Balance Sheet
Derivatives Designated as Hedging Instruments	Gross Amounts of Recognized Assets (Liabilities)			Gross Amounts Offset in the Balance Sheet			Net Amounts of Assets (Liabilities) Presented in the Balance Sheet			Financial Instruments		Cash Collateral Received or Pledged		Net Amount
Foreign exchange contracts
Financial assets	$	10		$	(10	)	$	—		$	—	$	—	$	—
Financial liabilities	(67		)	10			(57		)	—		—		(57		)
Total derivative instruments	$	(57	)	$	—		$	(57	)	$	—	$	—	$	(57	)

The impact on the condensed consolidated financial statements was as follows (in millions):



	Amount of Gain Recognized in Accumulated OCI on Derivatives								Location of Gain (Loss) Reclassified from Accumulated OCI into Income	Amount of Gain (Loss) Reclassified From Accumulated OCI into Income
Derivatives in Cash Flow Hedging Relationships	Three Months Ended		Nine Months Ended		Three Months Ended		Nine Months Ended			Three Months Ended			Nine Months Ended			Three Months Ended		Nine Months Ended
Derivatives in Cash Flow Hedging Relationships	March 28, 2014				March 29, 2013					March 28, 2014						March 29, 2013
Foreign exchange contracts	$	13	$	2	$	18	$	64	Cost of revenue	$	(32	)	$	(28	)	$	13	$	32

The total net realized transaction and foreign exchange contract currency gains and losses were not material to the condensed consolidated financial statements during the three and nine months ended March 28, 2014 and March 29, 2013.

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9. Stock-Based Compensation

In connection with the acquisition of Virident, the Company assumed all stock options that were outstanding and unvested as of the acquisition date. In connection with the acquisition of sTec, the Company assumed all of the unvested RSUs outstanding under sTec’s stock plans as of the acquisition date. In addition, the Company assumed all of the stock options outstanding under sTec’s stock plans as of the acquisition date with the exception of any unvested, unexercised and outstanding stock options that had an exercise price greater than the merger consideration as defined in the merger agreement. The assumed stock options and RSUs were converted into equivalent stock options and RSUs with respect to shares of the Company’s common stock using an equity award exchange ratio.

Stock-based Compensation Expense

During the three and nine months ended March 28, 2014, the Company recognized in expense $24 million and $69 million, respectively, for stock-based compensation related to the vesting of options issued under the Company’s stock plans and the ESPP, as compared to $21 million and $70 million in the respective prior-year periods. The tax benefit realized as a result of the aforementioned stock-based compensation expense was $6 million and $17 million in the three and nine months ended March 28, 2014, respectively, as compared to $6 million and $19 million in the three and nine months ended March 29, 2013, respectively. As of March 28, 2014, total compensation cost related to unvested stock options and ESPP rights issued to employees but not yet recognized was $137 million and will be amortized on a straight-line basis over a weighted average service period of approximately 2.3 years.

During the three and nine months ended March 28, 2014, the Company recognized in expense $17 million and $56 million, respectively, for stock-based compensation related to the vesting of awards of RSUs issued under the Company's stock plans, as compared to $15 million and $40 million in the respective prior-year periods. The tax benefit realized as a result of the aforementioned stock-based compensation expense was $5 million and $14 million in the three and nine months ended March 28, 2014, respectively, as compared to $4 million and $11 million in the three and nine months ended March 29, 2013. As of March 28, 2014, the aggregate unamortized fair value of all unvested RSUs was $107 million, which will be recognized on a straight-line basis over a weighted average vesting period of approximately 1.5 years. RSUs include performance stock unit awards (“PSUs”). The effect of PSUs was immaterial to the condensed consolidated financial statements in the three and nine months ended March 28, 2014 and March 29, 2013.

During the three and nine months ended March 28, 2014, the Company recognized in expense $11 million and $35 million, respectively, related to adjustments to market value as well as the vesting of stock appreciation rights (“SARs”), as compared to $12 million and $28 million in the respective prior-year periods. The tax benefit realized as a result of the aforementioned SARs expense was $2 million and $7 million in the three and nine months ended March 28, 2014, respectively, as compared to $3 million and $7 million in the three and nine months ended March 29, 2013, respectively. The SARs will be settled in cash upon exercise. As a result, the Company had a total liability of $75 million related to SARs included in accrued expenses in the condensed consolidated balance sheet as of March 28, 2014. In addition, as of March 28, 2014, total compensation cost related to unvested SARs issued to employees but not yet recognized was $1 million and will be recognized over the remainder of calendar 2014.

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Stock Option Activity

The following table summarizes stock option activity under the Company’s stock option plans (in millions, except per share amounts and remaining contractual lives):



	Number of Shares		Weighted Average Exercise Price Per Share		Weighted Average Remaining Contractual Life (in years)	Aggregate Intrinsic Value
Options outstanding at June 28, 2013	11.9		$	29.47
Granted	1.6		68.40
Assumed in acquisition	0.4		117.41
Exercised	(0.7	)	30.14
Canceled or expired	(0.1	)	29.93
Options outstanding at September 27, 2013	13.1		36.77
Assumed in acquisition	1.3		12.32
Exercised	(1.6	)	25.34
Canceled or expired	(0.3	)	76.28
Options outstanding at December 27, 2013	12.5		34.99
Exercised	(1.0	)	28.15
Canceled or expired	(0.1	)	60.21
Options outstanding at March 28, 2014	11.4		$	35.32	4.7	$	623
Exercisable at March 28, 2014	5.2		$	28.48	3.1	$	329
Vested and expected to vest after March 28, 2014	11.2		$	35.11	4.6	$	616

If an option has an exercise price that is less than the quoted price of the Company’s common stock at the particular time, the aggregate intrinsic value of that option at that time is calculated based on the difference between the exercise price of the underlying options and the quoted price of the Company’s common stock at that time. As of March 28, 2014, the Company had options outstanding to purchase an aggregate of 11.2 million shares with an exercise price below the quoted price of the Company’s stock on that date resulting in an aggregate intrinsic value of $623 million at that date. During the three and nine months ended March 28, 2014, the aggregate intrinsic value of options exercised under the Company’s stock option plans was $60 million and $164 million, respectively, determined as of the date of exercise, as compared to $41 million and $120 million in the respective prior-year periods.

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RSU Activity

The following table summarizes RSU activity under the Company's stock plans (in millions, except weighted average grant date fair value):



	Number of Shares		Weighted Average Grant-Date Fair Value
RSUs outstanding at June 28, 2013	3.6		$	35.82
Granted	1.3		68.41
Assumed in acquisition	0.2		62.73
Vested	(0.9	)	29.73
RSUs outstanding at September 27, 2013	4.2		48.39
Granted	0.1		74.54
Vested	(0.2	)	42.86
Forfeited	(0.1	)	46.19
RSUs outstanding at December 27, 2013	4.0		49.10
Vested	(0.1	)	44.57
RSUs outstanding at March 28, 2014	3.9		$	49.29
Expected to vest after March 28, 2014	3.7		$	49.02

The fair value of each RSU is the market price of the Company’s stock at the date of grant. RSUs are generally payable in an equal number of shares of the Company’s common stock at the time of vesting of the units. The grant-date fair value of the shares underlying the RSU awards at the date of grant was $93 million in the nine months ended March 28, 2014. These amounts are being recognized to expense over the corresponding vesting periods. The Company has assumed a forfeiture rate of 3.9% and 3.3% for the three and nine months ended March 28, 2014, respectively, based on a historical analysis indicating forfeitures for these types of awards.

SARs Activity

The share-based compensation liability for SARs is recognized for the portion of fair value for which service has been rendered at the reporting date. The share-based liability is remeasured at each reporting date, using a binomial option-pricing model, through the requisite service period. As of March 28, 2014, 0.9 million SARs were outstanding with a weighted average exercise price of $7.77. There were no SARs granted and all other SARs activity was immaterial to the condensed consolidated financial statements for the three and nine months ended March 28, 2014.

Fair Value Disclosure — Binomial Model

The fair value of stock options granted is estimated using a binomial option-pricing model. The binomial model requires the input of highly subjective assumptions. The Company uses historical data to estimate exercise, employee termination, and expected stock price volatility within the binomial model. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The fair value of stock options granted was estimated using the following weighted average assumptions:



	Three Months Ended		Nine Months Ended
	March 28, 2014	March 29, 2013	March 28, 2014	March 29, 2013
Suboptimal exercise factor	2.29	1.99	2.06	1.90
Range of risk-free interest rates	0.13% to 2.31%	0.14% to 1.24%	0.10% to 2.44%	0.14% to 1.24%
Range of expected stock price volatility	0.27 to 0.48	0.41 to 0.51	0.27 to 0.50	0.41 to 0.53
Weighted average expected volatility	0.39	0.46	0.43	0.49
Post-vesting termination rate	3.29%	2.92%	3.09%	2.14%
Dividend yield	1.34%	1.99%	1.57%	2.41%
Fair value	$28.78	$17.31	$24.06	$15.67

The weighted average expected term of the Company’s stock options granted during the three and nine months ended March 28, 2014 was 5.6 years and 5.0 years, respectively, compared to 4.5 years and 4.0 years in the respective prior-year periods.

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Fair Value Disclosure — Black-Scholes-Merton Model

The fair value of ESPP purchase rights issued is estimated at the date of grant of the purchase rights using the Black-Scholes-Merton option-pricing model. The Black-Scholes-Merton option-pricing model requires the input of highly subjective assumptions such as the expected stock price volatility and the expected period until options are exercised. Purchase rights under the current ESPP are granted on either June 1st or December 1st of each year. ESPP activity was immaterial to the condensed consolidated financial statements for the three and nine months ended March 28, 2014 and March 29, 2013.

Stock Repurchase Program

Since May 21, 2012, the Company's Board of Directors has authorized an additional $3.0 billion for the repurchase of its common stock and the extension of its stock repurchase program through September 13, 2017. The Company repurchased 2.8 million and 7.1 million shares for a total cost of $244 million and $544 million during the three and nine months ended March 28, 2014, respectively. The remaining amount available to be purchased under the Company’s stock repurchase program as of March 28, 2014 was $1.4 billion. The Company may continue to repurchase its stock as it deems appropriate and market conditions allow. 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 and borrowings under the Company's Credit Agreement.

Dividends to Shareholders

On September 13, 2012, the Company announced that its Board of Directors had authorized the adoption of a quarterly cash dividend policy. Under the cash dividend policy, holders of the Company’s common stock receive dividends when and as declared by the Company’s Board of Directors. In the three months ended March 28, 2014, the Company declared a cash dividend of $0.30 per share of the Company’s common stock to shareholders of record as of March 28, 2014, totaling $71 million, which was paid on April 15, 2014. In addition, in the three months ended December 27, 2013 and the three months ended September 27, 2013, the Company declared cash dividends of $0.30 per share and $0.25 per share of the Company's common stock to shareholders of record as of December 27, 2013 and September 30, 2013, respectively, for a total of $71 million and $59 million, which were each paid on January 15, 2014 and October 15, 2013, respectively. The Company may modify, suspend or cancel its cash dividend policy in any manner and at any time.

10. Pensions and Other Post-retirement Benefit Plans

The Company’s principal pension and other post-retirement benefit plans are in Japan. All pension and other post-retirement benefit plans outside of the Company’s Japanese plans were immaterial to the Company’s condensed consolidated financial statements for the three and nine months ended March 28, 2014 and March 29, 2013. The expected long-term rate of return on the Japanese plan assets is 3.5%.

The following table presents the unfunded status of the benefit obligations and Japanese plan assets (in millions):



	March 28, 2014			June 28, 2013
Benefit obligation	$	240		$	234
Fair value of plan assets	(178		)	(167		)
Unfunded status	$	62		$	67

The following table presents the unfunded amounts as recognized on the Company’s condensed consolidated balance sheets (in millions):



	March 28, 2014		June 28, 2013
Current liabilities	$	1	$	1
Non-current liabilities	61		66
Net amount recognized	$	62	$	67

The net periodic benefit cost of the Company’s pension plans was not material to the condensed consolidated financial statements for the three and nine months ended March 28, 2014 and March 29, 2013. The Company’s expected employer contribution for its Japanese defined benefit pension plans is $13 million in fiscal 2014.

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11. Acquisitions

Acquisition of Virident

On October 17, 2013, the Company acquired Virident, a provider of server-side flash storage solutions for virtualization, database, cloud computing and webscale applications. As a result of the acquisition, Virident was fully integrated into the Company's HGST subsidiary and became a wholly owned indirect subsidiary of the Company. The purchase price of the acquisition was approximately $613 million, consisting of $598 million which was funded with available cash, and $15 million related to the fair value of stock options assumed. The acquisition is expected to further HGST's strategy to address the rapidly changing needs of enterprise customers by delivering intelligent storage solutions that maximize application performance by leveraging the tightly coupled server, storage and network resources of today’s converged datacenter infrastructures.

The Company identified and recorded the assets acquired and liabilities assumed at their estimated fair values at the date of acquisition, and allocated the remaining value of $505 million to goodwill. The values assigned to the acquired assets and liabilities are based on preliminary estimates of fair value available as of the date of this Quarterly Report on Form 10-Q, and may be adjusted as further information becomes available during the measurement period of up to 12 months from the date of the acquisition. The primary area of the preliminary purchase price allocation that is not yet finalized due to information that may become available subsequently is income taxes, and any changes in fair values could potentially result in material adjustments to goodwill. The individual tangible and intangible assets acquired as well as the liabilities assumed in the acquisition were immaterial to the Company's condensed consolidated financial statements. In addition, pro forma financial information has not been presented as the acquisition did not have a material impact on the Company’s condensed consolidated financial statements for the nine months ended March 28, 2014.

The preliminary purchase price allocation for Virident was as follows (in millions):



	October 17, 2013
Tangible assets acquired and liabilities assumed	$	59
Intangible assets	49
Goodwill	505
Total	$	613

The $505 million of goodwill recognized is primarily attributable to the benefits the Company expects to derive from an ability to create server-side flash storage solutions leveraging the core technology acquired and is not expected to be deductible for tax purposes. The impact to revenue and net income attributable to Virident was immaterial to the Company’s condensed consolidated financial statements for the three and nine months ended March 28, 2014.

Acquisition of sTec

On September 12, 2013, the Company completed its acquisition of sTec, a provider of enterprise solid-state drives. As a result of the acquisition, sTec was fully integrated into the Company's HGST subsidiary and became a wholly owned indirect subsidiary of the Company. The purchase price of the acquisition was approximately $336 million, consisting of $325 million which was funded with available cash, and $11 million related to the fair value of stock options and RSUs assumed. The acquisition is intended to augment HGST's existing solid-state storage capabilities.

The Company identified and recorded the assets acquired and liabilities assumed at their estimated fair values at the date of acquisition, and allocated the remaining value of $88 million to goodwill. The values assigned to the acquired assets and liabilities are based on preliminary estimates of fair value available as of the date of this Quarterly Report on Form 10-Q, and may be adjusted as further information becomes available during the measurement period of up to 12 months from the date of the acquisition. The primary areas of the preliminary purchase price allocation that are not yet finalized due to information that may become available subsequently include contingencies and income taxes, and any changes in these fair values could potentially result in material adjustments to goodwill. The individual tangible and intangible assets acquired as well as the liabilities assumed in the acquisition were immaterial to the Company's condensed consolidated financial statements. In addition, pro forma financial information has not been presented as the acquisition did not have a material impact on the Company’s condensed consolidated financial statements for the nine months ended March 28, 2014.

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The preliminary purchase price allocation for sTec was as follows (in millions):



	September 12, 2013
Tangible assets acquired and liabilities assumed	$	190
Intangible assets	58
Goodwill	88
Total	$	336

In the three months ended March 28, 2014, the Company recorded a $3 million increase to goodwill to reflect an adjustment to the value of investments acquired in the acquisition of sTec. The $88 million of goodwill recognized is primarily attributable to the benefits the Company expects to derive from augmenting HGST's existing solid-state storage capabilities and accelerating its ability to expand its participation in the growing area of enterprise solid-state drives and is not expected to be deductible for tax purposes. The impact to revenue and net income attributable to sTec was immaterial to the Company’s condensed consolidated financial statements for the three and nine months ended March 28, 2014.

Acquisition of VeloBit

On July 10, 2013, the Company acquired VeloBit, a privately held provider of high-performance storage I/O optimization software. As a result of the acquisition, VeloBit was fully integrated into the Company's HGST subsidiary and became a wholly owned indirect subsidiary of the Company. The acquisition is intended to build on HGST's strategy to enhance the overall value of datacenter storage by integrating HGST SSDs with software. The acquisition was not material to the Company's condensed consolidated financial statements.

12. Employee Termination Benefits and Other Charges

During 2013, the Company incurred charges of $138 million to realign its operations with anticipated market demand. These charges consisted of $109 million of employee termination benefits, $14 million of asset impairment charges and $15 million of contract and other termination charges and were classified as operating expenses and included within employee termination benefits and other charges in the consolidated statements of income. At June 28, 2013, the Company had a liability of $46 million related to these charges. In the nine months ended March 28, 2014, the Company paid $33 million of employee termination benefits and settled $9 million of contract and other termination charges. As a result, the Company's remaining liability totaled $4 million at March 28, 2014 and is expected to be settled by the end of fiscal 2014.

13. Recent Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” (“ASU 2013-02”). The new standard requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. The Company adopted this pronouncement in the first quarter of fiscal 2014. Since ASU 2013-02 related only to the presentation and disclosure of information, it did not have a material effect on the Company’s condensed consolidated financial statements.

In July 2013, the FASB issued ASU 2013-11, "Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists" ("ASU 2013-11"). The new standard requires the presentation of certain unrecognized tax benefits as reductions to deferred tax assets rather than as liabilities in the condensed consolidated balance sheets when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The new standard is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2013, which for the Company is the first quarter of fiscal 2015. The Company does not expect the adoption of ASU 2013-11 to have a material impact on its condensed consolidated financial statements.

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This information should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in this Quarterly Report on Form 10-Q, and the audited consolidated financial statements and notes thereto and Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, contained in our Annual Report on Form 10-K for the year ended June 28, 2013.

Unless otherwise indicated, references herein to specific years and quarters are to our fiscal years and fiscal quarters. As used herein, the terms “we,” “us,” “our,” and the “Company” refer to Western Digital Corporation and its subsidiaries.

Forward-Looking Statements

This document contains forward-looking statements within the meaning of the federal securities laws. Any statements that do not relate to historical or current facts or matters are forward-looking statements. You can identify some of the forward-looking statements by the use of forward-looking words, such as “may,” “will,” “could,” “would,” “project,” “believe,” “anticipate,” “expect,” “estimate,” “continue,” “potential,” “plan,” “forecast,” and the like, or the use of future tense. Statements concerning current conditions may also be forward-looking if they imply a continuation of current conditions. Examples of forward-looking statements include, but are not limited to, statements concerning:


•	expectations regarding industry demand and pricing in the June quarter and the ability of the industry to support this demand;


•	expectations concerning the anticipated benefits of our acquisitions;


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


•	our position in the industry;


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


•	our plans to continue to develop new products and expand into new storage markets and into emerging economic markets;


•	emergence of new storage markets for hard drives;


•	emergence of competing storage technologies;


•	our quarterly cash dividend policy;


•	our share repurchase plans;


•	our stock price volatility;


•	our belief regarding our compliance with environmental laws and regulations;


•	expectations regarding our external and internal supply base;


•	our belief regarding component availability;


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


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


•	contributions to our pension plans in fiscal 2014; and


•	our beliefs regarding the sufficiency of our cash and cash equivalents to meet our working capital, capital expenditure and other cash needs.

Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. You are urged to carefully review the disclosures we make concerning risks and other factors that may affect our business and operating results, including those made in Part II, Item 1A of this Quarterly Report on Form 10-Q, and any of those made in our other reports filed with the Securities and Exchange Commission (the “SEC”). You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document. We do not intend, and undertake no obligation, to publish revised forward-looking statements to reflect events or circumstances after the date of this document or to reflect the occurrence of unanticipated events.

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Our Company

We are a leading developer and manufacturer of data storage solutions that enable consumers, businesses, governments and other organizations to create, manage, experience and preserve digital content. Our principal products are hard disk drives. Our product portfolio also includes solid-state drives ("SSDs"). Hard disk drives are today’s primary storage medium for digital data, with solid-state storage products growing rapidly. Our products are marketed under the HGST, WD and G-Technology brand names. We currently operate our global business through two independent subsidiaries due to regulatory requirements - HGST and WD.

Acquisitions

Acquisition of Virident Systems, Inc. (“Virident”)

On October 17, 2013, we acquired Virident, a provider of server-side flash storage solutions for virtualization, database, cloud computing and webscale applications. Virident was fully integrated into our HGST subsidiary and became our wholly owned indirect subsidiary. The purchase price of the acquisition was approximately $613 million, consisting of $598 million which was funded with available cash and $15 million related to the fair value of stock options assumed. The acquisition is expected to further HGST's strategy to address the rapidly changing needs of enterprise customers by delivering intelligent storage solutions that maximize application performance by leveraging the tightly coupled server, storage and network resources of today’s converged datacenter infrastructures. The acquisition of Virident did not have a material impact on our condensed consolidated financial statements for the three and nine months ended March 28, 2014.

Acquisition of sTec, Inc. (“sTec”)

On September 12, 2013, we completed the acquisition of sTec, a provider of enterprise SSDs. As a result of the acquisition, sTec was fully integrated into our HGST subsidiary and became our wholly owned indirect subsidiary. The acquisition is intended to augment HGST's existing solid-state storage capabilities. The purchase price of the acquisition was approximately $336 million, consisting of $325 million which was funded with available cash and $11 million related to the fair value of stock options and RSUs assumed. The acquisition of sTec did not have a material impact on our condensed consolidated financial statements for the three and nine months ended March 28, 2014.

Acquisition of VeloBit, Inc. ("VeloBit")

On July 10, 2013, we acquired VeloBit, a privately held provider of high-performance storage I/O optimization software. As a result of the acquisition, VeloBit was fully integrated into our HGST subsidiary and became our wholly owned indirect subsidiary. The acquisition is intended to build on HGST's strategy to enhance the overall value of datacenter storage by integrating HGST SSDs with software. The acquisition was not material to our condensed consolidated financial statements.

Third Quarter Overview

In accordance with accounting principles generally accepted in the United States (“U.S. GAAP”), operating results for Virident, which was acquired on October 17, 2013, sTec, which was acquired on September 12, 2013, and VeloBit, which was acquired on July 10, 2013, are included in our operating results only after the respective dates of acquisition.

For the quarter ended March 28, 2014, we believe that overall hard drive industry shipments totaled approximately 137 million units, up 1% from the prior-year period and down 4% from the December quarter.

The following table sets forth, for the periods presented, selected summary information from our condensed consolidated statements of income by dollars and percentage of net revenue (in millions, except percentages):



	Three Months Ended								Nine Months Ended
	March 28, 2014				March 29, 2013				March 28, 2014				March 29, 2013
Net revenue	$	3,703	100.0	%	$	3,764	100.0	%	$	11,479	100.0	%	$	11,623	100.0	%
Gross profit	1,060		28.6		1,061		28.2		3,289		28.7		3,313		28.5
Total operating expenses	641		17.3		644		17.1		1,850		16.1		1,826		15.7
Operating income	419		11.3		417		11.1		1,439		12.5		1,487		12.8
Net income	375		10.1		391		10.4		1,300		11.3		1,245		10.7

The following is a summary of our financial performance for the third quarter of fiscal 2014:

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•	Consolidated net revenue totaled $3.7 billion.


•	53% of our net revenue was derived from non-PC (personal computer) markets, which include enterprise applications, branded products and CE (consumer electronics) products, as compared to 51% in the prior-year period.


•	Net revenue derived from enterprise SSDs was $134 million as compared to $92 million in the prior-year period.


•	Hard drive unit shipments remained relatively flat from the prior-year period at 60.4 million units.


•	Gross margin increased to 28.6%, compared to 28.2% for the prior-year period.


•	Operating income was $419 million, an increase of $2 million from the prior-year period.


•	We generated $697 million in cash flow from operations in the third quarter of fiscal 2014, and we ended the quarter with $4.6 billion in cash and cash equivalents.

For the quarter ending June 27, 2014, we expect overall hard drive industry shipments and our revenue to decrease as a result of seasonality.

Results of Operations

Net Revenue



	Three Months Ended								Nine Months Ended
(in millions, except percentages and average selling price)	March 28, 2014			March 29, 2013			Percentage Change		March 28, 2014			March 29, 2013			Percentage Change
Net revenue	$	3,703		$	3,764		(2	)%	$	11,479		$	11,623		(1	)%
Average selling price (per unit)*	$	58		$	61		(5	)%	$	59		$	62		(5	)%
Revenues by Geography (%)
Americas	25		%	27		%			26		%	26		%
Europe, Middle East and Africa	21			22					21			21
Asia	54			51					53			53
Revenues by Channel (%)
OEM	62		%	60		%			63		%	62		%
Distributors	25			26					24			24
Retailers	13			14					13			14
Unit Shipments*
PC	38.4			39.9					118.2			121.7
Non-PC	22.0			20.3					68.0			60.2
Total units shipped	60.4			60.2			—	%	186.2			181.9			2	%



*	Based on sales of hard drive units only.

For the quarter ended March 28, 2014, net revenue was $3.7 billion, a decrease of 2% from the prior-year period. For the nine months ended March 28, 2014, net revenue was $11.5 billion, a decrease of 1% from the prior-year period. These decreases in revenue were primarily due to decreases in average selling prices ("ASPs"), offset in part by increases in total hard drive shipments. Total hard drive shipments increased to 60.4 million units for the quarter ended March 28, 2014 as compared to 60.2 million units in the prior-year period. Total hard drive shipments increased to 186.2 million units for the nine months ended March 28, 2014, as compared to 181.9 million units in the prior-year period. For the quarter ended March 28, 2014, ASP decreased by $3 from the prior-year period, from $61 to $58. For the nine months ended March 28, 2014, ASP decreased by $3 from the prior-year period, from $62 to $59. These decreases in ASP were primarily driven by a competitive pricing environment as well as a change in product mix.

Changes in revenue by geography and channel generally reflect normal fluctuations in market demand and competitive dynamics. For both the three and nine months ended March 28, 2014, Hewlett-Packard Company accounted for approximately 11% of our net revenue. For the three and nine months ended March 29, 2013, no customer accounted for 10% or more of our net revenue.

Consistent with standard industry practice, we have sales incentive and marketing programs that provide customers with price protection and other incentives or reimbursements that are recorded as a reduction to gross revenue. For the three and nine months ended March 28, 2014, these programs represented 8% of gross revenues, flat with both of the respective prior-year

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periods. These amounts generally vary according to several factors, including industry conditions, seasonal demand, competitor actions, channel mix and overall availability of product.

Gross Margin



	Three Months Ended								Nine Months Ended
(in millions, except percentages)	March 28, 2014			March 29, 2013			Percentage Change		March 28, 2014			March 29, 2013			Percentage Change
Net revenue	$	3,703		$	3,764		(2	)%	$	11,479		$	11,623		(1	)%
Gross profit	1,060			1,061			—	%	3,289			3,313			(1	)%
Gross margin	28.6		%	28.2		%			28.7		%	28.5		%

For the three months ended March 28, 2014, gross margin as a percentage of revenue increased to 28.6% as compared to 28.2% for the prior-year period. For the nine months ended March 28, 2014, gross margin as a percentage of revenue increased slightly to 28.7% as compared to 28.5% for the prior-year period. These increases were primarily due to a change in product mix.

Operating Expenses



	Three Months Ended						Nine Months Ended
(in millions, except percentages)	March 28, 2014		March 29, 2013		Percentage Change		March 28, 2014		March 29, 2013		Percentage Change
R&D expense	$	426	$	396	8	%	$	1,248	$	1,170	7	%
SG&A expense	202		185		9	%	563		526		7	%
Charges related to arbitration award	13		—				39		—
Employee termination benefits and other charges	—		63				—		130
Total operating expenses	$	641	$	644			$	1,850	$	1,826

Research and development (“R&D”) expense was $426 million for the three months ended March 28, 2014, an increase of $30 million from the prior-year period. For the nine months ended March 28, 2014, R&D expense was $1.2 billion, an increase of $78 million from the prior-year period. These increases were primarily due to the inclusion of Virident and sTec's R&D expenses from the dates of acquisition, as well as expense related to adjustments to market value on our stock appreciation rights ("SARs"). As a percentage of net revenue, R&D expense increased to 11.5% and 10.9% in both the three and nine months ended March 28, 2014, respectively, compared to 10.5% and 10.1% in the respective prior-year periods.

Selling, general and administrative (“SG&A”) expense was $202 million for the three months ended March 28, 2014, an increase of $17 million from the prior-year period. For the nine months ended March 28, 2014, SG&A expense was $563 million, an increase of $37 million from the prior-year period. These increases were primarily due to the inclusion of Virident and sTec's SG&A expenses from the dates of acquisition, as well as expense related to adjustments to market value on our SARs. SG&A expense as a percentage of net revenue increased to 5.5% and 4.9% in the three and nine months ended March 28, 2014, respectively, compared to 4.9% and 4.5% in the respective prior-year periods.

During the three and nine months ended March 28, 2014, we recorded $13 million and $39 million, respectively, of interest charges related to an arbitration award for claims brought against us and a now former employee of ours by Seagate Technology LLC ("Seagate"), alleging misappropriation of confidential information and trade secrets. For further details see the "Arbitration Award" section below.

During the three months ended March 29, 2013, we recorded charges of $63 million consisting of $54 million of employee termination benefits and $9 million of contract and other termination costs in order to realign our operations with anticipated market demand. During the nine months ended March 29, 2013, we recorded charges of $130 million consisting of $105 million of employee termination benefits, $12 million of asset impairments and $13 million of contract and other termination costs in order to realign our operations with anticipated market demand.

Other Income (Expense)

Interest income for the three and nine months ended March 28, 2014 increased $1 million and $2 million, respectively, as compared to the respective prior-year periods primarily due to higher average daily invested cash balances for the periods.

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Interest and other expense for the three and nine months ended March 28, 2014 increased $3 million and $1 million, respectively, as compared to the respective prior-year periods primarily due a $4 million write-off of debt issuance costs associated with lenders that extinguished their interest in our newly entered into Credit Agreement (as defined below).

Income Tax Provision

Our income tax provision for the three months ended March 28, 2014 was $31 million as compared to $15 million in the prior-year period. Our income tax provision for the nine months ended March 28, 2014 was $105 million as compared to $207 million in the prior-year period. Our income tax provision for both the three and nine months ended March 29, 2013 reflected a tax benefit of $34 million as a result of the retroactive extension of the U.S. Federal research and experimentation tax credit (“R&D credit”) that was signed into law on January 2, 2013 as part of the American Taxpayer Relief Act of 2012. The R&D credit, which had previously expired on December 31, 2011, was extended through December 31, 2013. In addition, we recorded an $88 million charge to reduce our previously recognized California deferred tax assets in the nine months ended March 29, 2013 as a result of the enactment of California Proposition 39. The differences between the effective tax rate and the U.S. Federal statutory rate are primarily due to tax holidays in Malaysia, the Philippines, Singapore and Thailand that expire at various dates from 2014 through 2025 and the current year generation of income tax credits.

In the three months ended March 28, 2014, we recorded a net increase of $6 million in our liability for unrecognized tax benefits. In the nine months ended March 28, 2014, we recorded a net increase of $26 million in our liability for unrecognized tax benefits. In addition, we recorded a $9 million increase in our liability for unrecognized tax benefits related to the Virident and sTec acquisitions in the nine months ended March 28, 2014. As of March 28, 2014, we had a recorded liability for unrecognized tax benefits of approximately $275 million. Interest and penalties recognized on such amounts were not material to the condensed consolidated financial statements during the three and nine months ended March 28, 2014.

The Internal Revenue Service (“IRS”) completed its field examination of our federal income tax returns for fiscal years 2006 and 2007 and issued Revenue Agent Reports that proposed adjustments to income before income taxes of approximately $970 million primarily related to transfer pricing and intercompany payable balances. We disagreed with the proposed adjustments and filed a protest with the IRS Appeals Office. In June 2013, we reached an agreement with the IRS to resolve the transfer pricing issue. This agreement resulted in a decrease in the amount of net operating loss and tax credits realized, but did not have an impact on our consolidated statements of income. The proposed adjustment relating to intercompany payable balances for fiscal years 2006 and 2007 will be addressed in conjunction with the IRS’s examination of our fiscal years 2008 and 2009, which commenced in January 2012. In addition, in January 2012, the IRS commenced an examination of the 2007 fiscal period ended September 5, 2007 of Komag, Incorporated, which was acquired by us on September 5, 2007. In February 2013, the IRS commenced an examination of calendar years 2010 and 2011 of HGST, which was acquired by us on March 8, 2012.

We believe that adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in our tax audits are resolved in a manner not consistent with management's expectations, we could be required to adjust our provision for income taxes in the period such resolution occurs. As of March 28, 2014, it is not possible to estimate the amount of change, if any, in the unrecognized tax benefits that is reasonably possible within the next twelve months. Any significant change in the amount of our liability for unrecognized tax benefits would most likely result from additional information or settlements relating to the examination of our tax returns.

Arbitration Award

As disclosed above in Part I, Item 1, Note 5 in the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, on November 18, 2011, a sole arbitrator ruled against us in an arbitration in Minnesota. The arbitration involves claims brought by Seagate against us and a now former employee, alleging misappropriation of confidential information and trade secrets. The arbitrator issued an interim award against us in the amount of $525 million plus pre-award interest. On January 23, 2012, the arbitrator issued a final award adding pre-award interest in the amount of $105.4 million, for a total award of $630.4 million. On January 23, 2012, we filed a petition in the District Court of Hennepin County, Minnesota to have the final arbitration award vacated, and a hearing on the petition to vacate was held on March 1, 2012. On October 12, 2012, the District Court of Hennepin County, Minnesota vacated, in full, the $630.4 million final arbitration award and ordered that a rehearing be held concerning certain trade secret claims before a new arbitrator. On October 30, 2012, Seagate initiated an appeal of the District Court's decision with the Minnesota Court of Appeals. On July 22, 2013, the Minnesota Court of Appeals reversed the District Court's decision and remanded for entry of an order and judgment confirming the arbitration award. We strongly disagree with the decision of the Court of Appeals and believe that the District Court’s decision was correct. On August 20, 2013, we filed a petition for review with the Minnesota Supreme Court and, on October 15, 2013, we were informed that the Minnesota Supreme Court granted our petition. The appeal before the Minnesota Supreme Court was fully briefed, and oral argument was held on February 5, 2014. We will continue to vigorously defend ourselves in this matter. In light of uncertainties with respect to

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this matter, we recorded an accrual of $681 million for this matter in our financial statements for the three months ended June 28, 2013. This amount was in addition to the $25 million previously accrued in the fourth quarter of fiscal 2011. In the three and nine months ended March 28, 2014, we recorded an additional $13 million and $39 million, respectively, for interest related to the arbitration award. As a result, the total amount accrued of $745 million represents the amount of the final arbitration award, plus interest accrued on the initial arbitration award at the statutory rate of 10% from January 24, 2012 through March 28, 2014.

Liquidity and Capital Resources

We ended the first quarter of fiscal 2014 with total cash and cash equivalents of $4.6 billion. The following table summarizes our statements of cash flows (in millions):



	Nine Months Ended
	March 28, 2014			March 29, 2013
Net cash flow provided by (used in):
Operating activities	$	2,104		$	2,435
Investing activities	(1,756		)	(834		)
Financing activities	(88		)	(749		)
Net increase in cash and cash equivalents	$	260		$	852

Our investment policy is to manage our investment portfolio to preserve principal and liquidity while maximizing return through the full investment of available funds. On January 9, 2014 (the "Closing Date"), the outstanding balance on the existing credit facility entered into on March 8, 2012 (the "Prior Credit Facility") was repaid, the Prior Credit Facility was terminated, and we, along with Western Digital Technologies, Inc. ("WDT") and Western Digital Ireland, Ltd. ("WDI") entered into a new credit agreement with JPMorgan Chase Bank, N.A., as administrative agent, and the lenders party thereto (the "Credit Agreement"). The Credit Agreement provides for $4.0 billion of unsecured loan facilities consisting of a $2.5 billion term loan facility to WDT, and a $1.5 billion revolving credit facility to WDT and WDI (the "Borrowers"). Subject to certain conditions, a Borrower may also elect to expand the credit facilities by, or obtain incremental term loans of, up to $1.0 billion if existing or new lenders provide additional term or revolving commitments. For additional information on the Prior Credit Facility and the Credit Agreement, See Part I, Item 1, Note 4 of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. We believe our current cash, cash equivalents and cash generated from operations as well as our available credit facilities will be sufficient to meet our working capital, debt, dividend, stock repurchase and capital expenditure needs for at least the next twelve months. Our ability to sustain our working capital position is subject to a number of risks that we discuss in Part II, Item 1A of this Quarterly Report on Form 10-Q.

A total of $2.8 billion of our cash and cash equivalents was held outside of the United States at both March 28, 2014 and June 28, 2013. Substantially all of the amounts held outside of the United States are intended to be indefinitely reinvested in foreign operations. If we are required to pay the arbitration award described in the section “Arbitration Award” above, the award would be paid from one of our foreign subsidiaries using cash and cash equivalents held outside of the United States. On September 13, 2012, our Board of Directors approved a capital allocation plan which includes repurchases of our common stock and the adoption of a quarterly cash dividend policy. Our current plans do not anticipate that we will need funds generated from foreign operations to fund our domestic operations or capital allocation plan. In the event funds from foreign operations are needed in the United States, any repatriation could result in the accrual and payment of additional U.S. income tax.

Operating Activities

Net cash provided by operating activities was $2.1 billion during the nine months ended March 28, 2014. Cash flow from operating activities consists of net income, adjusted for non-cash charges, plus or minus working capital changes. This represents our principal source of cash. Net cash used by working capital changes was $180 million for the nine months ended March 28, 2014 as compared to $77 million provided by working capital changes in the prior-year period.

Our working capital requirements primarily depend on the effective management of our cash conversion cycle, which measures how quickly we can convert our products into cash through sales. The cash conversion cycles were as follows:

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	Three Months Ended
	March 28, 2014		March 29, 2013
Days sales outstanding	44		41
Days in inventory	44		40
Days payables outstanding	(65	)	(69	)
Cash conversion cycle	23		12

For the three months ended March 28, 2014, our average days sales outstanding (“DSOs”) increased by 3 days, days in inventory (“DIOs”) increased by 4 days, and days payable outstanding (“DPOs”) decreased by 4 days compared to the prior year period. Changes in average DSOs and DIOs are generally related to linearity of shipments and the timing of inventory builds, respectively. Changes in DPOs are generally related to production volume and the timing of purchases during the period. From time to time, we modify the timing of payments to our vendors. We make modifications primarily to manage our vendor relationships and to manage our cash flows, including our cash balances. Generally, we make the payment modifications through negotiations with our vendors or by granting to, or receiving from, our vendors’ payment term accommodations.

Investing Activities

Cash used in investing activities for the nine months ended March 28, 2014 was $1.8 billion and consisted primarily of $823 million related to acquisitions, net of cash acquired, $470 million of investments in available-for-sale securities and $467 million of capital expenditures, partially offset by a net $4 million for other investing activities, consisting of a flood-related insurance recovery and strategic investments. Cash used in investing activities for the nine months ended March 29, 2013 was $834 million and consisted primarily of $816 million of capital expenditures and $17 million related to the purchase of investments.

Our cash equivalents are invested in highly liquid money market funds that are invested in U.S. Treasury securities and U.S. Government Agency securities. In addition, we invest directly in U.S. Treasury securities, U.S. Government Agency securities, commercial paper, bank acceptances and certificates of deposit. We also have $14 million of auction-rate securities, which are classified as available-for-sale securities in our condensed consolidated balance sheets.

Financing Activities

Net cash used in financing activities for the nine months ended March 28, 2014 was $88 million as compared to $749 million in the prior-year period. Net cash used in financing activities for the nine months ended March 28, 2014 consisted of $2.5 billion of debt proceeds related to the term loan facility under the Credit Agreement, net of issuance costs, $500 million of debt proceeds related to the revolving credit facility under the Prior Credit Facility and a net $139 million provided by employee stock plans, offset by $2.5 billion used to make principal payments on the Prior Credit Facility before termination, used to repay the outstanding balance on the Prior Credit Facility at termination, and used to make principal payments on the Credit Agreement, $544 million used to repurchase shares of our common stock and $189 million used to pay dividends on our common stock. Net cash used in financing activities for the nine months ended March 29, 2013 consisted of $607 million used to repurchase shares of our common stock, $121 million used to pay dividends on our common stock and $173 million used to repay long-term debt, offset by a net $152 million provided by employee stock plans.

Off-Balance Sheet Arrangements

Other than facility lease commitments incurred in the normal course of business and certain indemnification provisions (see “Contractual Obligations and Commitments” below), we do not have any off-balance sheet financing arrangements or liabilities, guarantee contracts, retained or contingent interests in transferred assets, or any 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 our condensed consolidated financial statements. Additionally, we do not have an interest in, or relationships with, any special-purpose entities.

Contractual Obligations and Commitments

Long-Term Debt — On March 8, 2012, we, in our capacity as the parent entity and guarantor, WDT and WDI, entered into the Prior Credit Facility. The Prior Credit Facility provided for $2.8 billion of unsecured loan facilities, consisting of a $2.3 billion term loan facility and a $500 million revolving credit facility. On January 9, 2014, the outstanding balance on the Prior Credit Facility was repaid, the Prior Credit Facility was terminated, and the new Credit Agreement was entered into.

As of March 28, 2014, no amounts were outstanding under the revolving credit facility of the Credit Agreement and the term loan facility had an outstanding balance of $2.5 billion and a variable interest rate of 1.66%. We are required to make quarterly principal payments on the term loan facility totaling $31 million for the remainder of fiscal 2014, $125 million in fiscal

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2015, $156 million in fiscal 2016, $219 million in fiscal 2017, $250 million in fiscal 2018 and the remaining balance of $1.7 billion in fiscal 2019. For additional information, see Part I, Item 1, Note 4 in the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

Purchase Orders — 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 purchase orders with suppliers for capital equipment that are recorded as a liability upon receipt of the equipment. Our ability to change or cancel a capital equipment purchase order without penalty depends on the nature of the equipment being ordered. In some cases, we may be obligated to pay for certain costs related to changes to, or cancellation of, a purchase order, such as costs incurred for raw materials or work in process of components or capital equipment.

We have entered into long-term purchase agreements with various component suppliers, containing minimum quantity requirements. However, the dollar amount of the purchases may depend on the specific products ordered, achievement of pre-defined quantity or quality specifications or future price negotiations. We have also entered into long-term purchase agreements with various component suppliers that carry fixed volumes and pricing which obligate us to make certain future purchases, contingent on certain conditions of performance, quality and technology of the vendor’s components.

We enter into, from time to time, other long-term purchase agreements for components with certain vendors. Generally, future purchases under these agreements are not fixed and determinable as they depend on our overall unit volume requirements and are contingent upon the prices, technology and quality of the supplier’s products remaining competitive.

See Part II, Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations — Contractual Obligations and Commitments” in our Annual Report on Form 10-K for the year ended June 28, 2013, for further discussion of our purchase orders and purchase agreements and the associated dollar amounts. See Part II, Item 1A of this Quarterly Report on Form 10-Q for a discussion of the risks associated with these commitments.

Foreign Exchange Contracts — We purchase short-term, 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. See Part I, Item 3, of this Quarterly Report on Form 10-Q under the heading “Disclosure About Foreign Currency Risk,” for a description of our current foreign exchange contract commitments and Part I, Item 1, Note 8 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, 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.

Unrecognized Tax Benefits — As of March 28, 2014, the cash portion of our total recorded liability for unrecognized tax benefits was $239 million. We estimate the timing of the future payments of these liabilities to be within the next one to eight years. See Part I, Item 1, Note 6 of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for information regarding our total tax liability for unrecognized tax benefits.

Stock Repurchase Program — Since May 21, 2012, our Board of Directors has authorized an additional $3.0 billion for the repurchase of our common stock and the extension of our stock repurchase program until September 13, 2017. We repurchased 2.8 million and 7.1 million shares of our common stock for a total cost of $244 million and $544 million during the three and nine months ended March 28, 2014, respectively. The remaining amount available to be purchased under our stock repurchase program as of March 28, 2014 was $1.4 billion. Subsequent to March 28, 2014 and through May 1, 2014, we repurchased an additional 0.6 million shares of our common stock for a total cost of $52 million. We may continue to repurchase our common stock as we deem appropriate and market conditions allow. Repurchases under our 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. We expect stock repurchases to be funded principally by operating cash flows and borrowings under our Credit Agreement.

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Cash Dividend Policy — On September 13, 2012, we announced that our Board of Directors had authorized the adoption of a quarterly cash dividend policy. Under the cash dividend policy, holders of our common stock receive dividends when and as declared by our Board of Directors. In the three months ended March 28, 2014, we declared a cash dividend of $0.30 per share of our common stock to our shareholders of record as of March 28, 2014, totaling $71 million, which we paid on April 15, 2014. In addition, in the three months ended December 27, 2013 and September 27, 2013, the Company declared cash dividends of $0.30 and $0.25 per share, respectively, of the Company's common stock to shareholders of record as of December 27, 2013 and September 30, 2013, respectively, for a total of $71 million and $59 million which were each paid on January 15, 2014 and October 15, 2013, respectively. We may modify, suspend or cancel our cash dividend policy in any manner and at any time.

Critical Accounting Policies and Estimates

We have prepared the unaudited condensed consolidated financial statements in accordance with 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. We believe the following are our most critical accounting policies that affect significant areas and involve judgment and estimates made by us. 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 year ended June 28, 2013.

Revenue and Accounts Receivable

In accordance with standard industry practice, we provide distributors and retailers (collectively referred to as “resellers”) with limited price protection for inventories held by resellers at the time of published list price reductions, and we provide resellers and original equipment manufacturers ("OEMs") with other sales incentive programs. At the time we recognize revenue to resellers and OEMs, we record a reduction of revenue for estimated price protection until the resellers sell such inventory to their customers and we also record a reduction of revenue for the other programs in effect. We base these adjustments on several factors including anticipated price decreases during the reseller holding period, resellers’ sell-through and inventory levels, estimated amounts to be reimbursed to qualifying customers, historical pricing information and customer claim processing. If customer demand for our products or market conditions differs from our expectations, our operating results could be materially affected. We also have programs under which we reimburse qualified distributors and retailers for certain marketing expenditures, which are recorded as a reduction of revenue. These amounts generally vary according to several factors including industry conditions, seasonal demand, competitor actions, channel mix and overall availability of product. Generally, total sales incentive and marketing programs range from 7% to 11% of gross revenues per quarter. For the three months ended March 28, 2014, sales incentive and marketing programs were 8% of gross revenues. Changes in future customer demand and market conditions may require us to adjust our incentive programs as a percentage of gross revenue from the current range. Adjustments to revenues due to changes in accruals for these programs related to revenues reported in prior periods have averaged 0.8% of quarterly gross revenue since the first quarter of fiscal 2013. Customer sales incentive and marketing programs are recorded as a reduction of revenue.

We record an allowance for doubtful accounts by analyzing specific customer accounts and assessing the risk of loss based on insolvency, disputes or other collection issues. In addition, we routinely analyze the different receivable aging categories and establish reserves based on a combination of past due receivables and expected future losses based primarily on our historical levels of bad debt losses. If the financial condition of a significant customer deteriorates resulting in its inability to pay its accounts when due, or if our overall loss history changes significantly, an adjustment in our allowance for doubtful accounts would be required, which could materially affect operating results.

We establish provisions against revenue and cost of revenue for sales returns in the same period that the related revenue is recognized. We base these provisions on existing product return notifications. If actual sales returns exceed expectations, an increase in the sales return accrual would be required, which could materially affect operating results.

Warranty

We record an accrual for estimated warranty costs when revenue is recognized. We generally warrant our products for a period of one to five years. Our warranty provision considers estimated product failure rates and trends, estimated replacement costs, estimated repair costs which include scrap costs, and estimated costs for customer compensatory claims related to product quality issues, if any. We use a statistical warranty tracking model to help prepare our estimates and assist us in exercising judgment in determining the underlying estimates. Our statistical tracking model captures specific detail on hard drive reliability, such as factory test data, historical field return rates, and costs to repair by product type. Our judgment is subject to a greater degree of subjectivity with respect to newly introduced products because of limited field experience with those products upon which to base our warranty estimates. We review our warranty accrual quarterly for products shipped in prior periods and which are still under warranty. Any changes in the estimates underlying the accrual may result in adjustments that impact current period

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gross profit and income. Such changes are generally a result of differences between forecasted and actual return rate experience and costs to repair. If actual product return trends, costs to repair returned products or costs of customer compensatory claims differ significantly from our estimates, our future results of operations could be materially affected. For a summary of historical changes in estimates related to pre-existing warranty provisions, refer to Part I, Item 1, Note 2 of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

Inventory

We value inventories at the lower of cost (first-in, first-out and weighted-average methods) or net realizable value. We use the first-in, first-out (“FIFO”) method to value the cost of the majority of our inventories, while we use the weighted-average method to value precious metal inventories. Weighted-average cost is calculated based upon the cost of precious metals at the time they are received by us. We have determined that it is not practicable to assign specific costs to individual units of precious metals and, as such, we relieve our precious metals inventory based on the weighted-average cost of the inventory at the time the inventory is used in production. The weighted-average method of valuing precious metals does not materially differ from a FIFO method. We record inventory write-downs for the valuation of inventory at the lower of cost or net realizable value by analyzing market conditions and estimates of future sales prices as compared to inventory costs and inventory balances.

We evaluate inventory balances for excess quantities and obsolescence on a regular basis by analyzing estimated demand, inventory on hand, sales levels and other information, and reduce inventory balances to net realizable value for excess and obsolete inventory based on this analysis. Unanticipated changes in technology or customer demand could result in a decrease in demand for one or more of our products, which may require a write down of inventory that could materially affect operating results.

Litigation and Other Contingencies

When we become aware of a claim or potential claim, we assess the likelihood of any loss or exposure. We disclose information regarding each material claim where the likelihood of a loss contingency is probable or reasonably possible. If a loss contingency is probable and the amount of the loss can be reasonably estimated, we record an accrual for the loss. In such cases, there may be an exposure to potential loss in excess of the amount accrued. Where a loss is not probable but is reasonably possible or where a loss in excess of the amount accrued is reasonably possible, we disclose an estimate of the amount of the loss or range of possible losses for the claim if a reasonable estimate can be made, unless the amount of such reasonably possible losses is not material to our financial position, results of operations or cash flows. The ability to predict the ultimate outcome of such matters involves judgments, estimates and inherent uncertainties. The actual outcome of such matters could differ materially from management’s estimates. Refer to Part I, Item 1, Note 5 of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

Income Taxes

We account for income taxes under the asset and liability method, which provides that deferred tax assets and liabilities be recognized for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities and expected benefits of utilizing net operating loss and tax credit carryforwards. We record a valuation allowance when it is more likely than not that the deferred tax assets will not be realized. Each quarter, we evaluate the need for a valuation allowance for our deferred tax assets and we adjust the valuation allowance so that we record net deferred tax assets only to the extent that we conclude it is more likely than not that these deferred tax assets will be realized.

We recognize liabilities for uncertain tax positions based on a two-step process. To the extent a tax position does not meet a more-likely-than-not level of certainty, no benefit is recognized in the financial statements. If a position meets the more-likely-than-not level of certainty, it is recognized in the financial statements at the largest amount that has a greater than 50% likelihood of being realized upon ultimate settlement. Interest and penalties related to unrecognized tax benefits are recognized on liabilities recorded for uncertain tax positions and are recorded in our provision for income taxes. The actual liability for unrealized tax benefits in any such contingency may be materially different from our estimates, which could result in the need to record additional liabilities for unrecognized tax benefits or potentially adjust previously-recorded liabilities for unrealized tax benefits and materially affect our operating results.

Stock-based Compensation

We account for all stock-based compensation at fair value. Stock-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. The fair values of all stock options and SARs granted are estimated using a binomial option-pricing model, and the fair values of all Employee Stock Purchase Plan purchase rights are estimated using the Black-Scholes-Merton option-pricing model. We account for SARs as liability awards based upon our intention to settle such awards in cash. The SARs liability is recognized for that portion of fair value for the

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service period rendered at the reporting date. The share-based liability is remeasured at each reporting date through the requisite service period. Both the binomial and the Black-Scholes-Merton models require the input of highly subjective assumptions. We are required to use judgment in estimating the amount of stock-based awards that are expected to be forfeited. If actual forfeitures differ significantly from the original estimate, stock-based compensation expense and our results of operations could be materially affected.

Goodwill and Other Long-Lived Assets

The fair value of assets acquired and liabilities assumed in a business acquisition are recognized at the acquisition date, with amounts exceeding the fair values being recognized as goodwill. Goodwill is not amortized. Instead, it is tested for impairment on an annual basis or more frequently whenever events or changes in circumstances indicate that goodwill may be impaired. We perform our annual impairment test as of the first day of our fiscal fourth quarter.

We first use qualitative factors to determine whether goodwill is more likely than not impaired. If we conclude from the qualitative assessment that goodwill is more likely than not impaired, we follow a two-step approach to quantify the impairment.

We are required to use judgment when applying the goodwill impairment test, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. In addition, the estimates used to determine the fair value of each reporting unit may change based on results of operations, macroeconomic conditions or other factors. Changes in these estimates could materially affect our assessment of the fair value and goodwill impairment for each reporting unit.

Other intangible assets consist primarily of technology acquired in business combinations and in-process research and development. In-process research and development is not amortized until the point at which it reaches technological feasibility. Instead, it is tested for impairment on an annual basis or more frequently whenever events or changes in circumstances indicate that it may be impaired. Acquired intangibles are amortized on a straight-line basis over their respective estimated useful lives. Long-lived assets are tested for recoverability whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. If impairment is indicated, the impairment is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets.

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, refer to Part I, Item I, Note 13 of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, which is incorporated herein by reference.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Disclosure About Foreign Currency Risk

Although the majority of our transactions are in U.S. dollars, some transactions are based in various foreign currencies. We purchase short-term, foreign exchange contracts to hedge the impact of foreign currency exchange fluctuations on certain underlying assets, revenue, liabilities and commitments for operating expenses and product costs denominated in foreign currencies. The purpose of entering into these hedge transactions is to minimize the impact of foreign currency fluctuations on our results of operations. The contract maturity dates do not exceed 12 months. We do not purchase foreign exchange contracts for trading purposes. See Part I, Item 1, Note 8 of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

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As of March 28, 2014, we had outstanding the following purchased foreign exchange contracts (in millions, except weighted average contract rate):



	Contract Amount		Weighted Average Contract Rate*		Unrealized Gains (Losses)
Foreign exchange contracts:
Cash flow hedges:
Japanese Yen	$	228	$	100.32	$	(4	)
Malaysian Ringgit	$	181	$	3.24	$	(1	)
Philippine Peso	$	43