Edgar Filing: WESTERN DIGITAL CORP

10-Q

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 January 1, 2016



¨	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 February 8, 2016, 232,770,151 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 — January 1, 2016 and July 3, 2015	3

Condensed Consolidated Statements of Income — Three and Six Months Ended January 1, 2016 and January 2, 2015	4

Condensed Consolidated Statements of Comprehensive Income — Three and Six Months Ended January 1, 2016 and January 2, 2015	5

Condensed Consolidated Statements of Cash Flows — Six Months Ended January 1, 2016 and January 2, 2015	6

Notes to Condensed Consolidated Financial Statements	7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	21

Item 3. Quantitative and Qualitative Disclosures About Market Risk	30

Item 4. Controls and Procedures	31

PART II. OTHER INFORMATION	31

Item 1. Legal Proceedings	31

Item 1A. Risk Factors	31

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	59

Item 6. Exhibits	60

Unless otherwise indicated, references herein to specific years and quarters are to our fiscal years and fiscal quarters, and references to financial information are on a consolidated basis. As used herein, the terms “we,” “us,” “our,” the “Company,” “WDC” and “Western Digital” refer to Western Digital Corporation and its subsidiaries, unless, we state, or the context indicates, otherwise.

WDC, a Delaware corporation, is the parent company of our data storage business. Our principal executive offices are located at 3355 Michelson Drive, Suite 100, Irvine, California 92612. Our telephone number is (949) 672-7000 and our website is www.westerndigital.com. The information on our website 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)



	January 1, 2016			July 3, 2015
ASSETS
Current assets:
Cash and cash equivalents	$	5,363		$	5,024
Short-term investments	497			262
Accounts receivable, net	1,650			1,532
Inventories	1,238			1,368
Other current assets	200			331
Total current assets	8,948			8,517
Property, plant and equipment, net	2,801			2,965
Goodwill	2,766			2,766
Other intangible assets, net	292			332
Other non-current assets	659			601
Total assets	$	15,466		$	15,181
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,806		$	1,881
Accrued expenses	505			470
Accrued compensation	315			330
Accrued warranty	144			150
Accrued arbitration award	32			—
Revolving credit facility	255			255
Current portion of long-term debt	188			156
Total current liabilities	3,245			3,242
Long-term debt	2,062			2,156
Other liabilities	602			564
Total liabilities	5,909			5,962
Commitments and contingencies (Notes 4, 5, and 6)
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 — 232 and 230 shares, respectively	3			3
Additional paid-in capital	2,421			2,428
Accumulated other comprehensive loss	(8		)	(20		)
Retained earnings	9,407			9,107
Treasury stock — common shares at cost; 29 and 31 shares, respectively	(2,266		)	(2,299		)
Total shareholders’ equity	9,557			9,219
Total liabilities and shareholders’ equity	$	15,466		$	15,181

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						Six Months Ended
	January 1, 2016			January 2, 2015			January 1, 2016			January 2, 2015
Revenue, net	$	3,317		$	3,888		$	6,677		$	7,831
Cost of revenue	2,411			2,778			4,816			5,572
Gross profit	906			1,110			1,861			2,259
Operating expenses:
Research and development	389			426			774			863
Selling, general and administrative	207			164			399			384
Charges related to arbitration award	32			1			32			15
Employee termination, asset impairment and other charges	27			53			83			62
Total operating expenses	655			644			1,288			1,324
Operating income	251			466			573			935
Other income (expense):
Interest and other income	6			4			11			8
Interest and other expense	(13		)	(12		)	(26		)	(25		)
Total other expense, net	(7		)	(8		)	(15		)	(17		)
Income before income taxes	244			458			558			918
Income tax expense (benefit)	(7		)	20			24			57
Net income	$	251		$	438		$	534		$	861
Income per common share:
Basic	$	1.08		$	1.88		$	2.31		$	3.70
Diluted	$	1.07		$	1.84		$	2.28		$	3.60
Weighted average shares outstanding:
Basic	232			233			231			233
Diluted	234			238			234			239
Cash dividends declared per share	$	0.50		$	0.40		$	1.00		$	0.80

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						Six Months Ended
	January 1, 2016			January 2, 2015			January 1, 2016			January 2, 2015
Net income	$	251		$	438		$	534		$	861
Other comprehensive income (loss), net of tax:
Net unrealized gain (loss) on foreign exchange contracts	38			(18		)	13			(44		)
Net unrealized loss on available-for-sale securities	(2		)	—			(1		)	—
Other comprehensive income (loss), net of tax	36			(18		)	12			(44		)
Total comprehensive income	$	287		$	420		$	546		$	817

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)



	Six Months Ended
	January 1, 2016			January 2, 2015
Operating Activities
Net income	$	534		$	861
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization	488			579
Stock-based compensation	79			80
Deferred income taxes	15			31
Gain from insurance recovery	—			(37		)
Loss on disposal of assets	6			12
Non-cash portion of employee termination, asset impairment and other charges	18			19
Changes in:
Accounts receivable, net	(118		)	109
Inventories	127			(56		)
Accounts payable	(58		)	94
Accrued arbitration award	32			(758		)
Accrued expenses	35			70
Accrued compensation	(15		)	(9		)
Other assets and liabilities, net	—			75
Net cash provided by operating activities	1,143			1,070
Investing Activities
Purchases of property, plant and equipment	(300		)	(306		)
Proceeds from sale of property, plant and equipment	—			7
Proceeds from sales and maturities of investments	266			630
Purchases of investments	(408		)	(595		)
Acquisitions, net of cash acquired	—			(6		)
Other investing activities, net	(12		)	16
Net cash used in investing activities	(454		)	(254		)
Financing Activities
Issuance of stock under employee stock plans	54			112
Taxes paid on vested stock awards under employee stock plans	(44		)	(59		)
Excess tax benefits from employee stock plans	(6		)	11
Repurchases of common stock	(60		)	(532		)
Dividends paid to shareholders	(231		)	(187		)
Repayment of debt	(63		)	(63		)
Net cash used in financing activities	(350		)	(718		)
Net increase in cash and cash equivalents	339			98
Cash and cash equivalents, beginning of period	5,024			4,804
Cash and cash equivalents, end of period	$	5,363		$	4,902
Supplemental disclosure of cash flow information:
Cash paid (received) for income taxes	$	21		$	(45	)
Cash paid for interest	$	22		$	23
Supplemental disclosure of non-cash financing activities:
Accrual of cash dividend declared	$	116		$	93

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 July 3, 2015. 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”). 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 July 3, 2015. The results of operations for interim periods are not necessarily indicative of results to be expected for the full year.

The Company's fiscal year ends on the Friday nearest to June 30 and typically consists of 52 weeks. Approximately every six years, the Company reports a 53-week fiscal year to align its fiscal year with the foregoing policy. The Company's fiscal second quarters ended January 1, 2016 and January 2, 2015 both consisted of 13 weeks. The six months ended January 1, 2016 and January 2, 2015 consisted of 26 and 27 weeks, respectively. Fiscal 2016 will be comprised of 52 weeks and will end on July 1, 2016. Fiscal year 2015 was comprised of 53 weeks and ended on July 3, 2015.

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

Accounts Receivable

From time to time, in connection with a factoring agreement, the Company sells trade accounts receivable without recourse to a third party purchaser in exchange for cash. The Company did not sell trade accounts receivable during the three months ended January 1, 2016. During the six months ended January 1, 2016, the Company sold trade accounts receivable and received cash proceeds of $200 million. The Company did not sell trade accounts receivable during the three and six months ended January 2, 2015. The discounts on the sales of trade accounts receivable were not material and were recorded within interest and other expense in the condensed consolidated statements of income.

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



	January 1, 2016			July 3, 2015
	(in millions)
Inventories:
Raw materials and component parts	$	130		$	168
Work-in-process	474			500
Finished goods	634			700
Total inventories	$	1,238		$	1,368
Property, plant and equipment:
Property, plant and equipment	$	8,716		$	8,604
Accumulated depreciation	(5,915		)	(5,639		)
Property, plant and equipment, net	$	2,801		$	2,965
Other intangible assets:
Other intangible assets	$	1,018		$	1,008
Accumulated amortization	(726		)	(676		)
Other intangible assets, net	$	292		$	332

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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 product 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 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						Six Months Ended
	January 1, 2016			January 2, 2015			January 1, 2016			January 2, 2015
Warranty accrual, beginning of period	$	218		$	201		$	221		$	182
Charges to operations	43			50			88			99
Utilization	(40		)	(44		)	(94		)	(93		)
Changes in estimate related to pre-existing warranties	4			16			10			35
Warranty accrual, end of period	$	225		$	223		$	225		$	223

The long-term portion of the warranty accrual classified in other liabilities was $81 million as of January 1, 2016 and $71 million as of July 3, 2015.

Investments

The following tables summarize, by major type, the fair value and cost basis of the Company’s investments (in millions):



	January 1, 2016
	Cost Basis		Unrealized Losses			Fair Value
Available-for-sale securities:
U.S. Treasury securities	$	306	$	(1	)	$	305
U.S. Government agency securities	116		—			116
Commercial paper	50		—			50
Certificates of deposit	260		—			260
Total	$	732	$	(1	)	$	731



	July 3, 2015
	Cost Basis		Unrealized Gains (Losses)		Fair Value
Available-for-sale securities:
U.S. Treasury securities	$	287	$	—	$	287
U.S. Government agency securities	95		—		95
Commercial paper	109		—		109
Certificates of deposit	99		—		99
Total	$	590	$	—	$	590

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The fair value of the Company’s investments classified as available-for-sale securities at January 1, 2016, by remaining contractual maturity, were as follows (in millions):



	Cost Basis		Fair Value
Due in less than one year (short-term investments):	$	497	$	497
Due in one to five years (included in other non-current assets):	235		234
Total	$	732	$	731

The Company determined no available-for-sale securities were other-than-temporarily impaired during the three and six months ended January 1, 2016 and January 2, 2015. For more information on the Company's available-for-sale securities, see Note 7 to these condensed consolidated financial statements.

From time to time, the Company enters into certain strategic investments for the promotion of business and strategic objectives. These strategic investments are recorded at cost within other non-current assets in the condensed consolidated balance sheets and were not material to the condensed consolidated financial statements as of January 1, 2016 and July 3, 2015.

Joint Venture

In November 2015, the Company entered into an agreement to form a joint venture with Unisplendour Corporation Limited ("Unis") to market and sell the Company's current data center storage systems in China and to develop data storage systems for the Chinese market in the future. The joint venture will be 51% owned by Unis and its subsidiary, Unissoft (Wuxi) Group Co. Ltd., and 49% by the Company.

Other Comprehensive Income (Loss), Net of Tax

Other comprehensive income (loss), net of tax refers to revenue, expenses, gains and losses that are recorded as an element of shareholders’ equity but are excluded from net income. 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 (loss) for the six months ended January 1, 2016 (in millions):



	Actuarial Pension Gain		Unrealized Gain (Loss) on Foreign Exchange Contracts			Unrealized Loss on Available for Sale Securities			Accumulated Other Comprehensive Income (Loss)
Balance at July 3, 2015	$	5	$	(25	)	$	—		$	(20	)
Other comprehensive loss before reclassifications	—		(40		)	—			(40		)
Amounts reclassified from accumulated other comprehensive income (loss)	—		53			(1		)	52
Net current-period other comprehensive income (loss)	—		13			(1		)	12
Balance at January 1, 2016	$	5	$	(12	)	$	(1	)	$	(8	)

The following table illustrates the changes in the balances of each component of accumulated other comprehensive income (loss) for the six months ended January 2, 2015 (in millions):



	Actuarial Pension Gain		Unrealized Gain (Loss) on Foreign Exchange Contracts			Unrealized Gain (Loss) on Available for Sale Securities		Accumulated Other Comprehensive Income (Loss)
Balance at June 27, 2014	$	7	$	5		$	—	$	12
Other comprehensive loss before reclassifications	—		(57		)	—		(57		)
Amounts reclassified from accumulated other comprehensive income (loss)	—		13			—		13
Net current-period other comprehensive loss	—		(44		)	—		(44		)
Balance at January 2, 2015	$	7	$	(39	)	$	—	$	(32	)

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

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



	Three Months Ended				Six Months Ended
	January 1, 2016		January 2, 2015		January 1, 2016		January 2, 2015
Net income	$	251	$	438	$	534	$	861
Weighted average shares outstanding:
Basic	232		233		231		233
Employee stock options and other	2		5		3		6
Diluted	234		238		234		239
Income per common share:
Basic	$	1.08	$	1.88	$	2.31	$	3.70
Diluted	$	1.07	$	1.84	$	2.28	$	3.60
Anti-dilutive potential common shares excluded*	6		1		4		2



*	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

The Company's credit agreement, which was entered into in January 2014 and subsequently amended (the "Credit Agreement"), provides for $4.0 billion of unsecured loan facilities consisting of a $2.5 billion term loan facility and a $1.5 billion revolving credit facility. The loans under the Credit Agreement have a five-year term. Subject to certain conditions, the credit facilities may be expanded by, or incremental term loans may be obtained for, up to $1.0 billion if existing or new lenders provide additional term or revolving commitments.

The term loans and the revolving credit loans may be prepaid in whole or in part at any time without premium or penalty, subject to certain conditions. As of January 1, 2016, the revolving credit facility had a variable interest rate of 1.7% and an outstanding balance of $255 million. The revolving credit facility was classified within current liabilities as of January 1, 2016 as the Company intended to repay the borrowings within the next 12 months. The Company repaid the $255 million outstanding balance under the revolving credit facility on January 15, 2016. As of January 1, 2016, the term loan facility had a variable interest rate of 1.7% and a remaining outstanding balance of $2.3 billion. The Company is required to make quarterly principal payments on the term loan facility totaling $94 million for the remainder of 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.

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.

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Solely for purposes of this note, “WD” refers to Western Digital Corporation or one or more of its subsidiaries excluding HGST prior to the closing of the Company's acquisition of HGST on March 8, 2012 (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

In June 2008, Convolve, Inc. (“Convolve”) filed a complaint in the Eastern District of Texas against WD, HGST, and two other companies alleging infringement of U.S. Patent Nos. 6,314,473 and 4,916,635. The complaint sought unspecified monetary damages and injunctive relief. In October 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. In July 2011, a verdict was rendered 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. In March 2015, WD and HGST filed Notices of Appeal with the United States District Court for the Federal Circuit (“Federal Circuit”). In April 2015, Convolve filed a motion for reconsideration of the final judgment, and in May 2015, the Federal Circuit deactivated the appeal pending the Court’s decision on reconsideration. WD and HGST intend to continue to defend themselves vigorously in this matter.

Seagate Matter

In October 2006, Seagate Technology LLC (“Seagate”) brought an action against the Company and a now former employee, alleging misappropriation of confidential information and trade secrets. In January 2012, an arbitrator issued a final award against the Company, including pre-award interest, of $630.4 million. The matter was appealed and, in October 2014, the Minnesota Supreme Court upheld the arbitrator’s award. In October 2014, the Company paid Seagate $773.4 million to satisfy the final arbitration award and interest accrued through October 2014. This amount was paid by one of the Company’s foreign subsidiaries using cash held outside of the United States.

Seagate disputed the method the Company used for calculating post-award interest and contended that the Company owed Seagate approximately $29 million in additional interest. The Company denied Seagate’s contention. In April 2015, the District Court declared that all amounts due and owing from the Company to Seagate had been paid, and a corresponding judgment was entered. In May 2015, Seagate appealed the decision and judgment to the Minnesota Court of Appeals. On January 25, 2016, the Minnesota Court of Appeals reversed the District Court’s decision, determined that Seagate is owed additional post-award interest, and directed the District Court to enter judgment in accordance with its opinion. The Company has no automatic right to appeal and, on January 27, 2016, the Company paid the additional post-award interest, which was not material to the Company’s financial position, results of operations or cash flows. The additional post-award interest was paid by one of the Company’s foreign subsidiaries using cash held outside of the United States. The Company and Seagate have signed and filed with the court a stipulation of dismissal with prejudice resolving this matter.

SanDisk Matters

In November 2015, plaintiffs filed two putative class action complaints in the Superior Court of the State of California, County of Santa Clara, challenging the Agreement and Plan of Merger the Company entered into with SanDisk Corporation (“SanDisk”) on October 21, 2015 (the “Merger Agreement”). The complaints allege, among other things, that the members of the SanDisk board breached their fiduciary duties to SanDisk’s shareholders by agreeing to sell SanDisk for inadequate consideration, failing to properly value SanDisk, agreeing to inappropriate deal protection provisions that may inhibit other bidders from coming forward with a superior offer, not protecting against alleged conflicts of interest resulting from the SanDisk directors’ own interrelationships or connection with the proposed transaction, and failing to disclose all material information regarding the proposed transaction. The complaints also allege that the Company aided and abetted the SanDisk board members’ breaches of their fiduciary duties. The plaintiffs seek injunctive relief to prevent the merger from closing. The plaintiffs also seek, among other things, to recover costs and disbursement from the defendants, including attorneys’ fees and experts’ fees. The Company intends to defend itself vigorously in this matter.

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Other Matters

In December 2011, the German Central Organization for Private Copying Rights (Zentralstelle für private Überspielungsrechte), (“ZPÜ”), an organization consisting of several copyright collecting societies, instituted arbitration proceedings against Western Digital's German subsidiary (“WD Germany”) before the Copyright Arbitration Board (“CAB”) claiming copyright levies for multimedia hard drives, external hard drives and network hard drives sold or introduced into commerce in Germany by WD Germany from January 2008 through December 2010. In February 2013, WD Germany filed a declaratory relief action against ZPÜ in the Higher Regional Court of Munich (the “Higher Court”), seeking an order from the court to determine the copyright levy issue. On May 21, 2013, ZPÜ filed a counter-claim against WD Germany with the Higher Court, seeking copyright levies for multimedia hard drives, external hard drives and network hard drives sold or introduced into commerce from January 2008 through December 2010 based on tariffs published by ZPÜ on November 3, 2011. In January 2015, the Higher Court ruled in favor of ZPÜ. In its ruling, the Higher Court declared that WD Germany must pay certain levies on certain WD products which it sold in Germany between January 2008 and December 2010. The judgment specifies levy amounts on certain WD products sold from January 2008 through December 2010 and directs WD Germany to provide applicable sales data to the ZPÜ. The exact amount of the judgment has not been determined. ZPÜ and WD Germany filed appeals with the German Federal Court of Justice in February 2015. WD intends to defend itself vigorously in this matter.

In December 2014, ZPÜ submitted a pleading to the CAB seeking copyright levies for multimedia hard drives, external hard drives and network hard drives sold or introduced into commerce in Germany by WD Germany between January 2012 and December 2013. WD intends to defend itself vigorously in this matter.

The Company has recorded an accrual for German copyright levies in an amount that is not material to the Company’s financial position, results of operations or cash flows. It is reasonably possible that the Company may incur losses totaling up to $109 million, including the amounts accrued.

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, 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, any monetary liability and financial impact to the Company from these other matters could differ materially from the Company's expectations.

6. Income Taxes

The Company had an income tax benefit of $7 million and income tax expense of $24 million in the three and six months ended January 1, 2016, respectively. The Company's income tax expense for the three and six months ended January 2, 2015 was $20 million and $57 million, respectively. The Company's tax provision for both the three and six months ended January 1, 2016 reflects a tax benefit of $30 million for the retroactive extension of the U.S. Federal research and development tax credit that was permanently signed into law on December 19, 2015 and a tax benefit of $34 million from restructuring activities. The remaining 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 2016 through 2025 and the current year generation of income tax credits.

In the three and six months ended January 1, 2016, the Company recorded a net increase of $15 million and $25 million, respectively, in its liability for unrecognized tax benefits. As of January 1, 2016, the Company's liability for unrecognized tax benefits was approximately $375 million. Interest and penalties recognized on such amounts were not material to the condensed consolidated financial statements during the three and six months ended January 1, 2016.

The Internal Revenue Service (“IRS”) previously completed its field examination of the Company's federal income tax returns for fiscal years 2006 through 2009 and proposed certain adjustments. The Company has received Revenue Agent Reports (“RARs”) from the IRS that seek to increase the Company's U.S. taxable income which would result in additional federal tax expense totaling approximately $795 million, subject to interest. The issues in dispute relate primarily to transfer pricing with the Company’s foreign subsidiaries and intercompany payable balances. The Company disagrees with the proposed adjustments and in September 2015, filed a protest with the IRS Appeals Office. The Company believes that its tax positions are properly supported and will vigorously contest the position taken by the IRS. In September 2015, the IRS commenced an examination of the Company’s fiscal years 2010 through 2012. During the six months ended January 1, 2016, the IRS completed the examination of the fiscal period ended September 5, 2007 of Komag, Incorporated, which the Company acquired on September 5, 2007, with no material adjustments.

The Company believes that adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax examinations cannot be predicted with certainty. If any issues addressed in the Company’s tax examinations are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs. As of January 1, 2016, it is not possible to estimate the amount of

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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.

Level 2. Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3. Inputs that are unobservable for the asset or liability and that are significant to the fair value of the assets or liabilities.

The following tables present information about the Company’s financial assets and liabilities that are measured at fair value on a recurring basis as of January 1, 2016 and July 3, 2015, and indicate the fair value hierarchy of the valuation techniques utilized to determine such values (in millions):



	Fair Value Measurements at
	January 1, 2016
	Using
	Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents:
Money market funds	$	392	$	—	$	—	$	392
Total cash equivalents	392		—		—		392
Short-term investments:
U.S. Treasury securities	—		121		—		121
U.S. Government agency securities	—		66		—		66
Commercial paper	—		50		—		50
Certificates of deposit	—		260		—		260
Total short-term investments	—		497		—		497
Long-term investments:
U.S. Treasury securities	—		184		—		184
U.S. Government agency securities	—		50		—		50
Total long-term investments	—		234		—		234
Foreign exchange contracts	—		3		—		3
Total assets at fair value	$	392	$	734	$	—	$	1,126
Liabilities:
Foreign exchange contracts	$	—	$	22	$	—	$	22
Total liabilities at fair value	$	—	$	22	$	—	$	22

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	Fair Value Measurements at
	July 3, 2015
	Using
	Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents:
Money market funds	$	135	$	—	$	—	$	135
Total cash equivalents	135		—		—		135
Short-term investments:
U.S. Treasury securities	—		50		—		50
U.S. Government agency securities	—		4		—		4
Commercial paper	—		109		—		109
Certificates of deposit	—		99		—		99
Total short-term investments	—		262		—		262
Long-term investments:
U.S. Treasury securities	—		237		—		237
U.S. Government agency securities	—		91		—		91
Total long-term investments	—		328		—		328
Total assets at fair value	$	135	$	590	$	—	$	725
Liabilities:
Foreign exchange contracts	$	—	$	31	$	—	$	31
Total liabilities at fair value	$	—	$	31	$	—	$	31

Money Market Funds. The Company’s money market funds are funds that invest in U.S. Treasury and U.S. Government Agency securities. Money market funds are valued based on quoted market prices.

U.S. Treasury Securities. The Company’s U.S. Treasury securities are direct obligations of the U.S. federal government and are held in custody by a third party. U.S. Treasury 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. 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.

Commercial Paper. The Company’s commercial paper securities are investments issued by corporations which are held in custody by a third party. Commercial paper securities are valued using a market approach which is based on observable inputs including market interest rates from multiple pricing sources.

Certificates of Deposit. The Company’s certificates of deposit are investments which are held in custody by a third party. Certificates of deposit are valued using fixed interest rates.

Foreign Exchange Contracts. The Company’s foreign exchange contracts are short-term contracts to hedge the Company’s foreign currency risk. 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 consolidated balance sheets. 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. For more information on the Company's foreign exchange contracts, see Note 8 to these condensed consolidated financial statements.

In the three and six months ended January 1, 2016, there were no transfers between levels. 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.

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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 speculative or trading purposes. As of January 1, 2016, 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 six months ended January 1, 2016 and January 2, 2015.

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 cost of revenue or operating expenses, depending on the nature of the underlying hedged item. All fair value hedges were determined to be effective as of January 1, 2016 and July 3, 2015. The changes in fair value on these contracts were immaterial to the condensed consolidated financial statements during the three and six months ended January 1, 2016 and January 2, 2015.

As of January 1, 2016, 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 twelve months was $12 million. In addition, as of January 1, 2016, the Company did not have any foreign exchange contracts with credit-risk-related contingent features. The Company opened $992 million and $1.9 billion, and closed $1.1 billion and $2.1 billion, in foreign exchange contracts during the three and six months ended January 1, 2016, respectively. The Company opened $1.0 billion and $2.0 billion, and closed $1.1 billion and $2.1 billion, in foreign exchange contracts during the three and six months ended January 2, 2015, respectively. The fair value and balance sheet location of the Company's foreign exchange contracts as of January 1, 2016 and July 3, 2015 were as follows (in millions):

Asset Derivatives

Liability Derivatives

January 1, 2016

July 3, 2015

January 1, 2016

July 3, 2015

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 January 1, 2016 (in millions):



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
Foreign exchange contracts
Financial assets	$	5		$	(2	)	$	3
Financial liabilities	(24		)	2			(22		)
Total derivative instruments	$	(19	)	$	—		$	(19	)

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The Company had a gross and net liability of $31 million related to its derivative instruments outstanding at July 3, 2015. There were no amounts offset due to master netting arrangements in place at July 3, 2015.

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



	Amount of Gain (Loss) Recognized in Accumulated OCI on Derivatives											Location of Gain (Loss) Reclassified from Accumulated OCI into Income	Amount of Loss Reclassified From Accumulated OCI into Income
Derivatives in Cash Flow Hedging Relationships	Three Months Ended		Six Months Ended			Three Months Ended			Six Months Ended				Three Months Ended		Six Months Ended		Three Months Ended		Six Months Ended
Derivatives in Cash Flow Hedging Relationships	January 1, 2016					January 2, 2015							January 1, 2016				January 2, 2015
Foreign exchange contracts	$	13	$	(40	)	$	(35	)	$	(57	)	Cost of revenue	$	25	$	53	$	17	$	13

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 six months ended January 1, 2016 and January 2, 2015.

9. Shareholders' Equity

Stock-Based Compensation Expense

The following table presents the Company's stock-based compensation and related tax benefit for the three and six months ended January 1, 2016 and January 2, 2015 (in millions):



	Three Months Ended								Six Months Ended
	January 1, 2016				January 2, 2015				January 1, 2016				January 2, 2015
	Expense		Tax Benefit		Expense		Tax Benefit		Expense		Tax Benefit		Expense		Tax Benefit
Options and ESPP	$	13	$	4	$	18	$	7	$	32	$	8	$	37	$	12
RSUs	24		6		23		6		47		12		43		11
Total	$	37	$	10	$	41	$	13	$	79	$	20	$	80	$	23

As of January 1, 2016, total compensation cost related to unvested stock options and ESPP rights issued to employees but not yet recognized was $118 million and will be amortized on a straight-line basis over a weighted average service period of approximately 2.4 years.

For purposes of this footnote, references to RSUs include performance stock unit awards. As of January 1, 2016, the aggregate unamortized fair value of all unvested RSUs was $158 million, which will be recognized on a straight-line basis over a weighted average vesting period of approximately 1.8 years.

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 July 3, 2015	6.8		$	50.00
Granted	1.6		84.41
Exercised	(0.5	)	29.49
Forfeited or expired	(0.1	)	49.08
Options outstanding at October 2, 2015	7.8		58.58
Exercised	(0.2	)	23.25
Forfeited or expired	(0.1	)	68.75
Options outstanding at January 1, 2016	7.5		$	59.54	4.5	$	107
Exercisable at January 1, 2016	3.8		$	43.58	3.3	$	88
Vested and expected to vest after January 1, 2016	7.4		$	58.92	4.4	$	107

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Options granted during the three and six months ended January 1, 2016 had a weighted average fair value per share of $17.74 and $22.87, respectively. As of January 1, 2016, the Company had options outstanding to purchase an aggregate of 3.7 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 $107 million at that date. During the three and six months ended January 1, 2016, the aggregate intrinsic value of options exercised under the Company’s stock option plans was $9 million and $36 million, respectively, determined as of the date of exercise, as compared to $76 million and $163 million in the respective prior-year periods.

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 July 3, 2015	3.0		$	73.80
Granted	1.2		84.39
Vested	(1.5	)	62.14
Forfeited	(0.1	)	81.55
RSUs outstanding at October 2, 2015	2.6		84.43
Granted	0.1		68.31
Vested	(0.1	)	61.61
Forfeited	(0.1	)	85.31
RSUs outstanding at January 1, 2016	2.5		84.71
Expected to vest after January 1, 2016	2.4		$	84.57

RSUs are generally settled in an equal number of shares of the Company’s common stock at the time of vesting of the units. The fair value of the shares underlying the RSU awards at the date of grant or assumption was $10 million and $109 million for awards granted in the three and six months ended January 1, 2016. These amounts are being recognized to expense over the corresponding vesting periods.

SARs Activity

During the three and six months ended January 1, 2016, the Company recognized a $10 million and $11 million benefit, respectively, related to adjustments to fair market value of stock appreciation rights ("SARs"), as compared to $8 million and $12 million of expense in the respective prior-year periods. The tax expense realized as a result of the aforementioned SARs benefit was $1 million and $1 million during the three and six months ended January 1, 2016, as compared to $2 million and $3 million of tax benefits during the three and six months ended January 2, 2015, respectively. The Company's SARs will be settled in cash upon exercise. The Company had a total liability of $29 million and $41 million related to SARs included in accrued expenses in the condensed consolidated balance sheet as of January 1, 2016 and July 3, 2015, respectively. As of January 1, 2016, all SARs issued to employees were fully vested, and the fair values are now solely subject to market price fluctuations. As of January 1, 2016, 0.5 million SARs were outstanding with a weighted average exercise price of $7.86. There were no SARs granted during the three and six months ended January 1, 2016.

Stock Repurchase Program

The Company's Board of Directors previously authorized $5.0 billion for the repurchase of the Company's common stock and approved the extension of its stock repurchase program to February 3, 2020. Effective October 21, 2015, in connection with the Company's planned SanDisk merger, the stock repurchase program was suspended. The Company did not repurchase any shares during the three months ended January 1, 2016. The Company repurchased 0.7 million shares for a total cost of $60 million during the six months ended January 1, 2016. The remaining amount available to be purchased under the Company’s stock repurchase program as of January 1, 2016 was $2.1 billion.

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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 January 1, 2016, the Company declared a cash dividend of $0.50 per share to shareholders of record as of January 1, 2016, totaling $116 million, which was paid on January 15, 2016. In addition, in the three months ended October 2, 2015, the Company declared a cash dividend of $0.50 per share to shareholders of record as of October 2, 2015, totaling $116 million, which was paid on October 15, 2015. The Company may modify, suspend or cancel its cash dividend policy in any manner and at any time.

Investment by Unis

On September 30, 2015, the Company announced that it had entered into an agreement with Unis and Unis Union Information System Ltd., a subsidiary of Unis ("Investor"), pursuant to which Investor will make a $3.8 billion equity investment in the Company (the "Unis Investment"). Under the terms of the agreement for the Unis Investment, Investor has agreed to purchase 40,814,802 shares of newly issued common stock of the Company at a price of $92.50 per share and has agreed to a five-year position standstill, voting restrictions, and a five-year lock-up on its shares, with a limited number becoming available for transfer each year. Following the closing of the investment, Unis will have the right to nominate one representative for election to the Company's Board of Directors, so long as Unis holds more than 10% of the issued and outstanding shares of the Company's common stock. The performance of Investor’s obligations pursuant to the agreement, including payment of the purchase price for the shares, is guaranteed by Unis. The closing of the Unis Investment is subject to clearance by the U.S. Committee on Foreign Investment in the United States ("CFIUS"), the receipt of requisite regulatory approvals, including clearance by U.S. antitrust authorities and certain Chinese regulatory approvals, approval of the transaction by shareholders of Unis and other customary closing conditions. In November 2015, the Company and Unis withdrew from the CFIUS clearance process and refiled the notice with CFIUS in January 2016. The Company expects to receive a determination from CFIUS in February 2016. Although approval from Unis shareholders and approval from some of the Chinese regulatory authorities have been received, the Company cannot provide assurance that CFIUS clearance will be received or the other conditions to the completion of the Unis Investment will be satisfied in a timely manner or at all.

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 six months ended January 1, 2016 and January 2, 2015. The expected long-term rate of return on the Japanese plan assets is 2.5%.

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



	January 1, 2016			July 3, 2015
Benefit obligation	$	240		$	231
Fair value of plan assets	(195		)	(185		)
Unfunded status	$	45		$	46

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



	January 1, 2016		July 3, 2015
Current liabilities	$	1	$	1
Non-current liabilities	44		45
Net amount recognized	$	45	$	46

The net periodic benefit cost of the Company’s pension plans was not material to the condensed consolidated financial statements for the three and six months ended January 1, 2016 and January 2, 2015. The Company’s expected employer contribution for its Japanese defined benefit pension plans is $10 million in fiscal 2016.

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11. Acquisitions

Planned SanDisk Merger

On October 21, 2015, the Company entered into the Merger Agreement with SanDisk, a global leader in NAND flash storage solutions, pursuant to which a subsidiary of the Company will merge with and into SanDisk, with SanDisk surviving as a wholly owned subsidiary of the Company. The merger is primarily intended to deepen the Company's expertise in non-volatile memory and enable the Company to vertically integrate into NAND, securing long-term access to solid state technology at a lower cost.

The Merger Agreement values SanDisk’s outstanding common stock at a value of $86.50 per share, or a total equity value of approximately $18.9 billion, based on the volume weighted average price of the Company’s common stock for the five trading days ending on October 20, 2015. If the Unis Investment closes prior to the merger, the Company will pay $85.10 per share in cash and issue 0.0176 shares of its common stock per share of SanDisk’s common stock; and if the Unis Investment has not occurred or has been terminated, the Company will pay $67.50 per share in cash and issue 0.2387 shares of its common stock per share of SanDisk’s common stock. The above allocation between cash and shares of the Company’s common stock is subject to reallocation, at the Company’s election, if the amount of cash that SanDisk has available at the closing of the merger falls below certain thresholds.

The merger consideration will be financed by a mix of cash, new debt financing and issuance of the Company’s common stock. In connection with the merger, the Company expects to enter into new debt facilities totaling $18.1 billion. The Company has received commitments for a $1.0 billion revolving credit facility, $3.0 billion in amortizing term loans, $6.0 billion in other term loans and $8.1 billion in secured and unsecured bridge facilities. The Company expects to issue approximately $5.1 billion in secured and unsecured notes in lieu of drawing the bridge facilities at close, with the balance of the bridge facilities to be repaid with available cash. The proceeds from the new debt facilities are expected to be used to pay part of the purchase price, refinance existing debt of both the Company and SanDisk and pay transaction related fees and expenses.

Consummation of the merger is subject to customary closing conditions, including without limitation: (i) the required approval by SanDisk shareholders and, if the Unis Investment has not occurred or has been terminated, approval by the Company’s shareholders; (ii) the expiration or early termination of the waiting period applicable to the consummation of the merger under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR Act"), which expired on January 15, 2016, and the receipt of regulatory clearance under the foreign antitrust laws of the People's Republic of China, the European Union, Japan, South Africa, South Korea, Taiwan and Turkey; and (iii) if the Unis Investment has not been terminated and is a “covered transaction” for CFIUS purposes, or if CFIUS otherwise requests or requires a filing with respect to the merger, the approval of CFIUS. Clearance was obtained in Japan on January 22, 2016, in Taiwan on February 1, 2016 and in the European Union on February 4, 2016. Clearance was obtained in Singapore on January 19, 2016. In certain circumstances, a termination fee of up to $1.06 billion may be payable by the Company or a termination fee of up to $553.3 million may be payable by SanDisk, upon termination of the transaction as more fully described in the Merger Agreement.

Acquisition of Amplidata NV ("Amplidata")

On March 9, 2015, the Company acquired Amplidata, a developer of object storage software for public and private cloud data centers. As a result of the acquisition, Amplidata was fully integrated and became a wholly owned indirect subsidiary of the Company. The purchase price of the acquisition was approximately $267 million, consisting of $245 million funded with available cash at the time of the acquisition, $19 million related to the fair value of a previously-held cost method investment and $3 million related to the fair value of stock options assumed. The acquisition furthers the Company's strategy to expand into higher value data storage platforms and systems that address the growth in storage requirements in cloud data centers.

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 $215 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 during the measurement period of up to 12 months from the date of the acquisition as further information becomes available with any changes in the fair values potentially resulting in 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.

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The preliminary purchase price allocation for Amplidata is as follows (in millions):



	March 9, 2015
Tangible assets acquired and liabilities assumed	$	(24	)
Intangible assets	76
Goodwill	215
Total	$	267

Since the date of acquisition, the Company recorded an increase of $42 million to goodwill which primarily related to an adjustment to the value of deferred taxes acquired, an adjustment to the value of intangible assets acquired, and an adjustment for the fair value of stock options assumed in the acquisition of Amplidata. 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. Any changes in the fair value could potentially result in adjustments to goodwill.

The $215 million of goodwill recognized is primarily attributable to the benefits the Company expects to derive from an ability to create hard disk drive storage solutions leveraging the core software acquired and is not expected to be deductible for tax purposes. The impact to revenue and net income attributable to Amplidata was immaterial to the Company’s condensed consolidated financial statements for the three and six months ended January 1, 2016.

12. Employee Termination, Asset Impairment and Other Charges

The Company periodically incurs charges to realign its operations with anticipated market demand. The employee termination, asset impairment and other charges line item within the Company's condensed consolidated statements of income consisted of the following (in millions):



	Three Months Ended				Six Months Ended
	January 1, 2016		January 2, 2015		January 1, 2016		January 2, 2015
Employee termination benefits	$	18	$	34	$	56	$	42
Impairment of assets	—		19		8		20
Contract termination and other	9		—		19		—
Total	$	27	$	53	$	83	$	62

There were no impairment charges during the three months ended January 1, 2016. Impairment charges during the six months ended January 1, 2016 and January 2, 2015 relate to equipment and other long-lived assets.

The following table provides those amounts recorded as liabilities within the Company's condensed consolidated balance sheets:



	July 3, 2015		Accruals		Payments			October 2, 2015		Accruals		Payments			January 1, 2016
Employee termination benefits	$	10	$	38	$	(12	)	$	36	$	18	$	(30	)	$	24

Closure of Foreign Manufacturing Facility

On January 18, 2016, the Company announced it will be closing its head component front end wafer manufacturing facility in Odawara, Japan, in order to reduce manufacturing costs. The Company expects the closure to be substantially completed by the end of the third quarter of fiscal 2016 and it is expected to result in total pre-tax charges of approximately $200 million. These charges are expected to consist of approximately $90 million in asset charges, $90 million in employee termination costs and $20 million in contract termination and other costs. Approximately $110 million of these charges are expected to be cash expenditures. In the three months ended January 1, 2016, the Company recorded a $20 million charge related to the acceleration of depreciation on assets held at the Odawara facility as a result of the planned closure of the facility. This charge was recorded within cost of revenue in the condensed consolidated statements of income. The remaining charges are expected to be primarily incurred in the third quarter of fiscal 2016.

13. Recent Accounting Pronouncements

Recently Adopted

In November 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2015-17, "Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes" ("ASU 2015-17"), which requires that

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deferred tax liabilities and assets for each tax-paying jurisdiction within each tax-paying component to be classified as noncurrent in a classified statement of financial position. The Company early adopted ASU 2015-17 during the second quarter of fiscal 2016 on a prospective basis, which resulted in the reclassification of approximately $165 million of net deferred tax assets as of January 1, 2016 from current assets to noncurrent assets. Since the Company adopted this standard on a prospective basis, no adjustments were made to prior-period balance sheets.

Recently Issued

In January 2016, the FASB issued ASU No. 2016-01, "Financial Instruments — Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities" ("ASU 2016-01"). The new standard requires equity investments to be measured at fair value with changes in fair value recognized in net income, simplifies the impairment assessment of equity investments without readily determinable fair values, eliminates the requirement to disclose the methods and significant assumptions used to estimate fair value, requires use of the exit price notion when measuring fair value, requires separate presentation in certain financial statements, and requires an evaluation of the need for a valuation allowance on a deferred tax asset related to available-for-sale securities. The new standard is effective for fiscal years beginning after December 15, 2017, which for the Company is the first quarter of fiscal 2019. The Company is currently evaluating the impact ASU 2016-01 will have on its consolidated financial statements and related disclosures.

In September 2015, the FASB issued ASU No. 2015-16, "Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments" ("ASU 2015-16"), which eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. Acquirers must recognize measurement-period adjustments during the period of resolution, including the effect on earnings of any amounts they would have recorded in previous periods if the accounting had been completed at the acquisition date. The new standard is effective for fiscal years beginning after December 15, 2015, which for the Company is the first quarter of fiscal 2017. Earlier adoption is permitted for any interim and annual financial statements that have not yet been issued. The Company is currently evaluating the impact ASU 2015-16 will have on its consolidated financial statements and related disclosures.

In April 2015, the FASB issued ASU 2015-03, "Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs" ("ASU 2015-03"). The new standard requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The new standard is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2015, which for the Company is the first quarter of fiscal 2017. The Company is currently evaluating the impact ASU 2015-03 will have on its consolidated financial statements and related disclosures.

In February 2015, the FASB issued ASU 2015-02, "Consolidation (Topic 810): Amendments to the Consolidation Analysis" ("ASU 2015-02"). The new standard eliminates the presumption that a general partner should consolidate a limited partnership, requires that a reporting entity determine whether it has a variable interest in the entity being evaluated for consolidation, eliminates the requirement to consolidate variable interest entities ("VIEs") caused by certain fees paid to decision makers, and eliminates the indefinite deferral of FASB Statement No. 167 included in ASU 2010-10. The new standard is effective for fiscal years beginning after December 15, 2015, which for the Company is the first quarter of fiscal 2017. Early adoption is permitted. The Company is currently evaluating the impact ASU 2015-02 will have on its consolidated financial statements and related disclosures.

In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers" ("ASU 2014-09"), which amends the guidance in former Accounting Standards Codification Topic 605, "Revenue Recognition," to provide a single, comprehensive revenue recognition model for all contracts with customers. The new standard requires an entity to recognize revenue in a manner that depicts the transfer of promised goods or services to customers in amounts that reflect the consideration to which an entity expects to be entitled in exchange for those goods or services. The new standard also requires entities to enhance disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. In August 2015, the FASB issued ASU 2015-14, which deferred the effective date of this ASU by one year. The new standard allows for either a full retrospective or a modified retrospective transition method and is effective for fiscal years and interim periods within those years beginning after December 15, 2017, which for the Company is the first quarter of fiscal 2019, and early adoption is permitted beginning after December 15, 2016. The Company has not yet selected a transition method and is currently evaluating the impact ASU 2014-09 will have on its consolidated financial statements and related disclosures.

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

You should read this information in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in this Quarterly Report on Form 10-Q, and the audited consolidated financial statements and notes thereto and Part II, Item 7, contained in our Annual Report on Form 10-K for the year ended July 3, 2015.

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.

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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 concerning the planned SanDisk Corporation (“SanDisk”) merger;


•	expectations regarding the planned equity investment by Unisplendour Corporation Limited (“Unis”);


•	expectations regarding the integration of our HGST and WD subsidiaries following the decision by the Ministry of Commerce of the People’s Republic of China (“MOFCOM”) in October 2015;


•	expectations regarding the growth of digital data and demand for digital storage;


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


•	expectations regarding the PC market and the emergence of new storage markets for our products;


•	expectations regarding the amount and timing of charges and cash expenditures associated with our restructuring activities;


•	our quarterly cash dividend policy;


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


•	expectations regarding the repatriation of funds from our foreign operations;


•	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;


•	our beliefs regarding the sufficiency of our available liquidity to meet our working capital, debt, dividend and capital expenditure needs; and


•	expectations regarding our debt financing plans.

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 I, 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.

Our Company

We are a leading developer, manufacturer and provider of data storage solutions that enable consumers, businesses, governments and other organizations to create, manage, experience and preserve digital content. Our product portfolio includes hard disk drives (“HDDs”), solid state drives ("SSDs"), direct attached storage solutions, personal cloud network attached storage solutions, and public and private cloud data center storage solutions. HDDs are our principal products and are today’s primary storage medium for the vast majority of digital content, with the use of solid-state storage products growing rapidly. Our products are marketed under the HGST and WD brand names.

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 second quarters ended January 1, 2016 and January 2, 2015 both consisted of 13 weeks. The six months ended January 1, 2016 and January 2, 2015 consisted of 26 and 27 weeks, respectively. Fiscal 2016 will be comprised of 52 weeks and will end on July 1, 2016. Fiscal year 2015 was comprised of 53 weeks and ended on July 3, 2015.

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Recent Developments

Closure of Foreign Manufacturing Facility

On January 18, 2016, we announced that we will be closing our head component front end wafer manufacturing facility in Odawara, Japan, in order to reduce manufacturing costs. We expect the closure to be substantially completed by the end of the third quarter of fiscal 2016 and it is expected to result in total pre-tax charges of approximately $200 million. These charges are expected to consist of approximately $90 million in asset charges, $90 million in employee termination costs and $20 million in contract termination and other costs. Approximately $110 million of these charges are expected to be cash expenditures. In the three months ended January 1, 2016, we recorded a $20 million charge related to the acceleration of depreciation on assets held at the Odawara facility as a result of the planned closure of the facility. This charge was recorded within cost of revenue in the condensed consolidated statements of income. The remaining charges are expected to be primarily incurred in the third quarter of fiscal 2016.

Joint Venture

In November 2015, we entered into an agreement to form a joint venture with Unis to market and sell our current data center storage systems in China and to develop data storage systems for the Chinese market in the future. The joint venture will be 51% owned by Unis and its subsidiary, Unissoft (Wuxi) Group Co. Ltd., and 49% by us. The joint venture is expected to become operational by the fourth quarter of fiscal 2016, pending regulatory approvals.

Planned SanDisk Merger

On October 21, 2015, we entered into an Agreement and Plan of Merger with SanDisk (the "Merger Agreement"), a global leader in NAND flash storage solutions, pursuant to which a subsidiary of our company will merge with and into SanDisk, with SanDisk surviving as a wholly owned subsidiary of our company. The merger is primarily intended to deepen our expertise in non-volatile memory and enable us to vertically integrate into NAND, securing long-term access to solid state technology at a lower cost.

The Merger Agreement values SanDisk's outstanding common stock at a value of $86.50 per share, or a total equity value of approximately $18.9 billion, based on the volume weighted average price of our common stock for the five trading days ending on October 20, 2015. If the Unis Investment (see "Investment by Unis" below) closes prior to the merger, we will pay $85.10 per share in cash and issue 0.0176 shares of our common stock per share of SanDisk’s common stock; and if the Unis Investment has not occurred or has been terminated, we will pay $67.50 per share in cash and issue 0.2387 shares of our common stock per share of SanDisk’s common stock. The above allocation between cash and shares of our common stock is subject to reallocation, at our election, if the amount of cash that SanDisk has available at the closing of the merger falls below certain thresholds.

The merger consideration will be financed by a mix of cash, new debt financing and issuance of our common stock. In connection with the merger, we expect to enter into new debt facilities totaling $18.1 billion. The proceeds from the new debt facilities are expected to be used to pay part of the purchase price, refinance existing debt of both our company and SanDisk and pay transaction related fees and expenses.

Consummation of the merger is subject to customary closing conditions, including without limitation: (i) the required approval by SanDisk shareholders and, if the Unis Investment has not occurred or has been terminated, approval by our shareholders; (ii) the expiration or early termination of the waiting period applicable to the consummation of the merger under the Hart Scott Rodino Antitrust Improvements Act of 1976, as amended (“HSR Act”), which expired on January 15, 2016, and the receipt of regulatory clearance under the foreign antitrust laws of the People's Republic of China, the European Union, Japan, South Africa, South Korea, Taiwan and Turkey; and (iii) if the Unis Investment has not been terminated and is a “covered transaction” for U.S. Committee on Foreign Investment in the United States ("CFIUS") purposes, or if CFIUS otherwise requests or requires a filing with respect to the merger, the approval of CFIUS. Clearance was obtained in Japan on January 22, 2016, in Taiwan on February 1, 2016 and in the European Union on February 4, 2016. Clearance was obtained in Singapore on January 19, 2016. In certain circumstances, a termination fee of up to $1.06 billion may be payable by the Company or a termination fee of up to $553.3 million may be payable by SanDisk, upon termination of the transaction as more fully described in the Merger Agreement. The merger is expected to close in the fourth quarter of fiscal 2016.

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MOFCOM Decision

In connection with the regulatory approval process of the Hitachi Global Storage Technologies Holdings Pte. Ltd. ("HGST") acquisition, which closed on March 8, 2012, we agreed to certain conditions required by MOFCOM, including adopting measures to maintain HGST as an independent competitor until MOFCOM agreed otherwise. Accordingly, since March 2012, we have operated our global business through two independent subsidiaries — HGST and WD. In March 2014, we submitted an application to MOFCOM to lift the condition it imposed on us to operate these businesses separately. On October 19, 2015, MOFCOM issued a decision in response to our application that permits us to integrate our HGST and WD subsidiaries, except that we committed to maintain two sales teams that will separately offer products under the WD or HGST brands for two years from the date of the decision. We began integration planning activities immediately following the MOFCOM decision and integration is expected to occur through the end of calendar year 2017.

Investment by Unis

On September 30, 2015, we announced that we had entered into an agreement with Unis and Unis Union Information System Ltd., a subsidiary of Unis ("Investor"), pursuant to which Investor will make a $3.8 billion equity investment in our company (the "Unis Investment"). Under the terms of the agreement for the Unis Investment, Investor has agreed to purchase 40,814,802 shares of newly issued common stock at a price of $92.50 per share and has agreed to a five-year position standstill, voting restrictions, and a five-year lock-up on its shares, with a limited number becoming available for transfer each year. Following the closing of the investment, Unis will have the right to nominate one representative for election to our Board of Directors, so long as Unis holds more than 10% of the issued and outstanding shares of our common stock. The performance of Investor’s obligations pursuant to the agreement, including payment of the purchase price for the shares, is guaranteed by Unis. The closing of the Unis Investment is subject to clearance by CFIUS, the receipt of requisite regulatory approvals, including clearance by U.S. antitrust authorities and certain Chinese regulatory approvals, approval of the transaction by shareholders of Unis and other customary closing conditions. In November 2015, we and Unis withdrew from the CFIUS clearance process and refiled the notice with CFIUS in January 2016. We expect to receive a determination from CFIUS in February 2016. Although approval from Unis shareholders and approval from some of the Chinese regulatory authorities have been received, we cannot provide assurance that CFIUS clearance will be received or the other conditions to the completion of the Unis Investment will be satisfied in a timely manner or at all.

Second Quarter Overview

For the quarter ended January 1, 2016, we believe that overall HDD industry shipments totaled approximately 115 million units, down 18% from the prior-year period and down 3% from the quarter ended October 2, 2015. These decreases are the result of a softer demand environment largely driven by a challenging global economic environment.

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



	Three Months Ended								Six Months Ended
	January 1, 2016				January 2, 2015				January 1, 2016				January 2, 2015
Net revenue	$	3,317	100.0	%	$	3,888	100.0	%	$	6,677	100.0	%	$	7,831	100.0	%
Gross profit	906		27.3		1,110		28.5		1,861		27.9		2,259		28.8
Total operating expenses	655		19.7		644		16.6		1,288		19.3		1,324		16.9
Operating income	251		7.6		466		12.0		573		8.6		935		11.9
Net income	251		7.6		438		11.3		534		8.0		861		11.0

The following is a summary of our financial performance for the second quarter of fiscal 2016:


•	Consolidated net revenue totaled $3.3 billion.


•	Net revenue derived from enterprise SSDs was $270 million as compared to $187 million in the prior-year period.


•	HDD shipments decreased 19% from the prior-year period to 49.7 million units.


•	Gross margin decreased to 27.3% as compared to 28.5% in the prior-year period.


•	Operating income decreased to $251 million as compared to $466 million in the prior-year period.


•	We generated $598 million in cash flow from operations and ended the quarter with $5.4 billion in cash and cash equivalents.

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Results of Operations

Net Revenue



	Three Months Ended								Six Months Ended
(in millions, except percentages and average selling price)	January 1, 2016			January 2, 2015			Percentage Change		January 1, 2016			January 2, 2015			Percentage Change
Net revenue	$	3,317		$	3,888		(15	)%	$	6,677		$	7,831		(15	)%
Average selling price (per unit)*	$	61		$	60		2	%	$	61		$	59		3	%
Revenues by Geography (%)
Americas	31		%	27		%			31		%	27		%
Europe, Middle East and Africa	23			24					22			23
Asia	46			49					47			50
Revenues by Channel (%)
OEM	65		%	63		%			66		%	63		%
Distributors	21			23					21			24
Retailers	14			14					13			13
Unit Shipments*
PC	27.8			36.6					55.3			76.3
Non-PC	21.9			24.4					46.1			49.5
Total units shipped	49.7			61.0			(19	)%	101.4			125.8			(19	)%



*	Based on sales of HDD units only.

For the quarter ended January 1, 2016, net revenue was $3.3 billion, a decrease of 15% from the prior-year period. Total hard drive shipments decreased to 49.7 million units for the quarter ended January 1, 2016 as compared to 61.0 million units in the prior-year period. For the six months ended January 1, 2016, net revenue was $6.7 billion, a decrease of 15% from the prior-year period. Total hard drive shipments decreased to 101.4 million units for the six months ended January 1, 2016 as compared to 125.8 million units in the prior-year period. These decreases in revenue were primarily the result of a softer demand environment largely driven by a challenging global economic environment, partially offset by an increase in the average selling price ("ASP") for HDDs due to changes in product mix. Additionally, the first fiscal quarter of the prior year included an additional week of revenue due to a 14-week quarter. For the quarter ended January 1, 2016, the ASP for HDDs increased to $61 compared to the prior-year period ASP for HDDs of $60. For the six months ended January 1, 2016, the ASP for HDDs increased to $61 compared to the prior-year period ASP for HDDs of $59.

Changes in net revenue by geography and channel generally reflect normal fluctuations in market demand and competitive dynamics. For both the three and six months ended January 1, 2016, no one company accounted for 10% or more of our net revenue. For both the three and six months ended January 2, 2015, Hewlett-Packard Company accounted for approximately 11% 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. Total sales incentive and marketing programs have ranged from 7% to 13% of gross revenues per quarter since the first quarter of fiscal 2014. For the three and six months ended January 1, 2016, these programs represented 13% and 12% of gross revenues, respectively, as compared to 10% and 9% in the respective prior-year periods. These amounts generally vary according to several factors, including industry conditions, seasonal demand, competitor actions, channel mix and overall availability of product. 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 0.6% of quarterly gross revenue since the first quarter of fiscal 2014.

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Gross Margin



	Three Months Ended								Six Months Ended
(in millions, except percentages)	January 1, 2016			January 2, 2015			Percentage Change		January 1, 2016			January 2, 2015			Percentage Change
Net revenue	$	3,317		$	3,888		(15	)%	$	6,677		$	7,831		(15	)%
Gross profit	906			1,110			(18	)%	1,861			2,259			(18	)%
Gross margin	27.3		%	28.5		%			27.9		%	28.8		%

For the three months ended January 1, 2016, gross margin decreased to 27.3%, as compared to 28.5% for the prior-year period. For the six months ended January 1, 2016, gross margin decreased to 27.9%, as compared to 28.8% for the prior-year period. These decreases in gross margin were primarily the result of a change in product mix and the absorption impact due to lower volume.

Operating Expenses



	Three Months Ended						Six Months Ended
(in millions, except percentages)	January 1, 2016		January 2, 2015		Percentage Change		January 1, 2016		January 2, 2015		Percentage Change
R&D expense	$	389	$	426	(9	)%	$	774	$	863	(10	)%
SG&A expense	207		164		26	%	399		384		4	%
Charges related to arbitration award	32		1		3,100	%	32		15		113	%
Employee termination, asset impairment and other charges	27		53		(49	)%	83		62		34	%
Total operating expenses	$	655	$	644			$	1,288	$	1,324

Research and development (“R&D”) expense was $389 million for the three months ended January 1, 2016, a decrease of $37 million from the prior-year period. This decrease was primarily the result of reductions in our R&D costs as a result of our business realignment initiatives from the prior-year period. R&D expense was $774 million for the six months ended January 1, 2016, a decrease of $89 million from the prior-year period. This decrease was primarily the result of an additional week of operating expenses during the first fiscal quarter of the prior year and reductions in our R&D costs as a result of our business realignment initiatives from the prior-year period. As a percentage of net revenue, R&D expense was 11.7% and 11.6% in the three and six months ended January 1, 2016, as compared to 11.0% in both the respective prior-year periods.

Selling, general and administrative (“SG&A”) expense was $207 million for the three months ended January 1, 2016, an increase of $43 million from the prior-year period. This increase was primarily the result of acquisition-related expenses and charges incurred as part of cost-saving initiatives. SG&A expense was $399 million for the six months ended January 1, 2016, an increase of $15 million from the prior-year period. This increase was primarily the result of acquisition-related expenses and charges incurred as part of cost-saving initiatives, partially offset by an additional week of operating expenses during the first fiscal quarter of the prior year. SG&A expense as a percentage of net revenue was 6.2% and 6.0% in the three and six months ended January 1, 2016, respectively, as compared to 4.2% and 4.9% in the respective prior-year periods.

During both the three and six months ended January 1, 2016, we recorded $32 million of additional interest charges related to an arbitration award for claims brought against us and a now former employee of ours by Seagate Technology LLC, as compared to $1 million and $15 million in the respective prior-year periods. For additional information, refer to Part I, Item 1, Note 5 of the Notes to Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.

During the three and six months ended January 1, 2016, we recorded employee termination, asset impairment and other charges of $27 million and $83 million, respectively, in order to realign our operations with anticipated market demand, as compared to $53 million and $62 million in the respective prior-year periods. For additional information, refer to Part I, Item 1, Note 12 of the Notes to Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.

Other Income (Expense)

Other expense, net for the three and six months ended January 1, 2016 was $7 million and $15 million, respectively, as compared to $8 million and $17 million in the respective prior-year periods. Interest and other income for the three and six months ended January 1, 2016 increased $2 million and $3 million, respectively, as compared to the prior-year periods due to a higher average daily invested cash balance. Interest and other expense for both the three and six months ended January 1, 2016 increased $1 million, as compared to both the prior-year periods due to interest on a higher debt balance.

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Income Tax Provision

We had an income tax benefit of $7 million and income tax expense of $24 million in the three and six months ended January 1, 2016, respectively. Our income tax expense for the three and six months ended January 2, 2015 was $20 million and $57 million, respectively. Our tax provision for both the three and six months ended January 1, 2016 reflects a tax benefit of $30 million for the retroactive extension of the U.S. Federal R&D tax credit that was permanently signed into law on December 19, 2015 and a tax benefit of $34 million from restructuring activities. The remaining 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 2016 through 2025 and the current year generation of income tax credits. For additional information, refer to Part I, Item 1, Note 6 of the Notes to Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.

Liquidity and Capital Resources

We ended the second quarter of fiscal 2016 with total cash and cash equivalents of $5.4 billion. The following table summarizes our statements of cash flows (in millions):



	Six Months Ended
	January 1, 2016			January 2, 2015
Net cash flow provided by (used in):
Operating activities	$	1,143		$	1,070
Investing activities	(454		)	(254		)
Financing activities	(350		)	(718		)
Net increase in cash and cash equivalents	$	339		$	98

Our investment policy is to manage our investment portfolio to preserve principal and liquidity while maximizing return through the full investment of available funds. 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, 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.

As discussed above under Recent Developments, in connection with the planned SanDisk merger, we expect to enter into new debt facilities totaling $18.1 billion. We have received commitments for a $1.0 billion revolving credit facility, $3.0 billion in amortizing term loans, $6.0 billion in other term loans and $8.1 billion in secured and unsecured bridge facilities. We expect to issue approximately $5.1 billion in secured and unsecured notes in lieu of drawing the bridge facilities at close, with the balance of the bridge facilities to be repaid with available cash. The proceeds from the new debt facilities are expected to be used to pay a portion of the SanDisk merger consideration, refinance existing debt of both our company and SanDisk and pay transaction related fees and expenses. Also as discussed above under Recent Developments, on September 29, 2015, we entered into an agreement with Unis under which a subsidiary of Unis will make a $3.8 billion equity investment in our company. The closing of the Unis Investment is subject to clearance by CFIUS, the receipt of requisite regulatory approvals, including clearance by U.S. antitrust authorities and certain Chinese regulatory approvals, approval of the transaction by shareholders of Unis and other customary closing conditions.

A total of $4.9 billion and $4.3 billion of our cash and cash equivalents was held outside of the United States as of January 1, 2016 and July 3, 2015, respectively. Substantially all of the amounts held outside of the United States are intended to be indefinitely reinvested in foreign operations. Our current plans do not anticipate that we will need funds generated from foreign operations to fund our domestic operations or dividends to our shareholders pursuant to our quarterly cash dividend policy. 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 $1.1 billion during both the six months ended January 1, 2016 and January 2, 2015. 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 for working capital changes was $3 million for the six months ended January 1, 2016, as compared to $475 million used for working capital changes in the prior-year period. The decline in net cash used for working capital changes compared to the prior-year period was primarily attributable to the payment of the Seagate arbitration award in the six months ended January 2, 2015.

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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:



	Six Months Ended
	January 1, 2016		January 2, 2015
Days sales outstanding	47		45
Days in inventory	48		44
Days payables outstanding	(71	)	(70	)
Cash conversion cycle	24		19

For the six months ended January 1, 2016, our days sales outstanding (“DSOs”) increased by 2 days, days in inventory (“DIOs”) increased by 4 days, and days payable outstanding (“DPOs”) increased by 1 day compared to the prior year period. Changes in DSOs are generally due to the linearity of shipments. Changes in DIOs are generally related to the timing of inventory builds. 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 term modifications through negotiations with our vendors or by granting to, or receiving from, our vendors’ payment term accommodations.

Investing Activities

Net cash used in investing activities for the six months ended January 1, 2016 was $454 million as compared to $254 million used in investing activities in the prior-year period. Net cash used in investing activities for the six months ended January 1, 2016 consisted of $408 million related to the purchase of investments, $300 million of capital expenditures and a net $12 million of other investing activities, partially offset by $266 million of proceeds from sales and maturities of investments. Net cash used in investing activities for the six months ended January 2, 2015 consisted of $595 million related to the purchase of investments, $306 million of capital expenditures and $6 million related to an immaterial acquisition, net of cash acquired, partially offset by $630 million of proceeds from sales and maturities of investments, $7 million of proceeds from the sale of property, plant and equipment and $16 million, net for other investing activities.

Financing Activities

Net cash used in financing activities for the six months ended January 1, 2016 was $350 million as compared to $718 million used in financing activities in the prior-year period. Net cash used in financing activities for the six months ended January 1, 2016 consisted of $231 million used to pay dividends on our common stock, $63 million used to make principal payments on the term loan facility, $60 million used to repurchase shares of our common stock, partially offset by a net $4 million provided by employee stock plans. Net cash used in financing activities for the six months ended January 2, 2015 consisted of $532 million used to repurchase shares of our common stock, $187 million used to pay dividends on our common stock and $63 million used to make principal payments on the term loan facility, partially offset by a net $64 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.

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Contractual Obligations and Commitments

Debt — As of January 1, 2016, we had $255 million outstanding on our revolving credit facility and $2.3 billion outstanding on our term loan facility. On January 15, 2016, we repaid the outstanding balance of $255 million under the revolving credit facility. We are required to make quarterly principal payments on the term loan facility totaling $94 million for the remainder of fiscal 2016, $219 million in fiscal 2017, $250 million in fiscal 2018 and the remaining balance of $1.7 billion in fiscal 2019. As of January 1, 2016, under our credit agreement, we were in compliance with all covenants. In connection with the planned SanDisk merger, we expect to enter into debt facilities totaling $18.1 billion, including a $1.0 billion revolving credit facility. The proceeds from the debt facilities are expected to be used to pay a portion of the SanDisk merger consideration, refinance existing debt of both our company and SanDisk and pay transaction-related fees and expenses. For additional information on our outstanding debt, refer to Part I, Item 1, Note 4 of 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.

Refer to Part II, Item 7 of our Annual Report on Form 10-K for the year ended July 3, 2015, 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 January 1, 2016, the amount of unrecognized tax benefits was $375 million, of which $272 million could result in potential cash payments. We are not able to provide a reasonable estimate of the timing of future tax payments related to these obligations. 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 — Our Board of Directors previously authorized a stock repurchase program. Effective October 21, 2015, in connection with the planned SanDisk merger, we suspended this stock repurchase program. For additional information, refer to Part II, Item 2, Issuer Purchases of Equity Securities in this Quarterly Report on Form 10-Q.

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Cash Dividend Policy — Since the first quarter of fiscal 2014, we have issued a quarterly cash dividend. We may modify, suspend or cancel our cash dividend policy in any manner and at any time. For additional information, refer to Part I, Item 1, Note 9 of the Notes to Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.

Critical Accounting Policies and Estimates

We have prepared the unaudited condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States. The preparation of the financial statements requires the use of judgments and estimates that affect the reported amounts of revenues, expenses, assets, liabilities and shareholders’ equity. We have adopted accounting policies and practices that are generally accepted in the industry in which we operate. If these estimates differ significantly from actual results, the impact to the condensed consolidated financial statements may be material. For example, we test goodwill for impairment annually as of the first day of our fourth fiscal quarter and at other times if events have occurred or circumstances exist that indicate the carrying value of goodwill may no longer be recoverable. Given the recent volatility of our market capitalization, it is possible that our goodwill could become impaired in the near term which could result in a material charge and adversely affect our results of operations.

There have been no material changes in our critical accounting policies and estimates since our fiscal year ended July 3, 2015. Please refer to Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended July 3, 2015 for a discussion of our critical accounting policies and estimates.

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 1, Note 13 of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

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, 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 speculative or trading purposes. For additional information, refer to Part I, Item 1, Note 8 of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

As of January 1, 2016, 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	$	155		121.26	$	1
Malaysian Ringgit	$	118		4.06	$	(5	)
Philippine Peso	$	50		46.91	$	—
Singapore Dollar	$	43		1.41	$	—
Thai Baht	$	582		35.47	$	(8	)
Fair value hedges:
British Pound Sterling	$	(7	)