Document

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 December 29, 2017
Or
o
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
 
 
wdcorporatelogo.jpg
WESTERN DIGITAL CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
 
 
Delaware
33-0956711
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
5601 Great Oaks Parkway
San Jose, California
95119
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (408) 717-6000
 
 
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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
ý
Accelerated filer
¨
Non-accelerated filer
¨
Smaller reporting company
¨
Emerging growth company
¨
 
 
(Do not check if a smaller reporting company)
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
As of the close of business on January 30, 2018, 297,560,299 shares of common stock, par value $0.01 per share, were outstanding.


WESTERN DIGITAL CORPORATION
INDEX

 
 
PAGE NO.
PART I. FINANCIAL INFORMATION
 
 
 
Item 1.
Financial Statements (unaudited)
 
 
Condensed Consolidated Balance Sheets — As of December 29, 2017 and June 30, 2017
 
Condensed Consolidated Statements of Operations — Three and Six Months Ended December 29, 2017 and December 30, 2016
 
Condensed Consolidated Statements of Comprehensive Loss — Three and Six Months Ended December 29, 2017 and December 30, 2016
 
Condensed Consolidated Statements of Cash Flows — Six Months Ended December 29, 2017 and December 30, 2016
 
Notes to Condensed Consolidated Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
 
 
 
PART II. OTHER INFORMATION
Item 1.
Legal Proceedings
Item 1A.
Risk Factors
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.
Defaults Upon Senior Securities
Item 4.
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits

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

WDC, a Delaware corporation, is the parent company of our data storage business. Our principal executive offices are located at 5601 Great Oaks Parkway, San Jose, California 95119. Our telephone number is (408) 717-6000, and our website is www.wdc.com. The information on our website is not incorporated in this Quarterly Report on Form 10-Q.

Western Digital, WD, SanDisk, Tegile, and Upthere are registered trademarks or trademarks of Western Digital or its affiliates in the U.S. and/or other countries. All other trademarks, registered trademarks and/or service marks, indicated or otherwise, are the property of their respective owners.


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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 integration of, and anticipated benefits from, our acquisition of SanDisk Corporation;
•
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 in October 2015;
•
expectations regarding our Flash Ventures joint venture with Toshiba Memory Corporation;
•
our quarterly cash dividend policy;
•
expectations regarding our product development and technology plans;
•
expectations regarding the outcome of legal proceedings in which we are involved;
•
expectations regarding the impact of the Tax Cuts and Jobs Act enacted on December 22, 2017 on the Company;
•
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;
•
expectations regarding capital investments and sources of funding for those investments;
•
expectations regarding the outcome and anticipated benefits of the announced Refinancing Transactions (as defined below); and
•
our beliefs regarding the sufficiency of our available liquidity to meet our working capital, debt, dividend and capital expenditure needs.

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


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PART I. FINANCIAL INFORMATION

Item 1.
Financial Statements (unaudited)

WESTERN DIGITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions, except par value)
(Unaudited)
 
December 29,
2017
 
June 30,
2017
ASSETS
Current assets:
 
 
 
Cash and cash equivalents
$
6,272

 
$
6,354

Short-term investments
23

 
24

Accounts receivable, net
2,052

 
1,948

Inventories
2,281

 
2,341

Other current assets
485

 
389

Total current assets
11,113

 
11,056

Property, plant and equipment, net
3,054

 
3,033

Notes receivable and investments in Flash Ventures
1,845

 
1,340

Goodwill
10,076

 
10,014

Other intangible assets, net
3,230

 
3,823

Other non-current assets
522

 
594

Total assets
$
29,840

 
$
29,860

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
 
 
 
Accounts payable
$
1,921

 
$
2,144

Accounts payable to related parties
250

 
206

Accrued expenses
1,191

 
1,069

Accrued compensation
523

 
506

Accrued warranty
194

 
186

Current portion of long-term debt
274

 
233

Total current liabilities
4,353

 
4,344

Long-term debt
11,777

 
12,918

Other liabilities
2,438

 
1,180

Total liabilities
18,568

 
18,442

Commitments and contingencies (Notes 6, 8, 10 and 13)

 

Shareholders’ equity:
 
 
 
Preferred stock, $0.01 par value; authorized — 5 shares; issued and outstanding — none
—

 
—

Common stock, $0.01 par value; authorized — 450 shares; issued — 312 shares; outstanding — 297 shares and 294 shares, respectively
3

 
3

Additional paid-in capital
4,410

 
4,506

Accumulated other comprehensive loss
(46
)
 
(58
)
Retained earnings
8,250

 
8,633

Treasury stock — common shares at cost; 15 shares and 18 shares, respectively
(1,345
)
 
(1,666
)
Total shareholders’ equity
11,272

 
11,418

Total liabilities and shareholders’ equity
$
29,840

 
$
29,860


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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WESTERN DIGITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share amounts)
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
December 29,
2017
 
December 30,
2016
 
December 29,
2017
 
December 30,
2016
Revenue, net
$
5,336

 
$
4,888

 
$
10,517

 
$
9,602

Cost of revenue
3,323

 
3,355

 
6,591

 
6,734

Gross profit
2,013

 
1,533

 
3,926

 
2,868

Operating expenses:
 
 
 
 
 
 
 
Research and development
629

 
585

 
1,221

 
1,224

Selling, general and administrative
381

 
358

 
745

 
754

Employee termination, asset impairment, and other charges
48

 
45

 
100

 
113

Total operating expenses
1,058

 
988

 
2,066

 
2,091

Operating income
955

 
545

 
1,860

 
777

Interest and other income (expense):
 
 
 
 
 
 
 
Interest income
14

 
5

 
30

 
10

Interest expense
(197
)
 
(205
)
 
(402
)
 
(441
)
Other income (expense), net
2

 
(24
)
 
(4
)
 
(296
)
Total interest and other expense, net
(181
)
 
(224
)
 
(376
)
 
(727
)
Income before taxes
774


321


1,484

 
50

Income tax expense
1,597

 
86

 
1,626

 
181

Net income (loss)
$
(823
)
 
$
235

 
$
(142
)
 
$
(131
)
 
 
 
 
 
 
 
 
Income (loss) per common share
 
 
 
 
 
 
 
Basic
$
(2.78
)
 
$
0.82

 
$
(0.48
)
 
$
(0.46
)
Diluted
$
(2.78
)
 
$
0.80

 
$
(0.48
)
 
$
(0.46
)
Weighted average shares outstanding:
 
 
 
 
 
 
 
Basic
296

 
286

 
295

 
285

Diluted
296

 
294

 
295

 
285

 
 
 
 
 
 
 
 
Cash dividends declared per share
$
0.50

 
$
0.50

 
$
1.00

 
$
1.00


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 LOSS
(in millions)
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
December 29,
2017
 
December 30,
2016
 
December 29,
2017
 
December 30,
2016
Net income (loss)
$
(823
)
 
$
235

 
$
(142
)
 
$
(131
)
Other comprehensive income (loss), before tax:
 
 
 
 
 
 
 
Actuarial pension gain
—

 
1

 
—

 
6

Foreign currency translation adjustment
6

 
(186
)
 
2

 
(169
)
Net unrealized gain (loss) on derivative contracts
10

 
(136
)
 
14

 
(140
)
Net unrealized loss on available-for-sale securities
—

 
—

 
(1
)
 
—

Total other comprehensive income (loss), before tax
16

 
(321
)
 
15

 
(303
)
Income tax benefit (expense) related to items of other comprehensive income (loss), before tax
(3
)
 
9

 
(3
)
 
3

Other comprehensive income (loss), net of tax
13

 
(312
)
 
12

 
(300
)
Total comprehensive loss
$
(810
)
 
$
(77
)
 
$
(130
)
 
$
(431
)

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
 
December 29,
2017
 
December 30,
2016
Cash flows from operating activities
 
 
 
Net loss
$
(142
)
 
$
(131
)
Adjustments to reconcile net loss to net cash provided by operations:
 
 
 
Depreciation and amortization
1,068

 
1,022

Stock-based compensation
196

 
201

Deferred income taxes
(129
)
 
117

Loss on disposal of assets
12

 
10

Write-off of issuance costs and amortization of debt discounts
23

 
258

Loss on convertible debt and related instruments
—

 
5

Non-cash portion of employee termination, asset impairment and other charges
—

 
13

Other non-cash operating activities, net
16

 
42

Changes in:
 
 
 
Accounts receivable, net
(99
)
 
(540
)
Inventories
65

 
52

Accounts payable
(276
)
 
180

Accounts payable to related parties
44

 
6

Accrued expenses
95

 
59

Accrued compensation
17

 
194

Other assets and liabilities, net
1,425

 
12

Net cash provided by operations
2,315

 
1,500

Cash flows from investing activities
 
 
 
Purchases of property, plant and equipment
(416
)
 
(330
)
Proceeds from the sale of property, plant and equipment
10

 
1

Acquisitions, net of cash acquired
(99
)
 
—

Purchases of investments
(57
)
 
(239
)
Proceeds from sale of investments
29

 
55

Proceeds from maturities of investments
16

 
279

Investments in Flash Ventures
—

 
(20
)
Notes receivable issuances to Flash Ventures
(621
)
 
(309
)
Notes receivable proceeds from Flash Ventures
112

 
259

Strategic investments and other, net
19

 
(12
)
Net cash used in investing activities
(1,007
)
 
(316
)
Cash flows from financing activities
 
 
 
Issuance of stock under employee stock plans
99

 
90

Taxes paid on vested stock awards under employee stock plans
(67
)
 
(40
)
Excess tax benefits from employee stock plans
—

 
56

Proceeds from acquired call option
—

 
61

Dividends paid to shareholders
(295
)
 
(284
)
Settlement of debt hedge contracts
28

 
—

Repayment of debt
(4,114
)
 
(8,254
)
Proceeds from debt
2,963

 
3,992

Debt issuance costs
(5
)
 
(7
)
Net cash used in financing activities
(1,391
)
 
(4,386
)
Effect of exchange rate changes on cash
1

 
(9
)
Net decrease in cash and cash equivalents
(82
)
 
(3,211
)
Cash and cash equivalents, beginning of year
6,354

 
8,151

Cash and cash equivalents, end of period
$
6,272

 
$
4,940

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for income taxes
$
140

 
$
43

Cash paid for interest
$
308

 
$
299

Supplemental disclosure of non-cash investing and financing activities:
 
 
 
Accrual of cash dividend declared
$
149

 
$
144


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)

Note 1.
Organization and Basis of Presentation

Western Digital Corporation (“Western Digital” or “the Company”) is a leading developer, manufacturer and provider of data storage devices and solutions that address the evolving needs of the information technology (“IT”) industry and the infrastructure that enables the proliferation of data in virtually every industry. The Company’s broad portfolio of technology and products address the following key markets: Client Devices; Data Center Devices and Solutions; and Client Solutions. The Company also generates license and royalty revenue related to its intellectual property (“IP”), which is included in each of these three categories.

The accounting policies followed by 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 fiscal year ended June 30, 2017. In the opinion of management, all adjustments necessary to fairly state the Condensed Consolidated Financial Statements have been made. All such adjustments are of a normal, recurring nature. Certain information and footnote disclosures normally included in the Consolidated Financial Statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto included in the Company’s Annual Report on Form 10‑K for the fiscal year ended June 30, 2017. The results of operations for interim periods are not necessarily indicative of results to be expected for the full year.

Fiscal Year

The Company’s fiscal year ends on the Friday nearest to June 30 and typically consists of 52 weeks. Fiscal years 2018, which ends on June 29, 2018, and 2017, which ended on June 30, 2017, are both comprised of 52 weeks, with all quarters presented consisting of 13 weeks.

Use of Estimates

Company management has made estimates and assumptions relating to the reporting of certain assets and liabilities in conformity with U.S. GAAP. These estimates and assumptions have been applied using methodologies that are consistent throughout the periods presented. However, actual results could differ materially from these estimates.

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WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Note 2.
Recently Adopted Accounting Pronouncements

In August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-15, “Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”). ASU 2016-15 provides amendments that address eight specific cash flow classification issues for which there exists diversity in practice: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. The Company adopted ASU 2016-15 in the second quarter of 2018 on a modified retrospective basis as required by the standard. The Company’s adoption of ASU 2016-15 did not have a material effect on the Consolidated Financial Statements.

In March 2016, the FASB issued ASU No. 2016-09, “Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). ASU 2016-09 simplifies several aspects of the accounting for stock-based payment transactions and states that, among other things, all excess tax benefits and tax deficiencies should be recognized as income tax expense or benefit in the income statement and an entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur. The Company adopted this standard in the first quarter of 2018 using the modified retrospective approach. This adoption resulted in a one-time net increase to beginning retained earnings of $70 million, consisting of a $58 million cumulative adjustment for the previously unrecognized windfall tax benefits related to previous vesting and exercises of stock-based awards, and a $19 million cumulative adjustment related to the change in accounting policy for estimated forfeitures and share cancellations, partially offset by a decrease of $7 million for the related tax impacts of change in forfeiture policy. In addition, under the new standard, the Company will prospectively reflect the tax deficiencies and benefits as an operating activity, rather than as a financing activity under the previous standard, in the Company’s Consolidated Statements of Cash Flows. For the three and six months ended December 29, 2017, the Company recognized excess tax benefits of $5 million and $27 million, respectively, as a component of its income tax expense.

In March 2016, the FASB issued ASU No. 2016-07, “Investments- Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting” (“ASU 2016-07”). ASU 2016-07 eliminates the requirement to apply the equity method of accounting retrospectively when a reporting entity obtains significant influence over a previously held investment. The Company adopted this standard in the second quarter of 2018. The Company’s adoption of ASU 2016-07 did not have a material impact on its Consolidated Financial Statements.

In July 2015, the FASB issued ASU No. 2015‑11, “Inventory (Topic 330) - Simplifying the Measurement of Inventory” (“ASU 2015‑11”), which dictates that an entity should measure inventory within the scope of this update at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The Company adopted this standard in the first quarter of 2018. The Company’s adoption of ASU 2015‑11 did not have a material impact on its Consolidated Financial Statements.


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WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Note 3.
Supplemental Financial Statement Data

Inventories
 
December 29,
2017
 
June 30,
2017
 
(in millions)
Inventories:
 
 
 
Raw materials and component parts
$
634

 
$
646

Work-in-process
667

 
632

Finished goods
980

 
1,063

Total inventories
$
2,281

 
$
2,341


Property, plant and equipment, net
 
December 29,
2017
 
June 30,
2017
 
(in millions)
Property, plant, and equipment:
 
 
 
Land and buildings
$
1,913

 
$
1,855

Machinery and equipment
7,011

 
6,815

Computer equipment and software
433

 
404

Furniture and fixtures
50

 
49

Leasehold improvements
253

 
259

Construction-in-process
175

 
144

Property, plant and equipment, gross
9,835

 
9,526

Accumulated depreciation
(6,781
)
 
(6,493
)
Property, plant, and equipment, net
$
3,054

 
$
3,033


Goodwill
 
Carrying Amount
 
(in millions)
Balance at June 30, 2017
$
10,014

Goodwill recorded in connection with acquisitions
61

Foreign currency translation adjustment
1

Balance at December 29, 2017
$
10,076


On September 15, 2017, the Company acquired substantially all the assets of Tegile Systems, Inc., a provider of flash and persistent-memory storage solutions for enterprise data center applications. On August 25, 2017, the Company acquired substantially all the assets of Upthere, Inc., a cloud services company. These acquisitions are primarily intended to help meet the evolving needs of customers, while driving long-term growth for the Company's existing data center and client solution products over the long term.


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WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

The aggregate purchase price of acquisitions during the six months ended December 29, 2017 was $99 million in cash, with net assets acquired primarily consisting of developed technology and other intangibles assets, of which $61 million was allocated to goodwill. Goodwill is primarily attributable to the benefits the Company expects to derive from diversifying product offerings to its Data Center Devices and Solutions and Client Solutions end markets as well as the acquired workforce. Goodwill is expected to be deductible for tax purposes because the acquisitions were structured as asset acquisitions but accounted for as business combinations. Concurrent with these acquisitions, the Company received $36 million in proceeds on previously outstanding notes receivable due from these acquired entities.

During the six months ended December 29, 2017, the Company incurred $6 million of transaction expenses related to these acquisitions, which are primarily included within Selling, General and Administrative expenses in the Condensed Consolidated Statements of Operations. Revenues and earnings related to these acquisitions was not material.

Intangible assets
 
December 29,
2017
 
June 30,
2017
 
(in millions)
Finite-lived intangible assets
$
5,814

 
$
5,160

In-process research and development
80

 
696

Accumulated amortization
(2,664
)
 
(2,033
)
Intangible assets, net
$
3,230

 
$
3,823


As part of prior acquisitions, the Company recorded at the time of the acquisition acquired in-process research and development (“IPR&D”) for projects in progress that had not yet reached technological feasibility. IPR&D is initially accounted for as an indefinite-lived intangible asset. Once a project reaches technological feasibility, the Company reclassifies the balance to existing technology and begins to amortize the intangible asset over its estimated useful life. During the three months ended December 29, 2017, two IPR&D projects reached technological feasibility totaling $616 million and commenced amortization over an estimated useful life of 4 years.

Product warranty liability

Changes in the warranty accrual were as follows:
 
Three Months Ended
 
Six Months Ended
 
December 29,
2017
 
December 30,
2016
 
December 29,
2017
 
December 30,
2016
 
(in millions)
Warranty accrual, beginning of period
$
302

 
$
277

 
$
311

 
$
279

Charges to operations
46

 
44

 
90

 
91

Utilization
(43
)
 
(35
)
 
(81
)
 
(80
)
Changes in estimate related to pre-existing warranties
(1
)
 
27

 
(16
)
 
23

Warranty accrual, end of period
$
304

 
$
313

 
$
304

 
$
313


The long-term portion of the warranty accrual classified in Other liabilities was $110 million and $125 million as of December 29, 2017 and June 30, 2017, respectively.


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WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Other liabilities
 
December 29,
2017
 
June 30,
2017
 
(in millions)
Non-current income taxes payable
$
1,425

 
$
—

Other non-current liabilities
1,013

 
1,180

Total other non-current liabilities
$
2,438

 
$
1,180


Accumulated other comprehensive income (loss)

Other comprehensive loss (“OCI”), net of tax refers to expenses, gains and losses that are recorded as an element of shareholders’ equity but are excluded from net income. The following table illustrates the changes in the balances of each component of Accumulated other comprehensive income (loss) (“AOCI”):
 
Actuarial Pension Gains (Losses)
 
Foreign Currency Translation Gains (Losses)
 
Unrealized Gains (Losses) on Available for Sale Securities
 
Unrealized Gains (Losses) on Derivative Contracts
 
Total Accumulated Comprehensive Income (Loss)
 
(in millions)
Balance at June 30, 2017
$
(18
)
 
$
(39
)
 
$
2

 
$
(3
)
 
$
(58
)
Other comprehensive income (loss) before reclassifications
—

 
2

 
(1
)
 
15

 
16

Amounts reclassified from accumulated other comprehensive income
—

 
—

 
—

 
(1
)
 
(1
)
Income tax expense related to items of other comprehensive income
—

 
—

 
—

 
(3
)
 
(3
)
Net current-period other comprehensive income
—

 
2

 
(1
)
 
11

 
12

Balance at December 29, 2017
$
(18
)
 
$
(37
)
 
$
1

 
$
8

 
$
(46
)

During the three and six months ended December 29, 2017, there were no material reclassifications out of AOCI. The following table illustrates the significant amounts of each component reclassified out of AOCI to the Condensed Consolidated Statements of Operations:
 
 
Three Months Ended
 
Six Months Ended
 
 
AOCI Component
 
December 29,
2017
 
December 30,
2016
 
December 29, 2017
 
December 30, 2016
 
Statement of Operations Line Item
 
 
(in millions)
 
 
Unrealized holding gain (loss) on designated hedging activities:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
4

 
$
16

 
$
1

 
$
40

 
Cost of revenue
Foreign exchange contracts
 
—

 
—

 
—

 
2

 
Research and development
Unrealized holding gain on designated hedging activities
 
4

 
16

 
1

 
42

 
 
Total reclassifications for the period
 
$
4

 
$
16

 
$
1

 
$
42

 
 


12
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Note 4.
Fair Value Measurements and Investments

The Company’s total cash, cash equivalents and marketable securities was as follows:
 
December 29,
2017
 
June 30,
2017
 
(in millions)
Cash and cash equivalents
$
6,272

 
$
6,354

Short-term marketable securities
23

 
24

Long-term marketable securities (included within other non-current assets)
94

 
94

Total cash, cash equivalents and marketable securities
$
6,389

 
$
6,472


Financial Instruments Carried at Fair Value

Financial assets and liabilities that are remeasured and reported at fair value at each reporting period are classified and disclosed in one of the following three levels:

Level 1.
Quoted prices in active markets for identical assets or liabilities.

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

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


13
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

The following tables present information about the Company’s financial assets and liabilities that are measured at fair value on a recurring basis as of December 29, 2017 and June 30, 2017, and indicate the fair value hierarchy of the valuation techniques utilized to determine such values:
 
December 29, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in millions)
Assets:
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
3,016

 
$
—

 
$
—

 
$
3,016

Certificates of deposit
—

 
7

 
—

 
7

Total cash equivalents
3,016

 
7

 
—

 
3,023

Short-term investments:
 
 
 
 
 
 
 
Corporate notes and bonds
—

 
15

 
—

 
15

Asset-backed securities
—

 
4

 
—

 
4

Municipal notes and bonds
—

 
1

 
—

 
1

Equity securities
3

 
—

 
—

 
3

Total short-term investments
3

 
20

 
—

 
23

Long-term investments:
 
 
 
 
 
 
 
U.S. Treasury securities
5

 
—

 
—

 
5

U.S. Government agency securities
—

 
5

 
—

 
5

International government securities
—

 
1

 
—

 
1

Corporate notes and bonds
—

 
66

 
—

 
66

Asset-backed securities
—

 
6

 
—

 
6

Municipal notes and bonds
—

 
11

 
—

 
11

Total long-term investments
5

 
89

 
—

 
94

Foreign exchange contracts
—

 
11

 
—

 
11

Interest rate swap contract
—

 
8

 
—

 
8

Total assets at fair value
$
3,024

 
$
135

 
$
—

 
$
3,159

Liabilities:
 
 
 
 
 
 
 
Foreign exchange contracts
$
—

 
$
7

 
$
—

 
$
7

Total liabilities at fair value
$
—

 
$
7

 
$
—

 
$
7



14
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

 
June 30, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in millions)
Assets:
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
2,836

 
$
—

 
$
—

 
$
2,836

Certificates of deposit
—

 
10

 
—

 
10

Total cash equivalents
2,836

 
10

 
—

 
2,846

Short-term investments:
 
 
 
 
 
 
 
Corporate notes and bonds
—

 
11

 
—

 
11

Asset-backed securities
—

 
7

 
—

 
7

Municipal notes and bonds
—

 
2

 
—

 
2

Equity securities
4

 
—

 
—

 
4

Total short-term investments
4

 
20

 
—

 
24

Long-term investments:
 
 
 
 
 
 
 
U.S. Treasury securities
5

 
—

 
—

 
5

U.S. Government agency securities
—

 
5

 
—

 
5

International government securities
—

 
1

 
—

 
1

Corporate notes and bonds
—

 
67

 
—

 
67

Asset-backed securities
—

 
7

 
—

 
7

Municipal notes and bonds
—

 
9

 
—

 
9

Total long-term investments
5

 
89

 
—

 
94

Foreign exchange contracts
—

 
16

 
—

 
16

Total assets at fair value
$
2,845

 
$
135

 
$
—

 
$
2,980

Liabilities:
 
 
 
 
 
 
 
Foreign exchange contracts
$
—

 
$
8

 
$
—

 
$
8

Interest rate swap contract
—

 
1

 
—

 
1

Exchange options
—

 
—

 
1

 
1

Total liabilities at fair value
$
—

 
$
9

 
$
1

 
$
10


During the three and six months ended December 29, 2017, the Company had no transfers of financial assets and liabilities between Level 1 and Level 2.

Available-for-Sale Securities

The cost basis of the Company’s investments classified as available-for-sale securities, individually and in the aggregate, approximated its fair value as of December 29, 2017 and June 30, 2017. The cost basis and fair value of the Company’s investments classified as available-for-sale securities as of December 29, 2017, by remaining contractual maturity, were as follows:
 
Cost Basis
 
Fair Value
 
(in millions)
Due in less than one year (short-term investments)
$
24

 
$
23

Due in one to five years (included in other non-current assets)
94

 
94

Total
$
118

 
$
117


The Company determined available-for-sale securities had no material other-than-temporary impairments in the three and six months ended December 29, 2017 or December 30, 2016.


15
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Financial Instruments Not Carried at Fair Value

For financial instruments where the carrying value (which includes principal adjusted for any unamortized issuance costs, and discounts or premiums) differs from fair value (which is based on quoted market prices), the following table represents the related carrying value and fair value for each of the Company’s outstanding financial instruments. Each of the financial instruments presented below was categorized as Level 2 for all periods presented, based on the frequency of trading immediately prior to the end of the second quarter of 2018 and the fourth quarter of 2017, respectively.
 
December 29, 2017
 
June 30, 2017
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
 
(in millions)
Secured Notes
$
1,838

 
$
2,026

 
$
1,835

 
$
2,062

Unsecured Notes
3,252

 
3,892

 
3,244

 
3,956

Term Loan A
3,978

 
4,040

 
4,074

 
4,130

U.S. Term Loan B-2
—

 
—

 
2,968

 
2,989

U.S Term Loan B-3
2,952

 
2,966

 
—

 
—

Euro Term Loan B-2(1)
—

 
—

 
1,000

 
1,010

Convertible Debt 2020
31

 
33

 
30

 
34

Total
$
12,051

 
$
12,957

 
$
13,151

 
$
14,181

 
 
(1) 
Euro Term Loan B-2 outstanding principal amount as of June 30, 2017 was based upon the Euro to U.S. dollar exchange rate as of that respective date.

Cost Method Investments

From time to time, the Company enters into certain strategic investments for the promotion of business and strategic objectives. The Company reports these investments under the cost method of accounting as it does not have a significant influence over the operations of these investees. These investments consist of debt and equity securities of privately-held companies which do not have a readily determinable fair value and are carried at historical cost. The Company assesses these securities for indications of other-than-temporary impairments. There were no impairment charges during the three months ended December 29, 2017 and $6 million of impairment charges for the six months ended December 29, 2017, which were included in Other income (expense), net in the Condensed Consolidated Statements of Operations. As of December 29, 2017 and June 30, 2017, these investments aggregated $57 million and $91 million, respectively, and are reported under Other non-current assets in the Condensed Consolidated Balance Sheets.


16
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Note 5.
Derivative Instruments and Hedging Activities

As of December 29, 2017, the Company had outstanding foreign exchange forward contracts which were designated as either cash flow hedges or non-designated hedges. The contract maturity dates of these foreign exchange forward contracts do not exceed 12 months. In addition, the Company had outstanding interest rate swaps which were designated as cash flow hedges. 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 December 29, 2017 and December 30, 2016.

As of December 29, 2017, the amount of existing net gains related to cash flow hedges recorded in AOCI that are expected to be reclassified into earnings over the next twelve months was $8 million. In addition, as of December 29, 2017, the Company did not have any foreign exchange forward contracts with credit-risk-related contingent features.

A change in the fair value of non-designated hedges is recognized in earnings in the period incurred and is reported as a component of Other income (expense), net. The changes in fair value on these contracts were immaterial to the Condensed Consolidated Financial Statements for the three and six months ended December 29, 2017 and December 30, 2016.

Derivative Instruments

The fair value and balance sheet location of the Company’s derivative instruments were as follows:
 
Derivative Assets
 
Other current assets
 
December 29,
2017
 
June 30,
2017
 
(in millions)
Foreign exchange forward contracts, designated
$
6

 
$
6

Foreign exchange forward contracts, not designated
5

 
10

Interest rate swaps, designated
8

 
—

Total derivatives
$
19

 
$
16


 
Derivative Liabilities
 
Accrued expenses
 
December 29,
2017
 
June 30,
2017
 
(in millions)
Foreign exchange forward contracts, designated
$
4

 
$
2

Foreign exchange forward contracts, not designated
3

 
6

Interest rate swaps, designated
—

 
1

Total derivatives
$
7

 
$
9


Netting Arrangements

Under certain provisions and conditions within agreements with counterparties to the Company’s foreign exchange forward contracts, subject to applicable requirements, the Company has the right of offset associated with the Company’s foreign exchange forward contracts and is allowed to net settle transactions of the same currency with a single net amount payable by one party to the other. As of December 29, 2017 and June 30, 2017, the effect of rights of offset was not material and the Company did not offset or net the fair value amounts of derivative instruments in its Condensed Consolidated Balance Sheets.


17
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Effect of Derivative Contracts on the Condensed Consolidated Statements of Operations

The impact of derivative contracts designated as hedging instruments on the Condensed Consolidated Financial Statements was as follows:
 
Amount of Gain (Loss) Recognized in AOCI
 
Amount of Gain (Loss) Recognized in AOCI
 
Three Months Ended
 
Six Months Ended
 
December 29,
2017
 
December 30,
2016
 
December 29,
2017
 
December 30,
2016
 
(in millions)
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
Foreign exchange forward contracts
$
7

 
$
(119
)
 
$
7

 
$
(97
)
Interest rate swaps
7

 
—

 
8

 
—

Total
$
14

 
$
(119
)
 
$
15

 
$
(97
)

 
Amount of Gain (Loss) Reclassified from AOCI into Earnings
 
Amount of Gain (Loss) Reclassified from AOCI into Earnings
 
Three Months Ended
 
Six Months Ended
 
December 29,
2017
 
December 30,
2016
 
December 29,
2017
 
December 30,
2016
 
(in millions)
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
Foreign exchange forward contracts
$
4

 
$
16

 
$
1

 
$
42

Total
$
4

 
$
16

 
$
1

 
$
42


The total net realized transaction and foreign exchange forward contract currency gains and losses were not material to the Condensed Consolidated Financial Statements for the three and six months ended December 29, 2017 and December 30, 2016.


18
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Note 6.
Debt

Debt consisted of the following as of December 29, 2017 and June 30, 2017:
 
December 29,
2017
 
June 30,
2017
 
(in millions)
Variable interest rate Term Loan A maturing 2021
$
4,022

 
$
4,125

Variable interest rate U.S. Term Loan B-2 maturing 2023
—

 
2,970

Variable interest rate U.S. Term Loan B-3 maturing 2023
2,955

 
—

Variable interest rate Euro Term Loan B-2 maturing 2023(1)
—

 
1,001

7.375% senior secured notes due 2023
1,875

 
1,875

10.500% senior unsecured notes due 2024
3,350

 
3,350

Convertible senior notes
35

 
35

Total debt
12,237

 
13,356

Issuance costs and debt discounts
(186
)
 
(205
)
Subtotal
12,051

 
13,151

Less current portion of long-term debt
(274
)
 
(233
)
Long-term debt
$
11,777

 
$
12,918

 
 
(1) 
Euro Term Loan B-2 outstanding principal amount as of June 30, 2017 was based upon the Euro to U.S. dollar exchange rate as of that respective date.

On November 29, 2017, the Company entered into an amendment to the credit agreement entered into on April 29, 2016 (as amended, the “Credit Agreement”), to increase the size of its existing $1.0 billion revolving credit facility by $500 million to $1.5 billion. The term of the revolving credit facility remained unchanged and will mature on April 29, 2021. As of December 29, 2017, there were no borrowings under the revolving credit facility.

On November 17, 2017, the Company settled in full the principal amounts of the Euro Term Loan B-2, plus accrued interest, using cash on hand. On November 8, 2017, the Company borrowed $2.96 billion under a new U.S. dollar-denominated term loan (“U.S. Term Loan B-3”) under its Credit Agreement and used the proceeds of this new loan to prepay in full the U.S. Term Loan B-2 previously outstanding under the Credit Agreement. The U.S. Term Loan B-3 has an interest rate equal to, at the Company’s option, either an adjusted LIBOR rate, subject to a 0.00% floor, plus 2.00% or a base rate plus 1.00% (3.57% as of December 29, 2017). Principal payments on U.S. Term Loan B-3 of 0.25% are due quarterly and began on December 29, 2017 with the balance due on April 29, 2023. The U.S. Term Loan B-3 issuance costs are amortized to interest expense over the term of the loan and as of December 29, 2017, issuance costs of $3 million remain unamortized. In connection with the settlements of the U.S. Term Loan B-2 and Euro Term Loan B-2, the Company recognized an aggregate loss on debt extinguishment of $2 million consisting of unamortized issuance costs.

The Credit Agreement requires the Company to comply with certain financial covenants, such as a leverage ratio and an interest coverage ratio. As of December 29, 2017, the Company was in compliance with all financial covenants. In addition, the documents governing substantially all of the Company’s outstanding debt, including the Credit Agreement, require the Company to comply with customary covenants that limit or restrict the Company’s and its subsidiaries’ ability to incur liens and indebtedness; make certain restricted payments, acquisitions, investments, loans and guarantees; and enter into certain transactions with affiliates, mergers and consolidations.


19
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Note 7.
Pension and Other Post-Retirement Benefit Plans

The Company has pension and other post-retirement benefit plans in various countries. The Company’s principal pension plans are in Japan. All pension and other post-retirement benefit plans outside of the Company’s Japanese defined benefit pension plan (the “Japanese Plan”) are immaterial to the Condensed Consolidated Financial Statements. The expected long-term rate of return on the Japanese Plan assets is 2.5%.

Obligations and Funded Status

The following table presents the unfunded status of the benefit obligations for the Japanese Plan:
 
December 29,
2017
 
June 30,
2017
 
(in millions)
Benefit obligations
$
249

 
$
249

Fair value of plan assets
192

 
189

Unfunded status
$
57

 
$
60


The following table presents the unfunded amounts related to the Japanese Plan as recognized on the Company’s Condensed Consolidated Balance Sheets:
 
December 29,
2017
 
June 30,
2017
 
(in millions)
Current liabilities
$
1

 
$
1

Non-current liabilities
56

 
59

Net amount recognized
$
57

 
$
60




20
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Note 8.
Commitments, Contingencies and Related Parties

Flash Ventures

The Company’s business ventures with Toshiba Memory Corporation (“TMC”) consist of three separate legal entities: Flash Partners Ltd. (“Flash Partners”), Flash Alliance Ltd. (“Flash Alliance”), and Flash Forward Ltd. (“Flash Forward”), collectively referred to as “Flash Ventures”.

In connection with a settlement agreement with Toshiba, in December 2017, the Company entered into a facility agreement (“Y6 Facility Agreement”) with TMC related to the construction and operation of a new 300-millimeter wafer fabrication facility in Yokkaichi, Japan, referred to as “Fab 6”, which is primarily intended to provide cleanroom space to continue the transition of existing 2D NAND manufacturing capacity to BiCS 3D NAND manufacturing capacity. Under the Y6 Facility Agreement, the Company is committed to 50% of Fab 6’s start-up costs, as well as 50% of the joint ventures’ portion of an upcoming investment in manufacturing equipment for Fab 6. See also Note 13, Legal Proceedings.

The following table presents the notes receivable from, and equity investments in, Flash Ventures as of December 29, 2017 and June 30, 2017:
 
December 29,
2017
 
June 30,
2017
 
(in millions)
Notes receivable, Flash Partners
$
737

 
$
264

Notes receivable, Flash Alliance
101

 
119

Notes receivable, Flash Forward
429

 
379

Investment in Flash Partners
187

 
187

Investment in Flash Alliance
279

 
279

Investment in Flash Forward
112

 
112

Total notes receivable and investments in Flash Ventures
$
1,845

 
$
1,340


During the three and six months ended December 29, 2017, the Company made net payments to Flash Ventures of $1.2 billion and $2.0 billion, respectively, for purchased flash-based memory wafers and net loans.

The Company makes, or will make, loans to Flash Ventures to fund equipment investments for new process technologies and additional wafer capacity. The Company aggregates its Flash Ventures’ notes receivable into one class of financing receivables due to the similar ownership interest and common structure in each Flash Venture entity. For all reporting periods presented, no loans were past due and no loan impairments were recorded. The Company’s notes receivable from each Flash Ventures entity, denominated in Japanese yen, are secured by equipment owned by that Flash Ventures entity.

The Company assesses financing receivable credit quality through financial and operational reviews of the borrower and creditworthiness, including credit rating agency ratings, of significant investors of the borrower, where material or known. Impairments, when required for credit worthiness, are recorded in Other income (expense), net in the Condensed Consolidated Statements of Operations. There were no such impairments in the three and six months ended December 29, 2017 and December 30, 2016.

As of December 29, 2017 and June 30, 2017, the Company had accounts payable balances due to Flash Ventures of $250 million and $206 million, respectively.


21
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

The Company’s maximum reasonably estimable loss exposure (excluding lost profits) as a result of its involvement with Flash Ventures, based upon the Japanese yen to U.S. dollar exchange rate at December 29, 2017, is presented below. Investments in Flash Ventures are denominated in Japanese yen and the maximum possible loss exposure excludes any cumulative translation adjustment due to revaluation from the Japanese yen to the U.S. dollar.
 
December 29,
2017
 
 
Notes receivable
$
1,267

Equity investments
578

Operating lease guarantees
941

Inventory and prepayments
268

Maximum estimable loss exposure
$
3,054


The Company is committed to purchase its provided three-month forecast of Flash Ventures’ NAND wafer supply, which generally equals 50% of Flash Ventures’ output. The Company is not able to estimate its total wafer purchase commitment obligation beyond its rolling three-month purchase commitment because the price is determined by reference to the future cost of producing the semiconductor wafers. In addition, the Company is committed to fund 49.9% to 50.0% of each Flash Ventures entity’s investments to the extent that each Flash Ventures entity’s operating cash flow is insufficient to fund these investments.

Off-Balance Sheet Liabilities

Flash Ventures sells and leases back from a consortium of financial institutions a portion of its tools and has entered into equipment lease agreements of which the Company guarantees half of the total outstanding obligations. The lease agreements contain customary covenants for Japanese lease facilities. In addition to containing customary events of default related to Flash Ventures that could result in an acceleration of Flash Ventures’ obligations, the lease agreements contain acceleration clauses for certain events of default related to the guarantors, including the Company.

The following table presents the Company’s portion of the remaining guarantee obligations under the Flash Ventures’ lease facilities in both Japanese yen and U.S. dollar-equivalent, based upon the Japanese yen to U.S. dollar exchange rate as of December 29, 2017.
 
Lease Amounts
 
(Japanese yen, in billions)
 
(U.S. dollar, in millions)
Total guarantee obligations
¥
106

 
$
941


The following table details the breakdown of the Company’s remaining guarantee obligations between the principal amortization and the purchase option exercise price at the end of the term of the Flash Ventures lease agreements, in annual installments as of December 29, 2017 in U.S. dollars, based upon the Japanese yen to U.S. dollar exchange rate as of December 29, 2017:
Annual Installments
 
Payment of Principal Amortization
 
Purchase Option Exercise Price at Final Lease Terms
 
Guarantee Amount
 
 
(in millions)
Year 1
 
$
267

 
$
—

 
$
267

Year 2
 
178

 
34

 
212

Year 3
 
163

 
85

 
248

Year 4
 
80

 
98

 
178

Year 5
 
15

 
21

 
36

Total guarantee obligations
 
$
703

 
$
238

 
$
941



22
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

The Company and TMC have agreed to mutually contribute to, and indemnify each other and Flash Ventures for, environmental remediation costs or liability resulting from Flash Ventures’ manufacturing operations in certain circumstances. The Company has not made any indemnification payments, nor recorded any indemnification receivables, under any such agreements. As of December 29, 2017, no amounts have been accrued in the Condensed Consolidated Financial Statements with respect to these indemnification agreements.

23
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Note 9. 
Shareholders’ Equity

Stock-based Compensation Expense

The following tables present the Company’s stock-based compensation for equity-settled awards by type and financial statement line as well as the related tax benefit included in the Company’s Condensed Consolidated Statements of Operations:
 
Three Months Ended
 
Six Months Ended
 
December 29,
2017
 
December 30,
2016
 
December 29,
2017
 
December 30,
2016
 
(in millions)
Options
$
6

 
$
11

 
$
13

 
$
23

Restricted and performance stock units
88

 
90

 
171

 
169

Employee stock purchase plan
5

 
1

 
12

 
9

Subtotal
99

 
102

 
196

 
201

Tax benefit
(10
)
 
(29
)
 
(34
)
 
(54
)
Total
$
89

 
$
73

 
$
162

 
$
147


 
Three Months Ended
 
Six Months Ended
 
December 29,
2017
 
December 30,
2016
 
December 29,
2017
 
December 30,
2016
 
(in millions)
Cost of revenue
$
13

 
$
11

 
$
26

 
$
24

Research and development
45

 
43

 
89

 
87

Selling, general and administrative
41

 
43

 
81

 
85

Employee termination, asset impairment, and other charges
—

 
5

 
—

 
5

Subtotal
99

 
102

 
196

 
201

Tax benefit
(10
)
 
(29
)
 
(34
)
 
(54
)
Total
$
89

 
$
73

 
$
162

 
$
147


Compensation cost related to unvested stock options, restricted stock unit awards (“RSU”), performance-based restricted stock unit awards (“PSU”) and the Company’s Employee Stock Purchase Plan (“ESPP”) will generally be amortized on a straight-line basis over the remaining average service period. The following table presents the unamortized compensation cost and weighted average service period of all unvested outstanding awards as of December 29, 2017.
 
Unamortized Compensation Costs
 
Weighted Average Service Period
 
(in millions)
 
(years)
Options
$
38

 
2.1
RSUs and PSUs (1)
600

 
2.2
ESPP
15

 
0.6
Total unamortized compensation cost
$
653

 
 
 
 
(1) 
Weighted average service period assumes the performance metrics are met for the PSUs.


24
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Plan Activities

Stock Options

The following table summarizes stock option activity under the Company’s incentive plans:
 
Number of Shares
 
Weighted Average Exercise Price Per Share
 
Weighted Average Remaining Contractual Life
 
Aggregate Intrinsic Value
 
(in millions)
 
 
 
(in years)
 
(in millions)
Options outstanding at June 30, 2017
7.4

 
$
58.14

 
 
 
 
Exercised
(1.0
)
 
43.16

 
 
 
$
46

Canceled or expired
(0.2
)
 
63.44

 
 
 
 
Options outstanding at December 29, 2017
6.2

 
$
60.39

 
4.1
 
$
145

Exercisable at December 29, 2017
3.6

 
$
64.14

 
3.4
 
$
77


RSU and PSU

The following table summarizes RSU and PSU activity under the Company’s incentive plans:
 
Number of Shares
 
Weighted Average Grant Date Fair Value
 
Aggregate Intrinsic Value at Vest Date
 
(in millions)
 
 
 
(in millions)
RSUs and PSUs outstanding at June 30, 2017
13.7

 
$
45.01

 
 
Granted
4.0

 
84.95

 
 
Vested
(2.4
)
 
53.31

 
$
206

Forfeited
(0.7
)
 
47.75

 
 
RSUs and PSUs outstanding at December 29, 2017
14.6

 
$
53.41

 
 

RSUs and PSUs are generally settled in an equal number of shares of the Company’s common stock at the time of vesting of the units.

Stock Repurchase Program

The Company’s Board of Directors (the “Board”) has authorized $5.00 billion for the repurchase of the Company’s common stock. The stock repurchase program is effective until February 3, 2020. The Company did not repurchase any shares of common stock during the three months ended December 29, 2017. The remaining amount available to be purchased under the Company’s stock repurchase program as of December 29, 2017 was $2.10 billion.

Dividends to Shareholders

On September 13, 2012, the Company announced that the Board 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 Board.

On November 1, 2017, the Board declared a cash dividend of $0.50 per share of the Company’s common stock. The cash dividend aggregating $149 million was paid on January 16, 2018 to the Company’s shareholders of record as of December 29, 2017. On January 27, 2018, the Board declared a cash dividend of $0.50 per share to shareholders of record as of March 30, 2018, which will be paid on April 16, 2018. The Company may modify, suspend or cancel its cash dividend policy in any manner and at any time.


25
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Note 10.
Income Tax Expense

The Tax Cuts and Jobs Act (“2017 Act”) was enacted on December 22, 2017. The 2017 Act includes a broad range of tax reform proposals affecting businesses, including a reduction in the U.S. federal corporate tax rate from 35% to 21%, a one-time mandatory deemed repatriation tax on earnings of certain foreign subsidiaries that were previously tax deferred and creates new taxes on certain foreign earnings.

For the three and six months ended December 29, 2017, the Company has not finalized the accounting for the tax effects of the enactment of the 2017 Act. However, consistent with applicable SEC guidance, the Company has made a reasonable estimate of the effects on the Company’s existing deferred tax balances and the one-time mandatory deemed repatriation tax required by the 2017 Act and has recognized a provisional income tax expense of $1.66 billion for the one-time mandatory deemed repatriation tax and a provisional income tax benefit of $88 million related to the re-measurement of deferred tax assets and liabilities for the three and six months ended December 29, 2017. For other elements of tax expense noted below, or where the Company has not made an election, the Company has not been able to make a reasonable estimate and continues to account for such items based on the provisions of the tax laws that were in effect immediately prior to the 2017 Act. As the Company finalizes the accounting for the tax effects of the enactment of the 2017 Act during a one-year measurement period permitted by applicable SEC guidance, the Company expects to reflect adjustments to the recorded provisional amounts and record additional tax effects of the 2017 Act.

Additional information regarding the significant provisions of the 2017 Act that are expected to impact the Company is provided below.

Re-measurement of deferred taxes

The provisional income tax benefit of $88 million recorded for the three and six months ended December 29, 2017 related to the re-measurement of the Company’s deferred tax balance is based on the rates at which the deferred tax assets and liabilities are expected to reverse in the current and future fiscal years, which are generally 29% and 22%, respectively. However, the Company is still analyzing certain aspects of the 2017 Act and refining the calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. The Company is also analyzing the impact of the 2017 Act to the existing valuation allowance assessments from both a federal and state tax perspective, which could potentially affect the realizability of the existing deferred tax assets. In calculating the provisional amount, the Company utilized an estimate of the expected reversals of certain tax assets and liabilities, which will be revised in future quarters during the one-year measurement period as additional information becomes available.

Mandatory deemed repatriation tax

In connection with the transition from a global to a territorial U.S. tax system, companies are required to pay a mandatory deemed repatriation tax. The tax is to be computed using the Company’s total foreign post-1986 earnings and profits that were previously deferred from U.S. income taxes. This tax is based on the amount of foreign earnings held in cash and other specified assets which are taxed at 15.5% and 8%, respectively, and is payable over an 8-year period. For the three and six months ended December 29, 2017, the Company recorded a provisional amount for the mandatory deemed repatriation tax liability of $1.66 billion for foreign subsidiaries and $132 million of this amount is classified as a current tax liability. The calculation of the mandatory deemed repatriation tax liability is provisional and based upon preliminary estimates of post-1986 earnings and profits. In addition, the mandatory deemed repatriation tax is based on a provisional amount of foreign earnings held in cash and other specified assets, which the Company expects will require additional clarifying guidance from U.S. Treasury. As such, the provisional amount may change during the one-year measurement period when the Company finalizes the calculation of post-1986 foreign earnings and profits and the amount of foreign earnings held in cash or other specified assets.


26
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Although the mandatory deemed repatriation tax has removed U.S. federal taxes on distributions to the U.S., the Company continues to evaluate the expected manner of recovery to determine whether or not to continue to assert indefinite reinvestment on a part or all the foreign undistributed earnings. This requires the Company to re-evaluate the existing short and long-term capital allocation policies in light of the 2017 Act and calculate the tax cost that is incremental to the deemed repatriation tax, (e.g. foreign withholding, state income taxes, and additional U.S. tax on currency transaction gains or losses) of repatriating cash to the U.S. While the provisional tax expense for the three and six months ended December 29, 2017 is based upon an assumption that foreign undistributed earnings are indefinitely reinvested, the Company’s plan may change upon the completion of long-term capital allocation plans in light of the 2017 Act and completion of the calculation of the incremental tax effects on the repatriation of foreign undistributed earnings. In the event the Company determines not to continue to assert the permanent reinvestment of part or all of foreign undistributed earnings, such a determination could result in the accrual and payment of additional foreign, state and local taxes.

Deferred taxes on foreign earnings

As a result of the shift to a territorial system for U.S. taxation, the new minimum tax on certain foreign earnings (“global intangible low-tax income”) provision of the 2017 Act imposes a tax on foreign earnings and profits in excess of a deemed return on tangible assets of foreign subsidiaries. This provision is effective for tax years beginning on or after January 1, 2018 which for the Company would be the fiscal year beginning on June 30, 2018 (fiscal year 2019). The Company has not progressed sufficiently in the analysis of this provision to make an election either to account for the effects of this provision either as a component of future income tax expense in the period the tax arises or as a component of deferred taxes on the related investments. Accordingly, no deferred tax assets and liabilities have been established for timing differences between foreign U.S. GAAP income and foreign earnings and profits which would be expected to reverse under the new minimum tax in future years. Additionally, the Company has not yet completed the calculation of post-1986 foreign earnings and profits for the mandatory repatriation tax, which would be the starting point for the measurement of deferred tax assets and liabilities in order to record any provisional amounts.

The following table presents the Company’s income tax expense and the effective tax rate, which reflect provisional amounts related to the mandatory deemed repatriation tax and re-measurement of deferred tax assets and liabilities pursuant to the 2017 Act as discussed above:

 
Three Months Ended
 
Six Months Ended
 
December 29,
2017
 
December 30,
2016
 
December 29,
2017
 
December 30,
2016
 
(in millions)
Income before taxes
$
774

 
$
321

 
$
1,484

 
$
50

Income tax expense
$
1,597

 
$
86

 
$
1,626

 
$
181

Effective tax rate
206
%
 
27
%
 
110
%
 
362
%

Under the 2017 Act, the reduction of the U.S. federal corporate tax rate from 35% to 21% is effective January 1, 2018 requiring companies to use a blended rate for its fiscal 2018 tax year by applying a pro-rated percentage of the number of days before and after the January 1, 2018 effective date. This results in the use of an estimated annual effective rate of approximately 28% for the Company’s U.S. federal corporate tax rate for fiscal year 2018. The reduction in the U.S. federal corporate tax rate from 35% to the blended tax rate of 28% for fiscal year 2018 is estimated to have reduced the Company’s income tax expense by $7 million for the three and six months ended December 29, 2017. For fiscal year 2019 and beyond, the Company will utilize the enacted U.S. federal corporate tax rate of 21%.


27
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

The primary drivers for the difference between the effective tax rate for the three and six months ended December 29, 2017 and the U.S. Federal statutory rate of 28% are related to the net charge of $1.66 billion for the one-time mandatory deemed repatriation tax, offset in part by an income tax benefit related to the re-measurement of deferred taxes as required by the 2017 Act. Excluding these items, the effective tax rate for the three and six months ended December 29, 2017 would be approximately 4%. The primary drivers for the remaining difference between the effective tax rate for the three and six months ended December 29, 2017 and the U.S. Federal statutory rate of 28% are the current year generation of tax credits, and tax holidays in Malaysia, Philippines, Singapore and Thailand that expire at various dates during fiscal years 2018 through 2030 and windfall tax benefits related to vesting and exercises of stock-based awards. The windfall tax benefits are a result of the adoption of ASU 2016-09, which requires the Company to now recognize $5 million and $27 million of windfall tax benefits related to vesting and exercises of stock-based awards as a component of its income tax expense for the three and six months ended December 29, 2017, respectively. The windfall tax benefits for the three and six months ended December 30, 2016 were recorded within stockholders’ equity.

Income tax expense for the six months ended December 30, 2016 was attributable to discrete effects consisting of income tax expense from the integration of SanDisk Corporation (“SanDisk”) of $90 million and a valuation allowance on acquired tax attributes of $109 million, partially offset by income tax benefit from deductible debt issuance costs, debt discounts and prepayment fees from the debt extinguishment of $96 million. The primary drivers for the difference between the effective tax rate for the six months ended December 30, 2016 and the U.S. Federal statutory rate of 35% are these discrete items, the current year generation of tax credits and tax holidays in Malaysia, Philippines, Singapore and Thailand that expire at various dates during fiscal years 2018 through 2030.

During the six months ended December 29, 2017, the Company recorded a net increase of $7 million in its liability for unrecognized tax benefits (excluding accrued interest and penalties). As of December 29, 2017, the Company’s liability for unrecognized tax benefits (excluding accrued interest and penalties) was approximately $529 million. Accrued interest and penalties related to unrecognized tax benefits as of December 29, 2017 was approximately $94 million.

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 received Revenue Agent Reports from the IRS that seek to increase the Company’s U.S. taxable income which would result in additional federal tax expense totaling $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 and received the IRS rebuttal in July 2016. Meetings with the IRS Appeals Office began in March 2017. 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.

The Company believes that adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax examinations cannot be predicted with certainty. If any issues addressed in the Company’s tax examinations are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs. As of December 29, 2017, it is not possible to estimate the amount of change, if any, in the unrecognized tax benefits that is reasonably possible within the next twelve months. Any significant change in the amount of the Company’s liability for unrecognized tax benefits would most likely result from additional information or settlements relating to the examination of the Company’s tax returns.


28
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Note 11.
Net Income (Loss) Per Common Share

The following table presents the computation of basic and diluted income (loss) per common share:
 
Three Months Ended
 
Six Months Ended
 
December 29,
2017
 
December 30,
2016
 
December 29,
2017
 
December 30,
2016
 
(in millions, except per share data)
Net income (loss)
$
(823
)
 
$
235

 
$
(142
)
 
$
(131
)
Weighted average shares outstanding:
 
 
 
 
 
 
 
Basic
296

 
286

 
295

 
285

Employee stock options, RSUs, PSUs and ESPP
—

 
8

 
—

 
—

Diluted
296

 
294

 
295

 
285

Income (loss) per common share
 
 
 
 
 
 
 
Basic
$
(2.78
)
 
$
0.82

 
$
(0.48
)
 
$
(0.46
)
Diluted
$
(2.78
)
 
$
0.80

 
$
(0.48
)
 
$
(0.46
)
Anti-dilutive potential common shares excluded(1)
12

 
5

 
12

 
13

 
 
(1) 
For purposes of computing diluted income (loss) per common share, certain potentially dilutive securities have been excluded from the calculation because their effect would have been anti-dilutive.

The Company computes basic income (loss) per common share using net income (loss) and the weighted average number of common shares outstanding during the period. Diluted income (loss) per common share is computed using net income (loss) and the weighted average number of common shares and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares include dilutive outstanding employee stock options, RSUs and PSUs, and rights to purchase shares of common stock under the Company’s ESPP.


29
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Note 12.
Employee Termination, Asset Impairment and Other Charges

The Company recorded the following charges related to employee terminations benefits, asset impairment, and other charges:
 
Three Months Ended
 
Six Months Ended
 
December 29,
2017
 
December 30,
2016
 
December 29,
2017
 
December 30,
2016
 
(in millions)
Employee termination and other charges:
 
 
 
 
 
 
 
Restructuring Plan 2016
$
32

 
$
19

 
$
77

 
$
46

Closure of Foreign Manufacturing Facility
—

 
2

 
—

 
6

Business Realignment
16

 
7

 
23

 
44

Total employee termination and other charges
48

 
28

 
$
100

 
$
96

Stock-based compensation accelerations and adjustments
 
 
 
 
 
 
 
Business Realignment
—

 
3

 
—

 
4

Total stock-based compensation accelerations and adjustments
—

 
4

 
—

 
4

Asset impairment:
 
 
 
 
 
 
 
Closure of Foreign Manufacturing Facility
—

 
13

 
—

 
13

Total asset impairment
—

 
13

 
—

 
13

Total employee termination and other charges, and stock-based compensation accelerations and adjustments
$
48

 
$
45

 
$
100

 
$
113


Restructuring Plan 2016

In 2016, the Company initiated a set of actions relating to the restructuring plan associated with the integration of substantial portions of its HGST and WD subsidiaries (“Restructuring Plan 2016”). Restructuring Plan 2016 consists of asset and footprint reduction, product road map consolidation and organization rationalization. In addition to the amounts recognized under Restructuring Plan 2016 as presented above, the Company recognized $8 million and $30 million of accelerated depreciation on facility assets in cost of revenue during the six months ended December 29, 2017 and December 30, 2016, respectively.

The following table presents an analysis of the components of the activity against the reserve during the six months ended December 29, 2017:
 
Employee Termination Benefits
 
Contract Termination and Other
 
Total
 
(in millions)
Accrual balance at June 30, 2017
$
11

 
$
2

 
$
13

Charges
58

 
19

 
77

Cash payments
(49
)
 
(10
)
 
(59
)
Accrual balance at December 29, 2017
$
20

 
$
11

 
$
31


30
Table of Contents

WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)


Business Realignment

The Company periodically incurs charges as part of the integration process of recent acquisitions and to realign its operations with anticipated market demand. The following table presents an analysis of the components of the activity against the reserve: