Edgar Filing: WESTERN DIGITAL CORP

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 March 30, 2018



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

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 May 1, 2018, 299,242,061 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 March 30, 2018 and June 30, 2017	4
	Condensed Consolidated Statements of Operations — Three and Nine Months Ended March 30, 2018 and March 31, 2017	5
	Condensed Consolidated Statements of Comprehensive Income (Loss) — Three and Nine Months Ended March 30, 2018 and March 31, 2017	6
	Condensed Consolidated Statements of Cash Flows — Nine Months Ended March 30, 2018 and March 31, 2017	7
	Notes to Condensed Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	47
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	61
Item 4.	Controls and Procedures	62

PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	64
Item 1A.	Risk Factors	64
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	92
Item 3.	Defaults Upon Senior Securities	92
Item 4.	Mine Safety Disclosures	92
Item 5.	Other Information	92
Item 6.	Exhibits	92

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 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 combination of our HGST and WD product brands and sales teams;


•	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; 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)



	March 30, 2018			June 30, 2017
ASSETS
Current assets:
Cash and cash equivalents	$	4,963		$	6,354
Short-term investments	20			24
Accounts receivable, net	2,011			1,948
Inventories	2,670			2,341
Other current assets	500			389
Total current assets	10,164			11,056
Property, plant and equipment, net	3,011			3,033
Notes receivable and investments in Flash Ventures	2,160			1,340
Goodwill	10,079			10,014
Other intangible assets, net	2,956			3,823
Other non-current assets	634			594
Total assets	$	29,004		$	29,860
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	2,134		$	2,144
Accounts payable to related parties	282			206
Accrued expenses	1,015			1,069
Accrued compensation	509			506
Accrued warranty	195			186
Current portion of long-term debt	124			233
Total current liabilities	4,259			4,344
Long-term debt	11,076			12,918
Other liabilities	2,369			1,180
Total liabilities	17,704			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 — 299 shares and 294 shares, respectively	3			3
Additional paid-in capital	4,277			4,506
Accumulated other comprehensive income (loss)	46			(58		)
Retained earnings	8,155			8,633
Treasury stock — common shares at cost; 13 shares and 18 shares, respectively	(1,181		)	(1,666		)
Total shareholders’ equity	11,300			11,418
Total liabilities and shareholders’ equity	$	29,004		$	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						Nine Months Ended
	March 30, 2018			March 31, 2017			March 30, 2018			March 31, 2017
Revenue, net	$	5,013		$	4,649		$	15,530		$	14,251
Cost of revenue	3,086			3,126			9,677			9,860
Gross profit	1,927			1,523			5,853			4,391
Operating expenses:
Research and development	602			613			1,823			1,837
Selling, general and administrative	376			346			1,121			1,100
Employee termination, asset impairment, and other charges	35			39			135			152
Total operating expenses	1,013			998			3,079			3,089
Operating income	914			525			2,774			1,302
Interest and other income (expense):
Interest income	16			7			46			17
Interest expense	(160		)	(205		)	(562		)	(646		)
Other expense, net	(898		)	(23		)	(902		)	(319		)
Total interest and other expense, net	(1,042		)	(221		)	(1,418		)	(948		)
Income (loss) before taxes	(128		)	304			1,356			354
Income tax expense (benefit)	(189		)	56			1,437			237
Net income (loss)	$	61		$	248		$	(81	)	$	117

Income (loss) per common share
Basic	$	0.20		$	0.86		$	(0.27	)	$	0.41
Diluted	$	0.20		$	0.83		$	(0.27	)	$	0.40
Weighted average shares outstanding:
Basic	298			289			296			287
Diluted	308			299			296			295

Cash dividends declared per share	$	0.50		$	0.50		$	1.50		$	1.50

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 (LOSS)

(in millions)

(Unaudited)



	Three Months Ended						Nine Months Ended
	March 30, 2018			March 31, 2017			March 30, 2018			March 31, 2017
Net income (loss)	$	61		$	248		$	(81	)	$	117
Other comprehensive income (loss), before tax:
Actuarial pension gain	1			1			1			7
Foreign currency translation adjustment	76			58			78			(111		)
Net unrealized gain (loss) on derivative contracts	21			45			35			(95		)
Net unrealized loss on available-for-sale securities	(3		)	—			(4		)	—
Total other comprehensive income (loss), before tax	95			104			110			(199		)
Income tax expense related to items of other comprehensive income (loss), before tax	(3		)	(3		)	(6		)	—
Other comprehensive income (loss), net of tax	92			101			104			(199		)
Total comprehensive income (loss)	$	153		$	349		$	23		$	(82	)

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

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WESTERN DIGITAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

(Unaudited)



	Nine Months Ended
	March 30, 2018			March 31, 2017
Cash flows from operating activities
Net income (loss)	$	(81	)	$	117
Adjustments to reconcile net income (loss) to net cash provided by operations:
Depreciation and amortization	1,567			1,582
Stock-based compensation	299			303
Deferred income taxes	(336		)	61
Loss on disposal of assets	16			12
Write-off of issuance costs and amortization of debt discounts	208			275
Cash premium on extinguishment of debt	720			—
Loss on convertible debt and related instruments	—			6
Non-cash portion of employee termination, asset impairment and other charges	16			13
Other non-cash operating activities, net	(15		)	58
Changes in:
Accounts receivable, net	(58		)	(489		)
Inventories	(324		)	(117		)
Accounts payable	(41		)	319
Accounts payable to related parties	76			25
Accrued expenses	(89		)	160
Accrued compensation	2			90
Other assets and liabilities, net	1,382			83
Net cash provided by operations	3,342			2,498
Cash flows from investing activities
Purchases of property, plant and equipment	(643		)	(453		)
Proceeds from the sale of property, plant and equipment	24			21
Acquisitions, net of cash acquired	(99		)	—
Purchases of investments	(66		)	(274		)
Proceeds from sale of investments	39			75
Proceeds from maturities of investments	16			430
Investments in Flash Ventures	—			(20		)
Notes receivable issuances to Flash Ventures	(1,015		)	(480		)
Notes receivable proceeds from Flash Ventures	308			276
Strategic investments and other, net	30			(21		)
Net cash used in investing activities	(1,406		)	(446		)
Cash flows from financing activities
Issuance of stock under employee stock plans	146			123
Taxes paid on vested stock awards under employee stock plans	(164		)	(111		)
Excess tax benefits from employee stock plans	—			90
Proceeds from acquired call option	—			61
Repurchases of common stock	(155		)	—
Dividends paid to shareholders	(443		)	(428		)
Settlement of debt hedge contracts	28			—
Repayment of debt and premiums	(14,581		)	(12,179		)
Proceeds from revolving credit facility	500			—
Proceeds from debt	11,384			7,908
Debt issuance costs	(52		)	(10		)
Net cash used in financing activities	(3,337		)	(4,546		)
Effect of exchange rate changes on cash	10			(5		)
Net decrease in cash and cash equivalents	(1,391		)	(2,499		)
Cash and cash equivalents, beginning of year	6,354			8,151
Cash and cash equivalents, end of period	$	4,963		$	5,652
Supplemental disclosure of cash flow information:
Cash paid for income taxes	$	177		$	117
Cash paid for interest	$	633		$	454
Supplemental disclosure of non-cash investing and financing activities:
Accrual of cash dividend declared	$	150		$	145

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 Company’s historical 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, upon adoption of the new standard in the Company’s first quarter of 2018, the Company began prospectively reflecting 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 nine months ended March 30, 2018, the Company recognized excess tax benefits of $46 million and $73 million, respectively, as a component of its income tax expense (benefit).

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



	March 30, 2018		June 30, 2017
	(in millions)
Inventories:
Raw materials and component parts	$	855	$	646
Work-in-process	764		632
Finished goods	1,051		1,063
Total inventories	$	2,670	$	2,341

Property, plant and equipment, net



	March 30, 2018			June 30, 2017
	(in millions)
Property, plant, and equipment:
Land and buildings	$	1,927		$	1,855
Machinery and equipment	7,102			6,815
Computer equipment and software	432			404
Furniture and fixtures	49			49
Leasehold improvements	250			259
Construction-in-process	196			144
Property, plant and equipment, gross	9,956			9,526
Accumulated depreciation	(6,945		)	(6,493		)
Property, plant, and equipment, net	$	3,011		$	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	4
Balance at March 30, 2018	$	10,079

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 nine months ended March 30, 2018 was $99 million in cash, with net assets acquired primarily consisting of developed technology and other intangible 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 nine months ended March 30, 2018, the expenses incurred by the Company related to these acquisitions were immaterial and 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



	March 30, 2018			June 30, 2017
	(in millions)
Finite-lived intangible assets	$	5,816		$	5,160
In-process research and development	80			696
Accumulated amortization	(2,940		)	(2,033		)
Intangible assets, net	$	2,956		$	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 nine months ended March 30, 2018, 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						Nine Months Ended
	March 30, 2018			March 31, 2017			March 30, 2018			March 31, 2017
	(in millions)
Warranty accrual, beginning of period	$	304		$	313		$	311		$	279
Charges to operations	43			43			133			134
Utilization	(37		)	(36		)	(118		)	(116		)
Changes in estimate related to pre-existing warranties	(5		)	3			(21		)	26
Warranty accrual, end of period	$	305		$	323		$	305		$	323

The long-term portion of the warranty accrual classified in Other liabilities was $110 million and $125 million as of March 30, 2018 and June 30, 2017, respectively.

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WESTERN DIGITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

Other liabilities



	March 30, 2018		June 30, 2017
	(in millions)
Non-current income taxes payable	$	1,425	$	—
Other non-current liabilities	944		1,180
Total other non-current liabilities	$	2,369	$	1,180

Accumulated other comprehensive income (loss)

Other comprehensive income (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	1			78			(4		)	45			120
Amounts reclassified from accumulated other comprehensive income	—			—			—			(10		)	(10		)
Income tax expense related to items of other comprehensive income	—			(2		)	—			(4		)	(6		)
Net current-period other comprehensive income	1			76			(4		)	31			104
Balance at March 30, 2018	$	(17	)	$	37		$	(2	)	$	28		$	46

The following table illustrates the significant amounts of each component reclassified out of AOCI to the Condensed Consolidated Statements of Operations:



	Three Months Ended					Nine Months Ended
AOCI Component	March 30, 2018		March 31, 2017			March 30, 2018		March 31, 2017		Statement of Operations Line Item
	(in millions)
Unrealized holding gain (loss) on designated hedging activities:
Foreign exchange contracts	$	8	$	9		$	9	$	42	Cost of revenue
Foreign exchange contracts	1		(1		)	1		1		Research and development
Foreign exchange contracts	—		(3)			—		4		Selling, general and administrative
Unrealized holding gain on designated hedging activities	9		5			10		47
Total reclassifications for the period	$	9	$	5		$	10	$	47

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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 available-for-sale securities was as follows:



	March 30, 2018		June 30, 2017
	(in millions)
Cash and cash equivalents	$	4,963	$	6,354
Short-term available-for-sale securities	20		24
Long-term available-for-sale securities (included within other non-current assets)	93		94
Total cash, cash equivalents and available-for-sale securities	$	5,076	$	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.

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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 March 30, 2018 and June 30, 2017, and indicate the fair value hierarchy of the valuation techniques utilized to determine such values:



	March 30, 2018
	Level 1		Level 2		Level 3		Total
	(in millions)
Assets:
Cash equivalents:
Money market funds	$	2,353	$	—	$	—	$	2,353
Certificates of deposit	—		6		—		6
Total cash equivalents	2,353		6		—		2,359
Short-term investments:
U.S. Treasury securities	3		—		—		3
Corporate notes and bonds	—		14		—		14
Asset-backed securities	—		1		—		1
Municipal notes and bonds	—		1		—		1
Equity securities	1		—		—		1
Total short-term investments	4		16		—		20
Long-term investments:
U.S. Treasury securities	2		—		—		2
U.S. Government agency securities	—		5		—		5
International government securities	—		1		—		1
Corporate notes and bonds	—		65		—		65
Asset-backed securities	—		9		—		9
Municipal notes and bonds	—		11		—		11
Total long-term investments	2		91		—		93
Foreign exchange contracts	—		24		—		24
Interest rate swap contract	—		14		—		14
Total assets at fair value	$	2,359	$	151	$	—	$	2,510
Liabilities:
Foreign exchange contracts	$	—	$	10	$	—	$	10
Total liabilities at fair value	$	—	$	10	$	—	$	10

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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 nine months ended March 30, 2018, 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 March 30, 2018 and June 30, 2017. The cost basis and fair value of the Company’s investments classified as available-for-sale securities as of March 30, 2018, by remaining contractual maturity, were as follows:



	Cost Basis		Fair Value
	(in millions)
Due in less than one year (short-term investments)	$	22	$	20
Due in one to five years (included in other non-current assets)	95		93
Total	$	117	$	113

The Company determined available-for-sale securities had no material other-than-temporary impairments in the three and nine months ended March 30, 2018 or March 31, 2017.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

Financial Instruments Not Carried at Fair Value

The carrying value of the Company’s revolving credit facility approximates its fair value given the revolving nature of the balance and the variable market interest rate. 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 third quarter of 2018 and the fourth quarter of 2017, respectively.



	March 30, 2018				June 30, 2017
	Carrying Value		Fair Value		Carrying Value		Fair Value
	(in millions)
0.50% convertible senior notes due 2020	$	31	$	36	$	30	$	34
Variable interest rate Term Loan A maturing 2021	—		—		4,074		4,130
Variable interest rate Term Loan A-1 maturing 2023	5,013		5,047		—		—
Variable interest rate U.S. Term Loan B-2 maturing 2023	—		—		2,968		2,989
Variable interest rate U.S. Term Loan B-3 maturing 2023	2,452		2,470		—		—
Variable interest rate Euro Term Loan B-2 maturing 2023⁽¹⁾	—		—		1,000		1,010
7.375% senior secured notes due 2023	—		—		1,835		2,062
1.50% convertible notes due 2024	924		1,192		—		—
10.50% senior unsecured notes due 2024	—		—		3,244		3,956
4.750% senior unsecured notes due 2026	2,280		2,301		—		—
Total	$	10,700	$	11,046	$	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 that 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.

During the three and nine months ended March 30, 2018, the Company recorded impairment charges and losses related to the sale of these cost method investments of $9 million and $15 million, respectively, which were included in Other expense, net in the Condensed Consolidated Statements of Operations. During the three and nine months ended March 31, 2017, the Company recorded impairment charges and losses related to the sale of these cost method investments of $7 million and $11 million, respectively. As of March 30, 2018 and June 30, 2017, these investments aggregated $28 million and $91 million, respectively, and are reported under Other non-current assets in the Condensed Consolidated Balance Sheets.

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WESTERN DIGITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)


Note 5.	Derivative Instruments and Hedging Activities

As of March 30, 2018, the Company had outstanding foreign exchange forward contracts that 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 that were designated as cash flow hedges. The Company determined the ineffective portion and the amount excluded for effectiveness testing associated with its cash flow hedges to be immaterial to the Condensed Consolidated Financial Statements for the three and nine months ended March 30, 2018 and March 31, 2017.

As of March 30, 2018, the amount of existing net gains related to cash flow hedges recorded in AOCI was $28 million. Over the next twelve months, the Company expects to reclassify the majority of this amount into earnings. In addition, as of March 30, 2018, 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 expense, net. The changes in fair value on these contracts were immaterial to the Condensed Consolidated Financial Statements for the three and nine months ended March 30, 2018 and March 31, 2017.

The Company accounts for its interest rate swap as a designated cash flow hedge to mitigate variations in interest payments under a portion of its LIBOR-based term loans due to variations in the LIBOR index. The Company pays interest monthly at a fixed rate and receives interest monthly at the LIBOR rate on the notional amount of the contract. The effective portion of the change in fair value of this designated cash flow hedge is deferred in Other comprehensive income (loss), net of tax, with any ineffective portion recognized in Other income (expense), net.

Derivative Instruments

The fair value and balance sheet location of the Company’s derivative instruments were as follows:



	Derivative Assets
	Other current assets
	March 30, 2018		June 30, 2017
	(in millions)
Foreign exchange forward contracts, designated	$	9	$	6
Foreign exchange forward contracts, not designated	15		10
Interest rate swaps, designated	14		—
Total derivatives	$	38	$	16



	Derivative Liabilities
	Accrued expenses
	March 30, 2018		June 30, 2017
	(in millions)
Foreign exchange forward contracts, designated	$	1	$	2
Foreign exchange forward contracts, not designated	9		6
Interest rate swaps, designated	—		1
Total derivatives	$	10	$	9

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WESTERN DIGITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

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 March 30, 2018 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.

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				Nine Months Ended
	March 30, 2018		March 31, 2017		March 30, 2018		March 31, 2017
	(in millions)
Derivatives designated as hedging instruments:
Foreign exchange forward contracts	$	23	$	50	$	30	$	(48	)
Interest rate swaps	7		—		15		—
Total	$	30	$	50	$	45	$	(48	)



	Amount of Gain (Loss) Reclassified from AOCI into Earnings				Amount of Gain (Loss) Reclassified from AOCI into Earnings
	Three Months Ended				Nine Months Ended
	March 30, 2018		March 31, 2017		March 30, 2018		March 31, 2017
	(in millions)
Derivatives designated as hedging instruments:
Foreign exchange forward contracts	$	9	$	5	$	10	$	47
Total	$	9	$	5	$	10	$	47

The total net realized and unrealized transaction and foreign exchange forward contract currency gains and losses were not material to the Condensed Consolidated Financial Statements for the three and nine months ended March 30, 2018 and March 31, 2017.

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WESTERN DIGITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)


Note 6.	Debt

Debt consisted of the following as of March 30, 2018 and June 30, 2017:



	March 30, 2018			June 30, 2017
	(in millions)
0.50% convertible senior notes due 2020	$	35		$	35
Revolving credit facility maturing 2023	500			—
Variable interest rate Term Loan A maturing 2021	—			4,125
Variable interest rate Term Loan A-1 maturing 2023	5,022			—
Variable interest rate U.S. Term Loan B-2 maturing 2023	—			2,970
Variable interest rate U.S. Term Loan B-3 maturing 2023	2,455			—
Variable interest rate Euro Term Loan B-2 maturing 2023⁽¹⁾	—			1,001
7.375% senior secured notes due 2023	—			1,875
1.50% convertible notes due 2024	1,100			—
10.50% senior unsecured notes due 2024	—			3,350
4.750% senior unsecured notes due 2026	2,300			—
Total debt	11,412			13,356
Issuance costs and debt discounts	(212		)	(205		)
Subtotal	11,200			13,151
Less current portion of long-term debt	(124		)	(233		)
Long-term debt	$	11,076		$	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 date.

In February 2018, the Company issued $2.30 billion aggregate principal amount of senior unsecured notes due February 15, 2026 (the “2026 Senior Unsecured Notes”). The 2026 Senior Unsecured Notes bear interest at an annual rate of 4.750% with interest payable on February 15 and August 15 of each year. The Company is not required to make principal payments on the 2026 Senior Unsecured Notes prior to the maturity date. The 2026 Senior Unsecured Notes are jointly and severally guaranteed by certain material domestic subsidiaries of the Company. The 2026 Senior Unsecured Notes issuance costs are amortized to interest expense over the term of the 2026 Senior Unsecured Notes and as of March 30, 2018, issuance costs of $20 million remained unamortized.

In February 2018, the Company also issued $1.10 billion aggregate principal amount of convertible senior notes due February 1, 2024 (the “2024 Convertible Notes”). The 2024 Convertible Notes bear interest at an annual rate of 1.50% with interest payable on February 1 and August 1 of each year. The Company is not required to make principal payments on the 2024 Convertible Notes prior to the maturity date. The 2024 Convertible Notes are jointly and severally guaranteed by certain material domestic subsidiaries of the Company.

The 2024 Convertible Notes are convertible into cash, shares of the Company’s common stock, or a combination thereof at an initial conversion price of approximately $121.91 per share of common stock. Holders of the 2024 Convertible Notes may freely convert their 2024 Convertible Notes on or after November 1, 2023 until the close of business on the business day immediately preceding the maturity date. Prior to November 1, 2023, holders may convert their 2024 Convertible Notes based on variations in market price of the Company’s common stock in relation to the conversion price or the trading price of the 2024 Convertible Notes or upon the occurrence of specified corporate events.

On or after February 5, 2021, the Company may redeem all or part of the 2024 Convertible Notes, at its option, if the market price of the Company’s stock achieves certain levels.

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WESTERN DIGITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

The Company separately accounts for the liability and equity components of the 2024 Convertible Notes. The value of the liability component as of the date of issuance was recognized at the present value of its cash flows using a discount rate of 4.375%, the Company’s borrowing rate at the date of the issuance for a similar debt instrument without the conversion feature, resulting in a debt discount of $165 million, which was allocated to equity as the value of the conversion feature. The 2024 Convertible Notes debt issuance costs were approximately $18 million, of which $15 million was allocated to the debt component and $3 million was allocated to equity. The debt discount and issuance costs are amortized to interest expense over the term of the 2024 Convertible Notes. As of March 30, 2018, debt discount and issuance cost of $176 million remained unamortized.

In February 2018, the Company entered into an amendment to the credit agreement entered into on April 29, 2016 (as amended, the “Credit Agreement”), to provide for, among other things, (i) the issuance of a new $5.02 billion of term loan A-1 due 2023 (the “Term Loan A-1”), (ii) a new $2.25 billion revolving credit facility maturing in 2023 (the “Revolving Facility”), which replaced the Company’s prior $1.50 billion revolving credit facility maturing in 2021, (iii) modifications to the restrictive and financial maintenance covenants, to provide more flexibility and increased incremental debt capacity, (iv) amendments of the applicable varying interest rate margins to be based on the Company’s corporate credit ratings as described in the indenture, and (v) upon the occurrence of certain circumstances, a release of the security and guarantees as well as further covenant flexibility and increased incremental debt capacity. The Company used a portion of the proceeds of the Term Loan A-1 to repay in full its previous variable interest rate Term Loan A in the principal amount of $4.02 billion.

The Term Loan A-1 bears interest at a per annum rate equal to, at the Company’s option, either an adjusted London Interbank Offered Rate (“LIBOR”) rate, subject to a 0.00% floor, plus an applicable margin varying from 1.125% to 2.000% or a base rate plus an applicable margin varying from 0.125% to 1.000%, in each case depending on the Company’s corporate credit ratings. Currently the Company has selected the LIBOR rate option, and the applicable rate was 3.38% as of March 30, 2018. Principal payments are due in quarterly installments of (i) 0.625% per quarter from June 2018 through March 2019 and (ii) 1.25% per quarter from June 2019 through December 2022, with the remaining balance payable on February 27, 2023. The Term Loan A-1 issuance costs are amortized to interest expense over the term of the loan, and as of March 30, 2018, issuance costs of $9 million remained unamortized.

Proceeds of $500 million were drawn under the Revolving Facility and were used to fund a voluntary partial prepayment of the Company’s existing U.S. Dollar denominated term B-3 loans (“U.S. Term Loan B-3”). Loans under the Revolving Facility bear interest, at the Company’s option, at either LIBOR plus an applicable margin varying from 1.125% to 2.000% or a base rate plus an applicable margin varying from 0.125% to 1.000%, in each case depending on the Company’s corporate credit ratings. Currently the Company has selected the LIBOR rate option, and the applicable interest rate was 3.38% as of March 30, 2018. The Company will also pay an unused commitment fee on the Revolving Facility ranging from 0.120% to 0.350% based on the Company’s corporate credit ratings as described in the indenture, with an initial fee of 0.250%.

The Term Loan A-1 and the Revolving Facility are unconditionally guaranteed by each of the guarantors under the Credit Agreement and are secured on a first-priority basis (subject to permitted liens) by a lien on the same collateral that secure the other loans under the Credit Agreement; provided that the security and guarantees will be automatically suspended upon certain conditions.

During the three months ended March 30, 2018, the Company completed the redemption of all of its outstanding 7.375% senior secured notes due 2023 in the aggregate principal amount of $1.875 billion (the “2023 Notes”) and the tender offer and redemption and settlement of all of its outstanding 10.50% senior unsecured notes due 2024 in the aggregate principal amount of $3.350 billion (the “2024 Notes” and collectively with the 2023 Notes, the “Redeemed Notes”), including an aggregate of $720 million of “make-whole” and tender premiums required for the tender offer of the 2024 Notes and the optional redemption of the Redeemed Notes in accordance with the applicable indentures and accrued interest through the applicable redemption dates.

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WESTERN DIGITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

In November 2017, the Company settled in full the principal amounts of the Euro Term Loan B-2, plus accrued interest, using cash on hand. Additionally, in November 2017, the Company borrowed $2.96 billion under 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%. Currently the Company has selected the LIBOR rate option, and the applicable interest rate was 3.88% as of March 30, 2018. 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. During the three months ended March 30, 2018, the Company funded a voluntary partial prepayment of $500 million, which was allocated towards principal payments. As a result, the Company is not required to make principal payments on the U.S. Term Loan B-3 prior to its maturity date. The U.S. Term Loan B-3 issuance costs are amortized to interest expense over the term of the loan and as of March 30, 2018, issuance costs of $3 million remained unamortized.

In connection with the settlements of the various debt instruments described above, the Company recognized an aggregate loss on debt extinguishment of $896 million for the nine months ended March 30, 2018, consisting of $720 million of “make-whole” and tender premiums and $176 million of unamortized issuance costs, of which $894 million was incurred in the three months ended March 30, 2018. In the three and nine months ended March 31, 2017, the Company incurred losses on the extinguishment of debt of $7 million and $274 million, respectively.

The Credit Agreement requires the Company to comply with certain financial covenants, such as a leverage ratio and an interest coverage ratio. As of March 30, 2018, the Company was in compliance with all financial covenants. In addition, the Credit Agreement requires 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. In addition, the indentures governing the 2026 Senior Unsecured Notes and the 2024 Convertible Notes contain restrictive covenants that limit the Company’s and its subsidiaries’ ability to, among other things, consolidate, merge or sell all or substantially all of their assets; create liens; and incur, assume or guarantee additional indebtedness.

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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:



	March 30, 2018		June 30, 2017
	(in millions)
Benefit obligations	$	263	$	249
Fair value of plan assets	205		189
Unfunded status	$	58	$	60

The following table presents the unfunded amounts related to the Japanese Plan as recognized on the Company’s Condensed Consolidated Balance Sheets:



	March 30, 2018		June 30, 2017
	(in millions)
Current liabilities	$	1	$	1
Non-current liabilities	57		59
Net amount recognized	$	58	$	60

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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 the parties’ 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.

The following table presents the notes receivable from, and equity investments in, Flash Ventures as of March 30, 2018 and June 30, 2017:



	March 30, 2018		June 30, 2017
	(in millions)
Notes receivable, Flash Partners	$	838	$	264
Notes receivable, Flash Alliance	76		119
Notes receivable, Flash Forward	633		379
Investment in Flash Partners	198		187
Investment in Flash Alliance	295		279
Investment in Flash Forward	120		112
Total notes receivable and investments in Flash Ventures	$	2,160	$	1,340

During the three and nine months ended March 30, 2018, the Company made net payments to Flash Ventures of $1.00 billion and $3.0 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. There were no impairments for credit worthiness in the three and nine months ended March 30, 2018 and March 31, 2017.

As of March 30, 2018 and June 30, 2017, the Company had accounts payable balances due to Flash Ventures of $282 million and $206 million, respectively.

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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 March 30, 2018, 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.



	March 30, 2018

Notes receivable	$	1,547
Equity investments	613
Operating lease guarantees	1,109
Inventory and prepayments	319
Maximum estimable loss exposure	$	3,588

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 or all of the outstanding obligations under each lease agreement. 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 March 30, 2018.



	Lease Amounts
	(Japanese yen, in billions)		(U.S. dollar, in millions)
Total guarantee obligations	¥	118	$	1,109

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WESTERN DIGITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

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 March 30, 2018 in U.S. dollars, based upon the Japanese yen to U.S. dollar exchange rate as of March 30, 2018:



Annual Installments	Payment of Principal Amortization		Purchase Option Exercise Price at Final Lease Terms		Guarantee Amount
	(in millions)
Year 1	$	307	$	15	$	322
Year 2	212		40		252
Year 3	188		116		304
Year 4	94		81		175
Year 5	24		—		24
Year 6	3		29		32
Total guarantee obligations	$	828	$	281	$	1,109

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 March 30, 2018, no amounts have been accrued in the Condensed Consolidated Financial Statements with respect to these indemnification agreements.

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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						Nine Months Ended
	March 30, 2018			March 31, 2017			March 30, 2018			March 31, 2017
	(in millions)
Options	$	6		$	10		$	19		$	33
Restricted and performance stock units	89			85			260			254
Employee stock purchase plan	8			7			20			16
Subtotal	103			102			299			303
Tax benefit	(17		)	(26		)	(51		)	(80		)
Total	$	86		$	76		$	248		$	223



	Three Months Ended						Nine Months Ended
	March 30, 2018			March 31, 2017			March 30, 2018			March 31, 2017
	(in millions)
Cost of revenue	$	11		$	13		$	37		$	37
Research and development	45			45			134			132
Selling, general and administrative	46			40			127			125
Employee termination, asset impairment, and other charges	1			4			1			9
Subtotal	103			102			299			303
Tax benefit	(17		)	(26		)	(51		)	(80		)
Total	$	86		$	76		$	248		$	223

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 March 30, 2018.



	Unamortized Compensation Costs		Weighted Average Service Period
	(in millions)		(years)
Options	$	32	2.0
RSUs and PSUs ⁽¹⁾	528		2.2
ESPP	15		0.5
Total unamortized compensation cost	$	575


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

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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	(2.0	)	44.74			$	91
Canceled or expired	(0.3	)	61.95
Options outstanding at March 30, 2018	5.1		$	63.29	4.0	$	158
Exercisable at March 30, 2018	2.9		$	69.85	3.3	$	74

RSUs and PSUs

The following table summarizes RSU and PSU activity under the Company’s incentive plans:



	Number of Shares		Weighted Average Grant Date Fair Value		Aggregate Intrinsic Value at Vest Date
	(in millions)				(in millions)
RSUs and PSUs outstanding at June 30, 2017	13.7		$	45.01
Granted	5.0		79.10
Vested	(6.0	)	44.99		$	529
Forfeited	(0.9	)	48.72
RSUs and PSUs outstanding at March 30, 2018	11.8		$	57.62

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 had made repurchases aggregating $2.88 billion prior to fiscal 2018. The Company repurchased 1.78 million shares for a total cost of $155 million during the three and nine months ended March 30, 2018. The remaining amount available to be purchased under the Company’s stock repurchase program as of March 30, 2018 was $1.97 billion.

Dividends to Shareholders

Since the first quarter of 2013, the Company has issued a quarterly cash dividend. During the nine months ended March 30, 2018, the Company declared aggregate cash dividends of $1.50 per share on its outstanding common stock totaling $446 million, of which $296 million was paid during the period and $150 million was paid on April 16, 2018.

On May 2, 2018, the Board declared a cash dividend of $0.50 per share to shareholders of record as of June 29, 2018, which will be paid on July 16, 2018. The Company may modify, suspend or cancel its cash dividend policy in any manner and at any time.

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WESTERN DIGITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)


Note 10.	Income Tax Expense (Benefit)

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 nine months ended March 30, 2018, 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 $79 million related to the re-measurement of deferred tax assets and liabilities for the nine months ended March 30, 2018. 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 expense of $9 million and income tax benefit of $79 million recorded for the three and nine months ended March 30, 2018, respectively, related to the re-measurements of the Company’s deferred tax balances are 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 nine months ended March 30, 2018, 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. The Company made no adjustment to this provisional amount in the three months ended March 30, 2018.

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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 nine months ended March 30, 2018 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 that 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						Nine Months Ended
	March 30, 2018			March 31, 2017			March 30, 2018			March 31, 2017
	(in millions)
Income (loss) before taxes	$	(128	)	$	304		$	1,356		$	354
Income tax expense (benefit)	$	(189	)	$	56		$	1,437		$	237
Effective tax rate	148		%	18		%	106		%	67		%

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 their 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 tax rate of approximately 28% for the Company’s U.S. federal corporate tax rate for fiscal year 2018. The U.S. federal corporate tax rate was reduced from 35% to the blended tax rate of 28% for fiscal year 2018. For fiscal year 2019 and beyond, the Company will utilize the enacted U.S. federal corporate tax rate of 21%.

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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 months ended March 30, 2018 and the U.S. Federal statutory rate of 28% include discrete effects consisting of an income tax benefit of $211 million from deductible make-whole premiums and the write-off of unamortized issuance costs from the debt financing transactions. The primary drivers for the difference between the effective tax rate for the nine months ended March 30, 2018 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 and deductible make-whole premiums and the write-off of unamortized issuance costs from the debt financing transactions. The primary drivers for the remaining difference between the effective tax rate for the three and nine months ended March 30, 2018 and the U.S. Federal statutory rate of 28% are current year 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 $46 million and $73 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 nine months ended March 30, 2018, respectively. The windfall tax benefits for the three and nine months ended March 31, 2017 were recorded within shareholders’ equity.

The primary drivers for the difference between the effective tax rate for the nine months ended March 31, 2017 and the U.S. Federal statutory rate of 35% include discrete effects consisting of income tax expense from the integration of SanDisk Corporation (“SanDisk”) of $91 million and a valuation allowance on acquired tax attributes of $111 million, partially offset by income tax benefit from deductible debt issuance costs, debt discounts and prepayment fees from the debt extinguishment of $98 million. The primary drivers for the remaining difference between the effective tax rate for the three and nine months ended March 31, 2017 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 nine months ended March 30, 2018, the Company recorded a net decrease of $17 million in its liability for unrecognized tax benefits (excluding accrued interest and penalties). As of March 30, 2018, the Company’s liability for unrecognized tax benefits (excluding accrued interest and penalties) was approximately $505 million. Accrued interest and penalties related to unrecognized tax benefits as of March 30, 2018 was approximately $105 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 March 30, 2018, it was not possible to estimate the amount of change, if any, in the unrecognized tax benefits that is reasonably possible within the next twelve months. Any significant change in the amount of the Company’s liability for unrecognized tax benefits would most likely result from additional information or settlements relating to the examination of the Company’s tax returns.

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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				Nine Months Ended
	March 30, 2018		March 31, 2017		March 30, 2018			March 31, 2017
	(in millions, except per share data)
Net income (loss)	$	61	$	248	$	(81	)	$	117
Weighted average shares outstanding:
Basic	298		289		296			287
Employee stock options, RSUs, PSUs and ESPP	10		10		—			8
Diluted	308		299		296			295
Income (loss) per common share
Basic	$	0.20	$	0.86	$	(0.27	)	$	0.41
Diluted	$	0.20	$	0.83	$	(0.27	)	$	0.40
Anti-dilutive potential common shares excluded⁽¹⁾	2		2		13			4


⁽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.

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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

Nine Months Ended

March 30,
2018

March 31,
2017

March 30,
2018

March 31,
2017

(in millions)

Employee termination and other charges: