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EX-32.2 - CFO CERTIFICATION TO SECTION 906 - WESTERN DIGITAL CORPwdc-2017q3ex322.htm
EX-32.1 - CEO CERTIFICATION TO SECTION 906 - WESTERN DIGITAL CORPwdc-2017q3ex321.htm
EX-31.2 - CFO CERTIFICATION TO SECTION 302 - WESTERN DIGITAL CORPwdc-2017q3ex312.htm
EX-31.1 - CEO CERTIFICATION TO SECTION 302 - WESTERN DIGITAL CORPwdc-2017q3ex311.htm
EX-12.1 - EX 12.1 - COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - WESTERN DIGITAL CORPwdc-2017q3ex121.htm

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 31, 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 May 3, 2017, 291,242,394 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 31, 2017 and July 1, 2016
 
Condensed Consolidated Statements of Operations — Three and Nine Months Ended March 31, 2017 and April 1, 2016
 
Condensed Consolidated Statements of Comprehensive Income (Loss) — Three and Nine Months Ended March 31, 2017 and April 1, 2016
 
Condensed Consolidated Statements of Cash Flows — Nine Months Ended March 31, 2017 and April 1, 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, the WD logo and SanDisk 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.


2


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 anticipated benefits of 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 business strategy, our ability to execute that strategy and its intended benefits;
our plans to develop and invest in new products and expand into new storage markets and into emerging economic markets;
our quarterly cash dividend policy;
expectations regarding the outcome of legal proceedings in which we are involved;
expectations regarding the repatriation of funds from our foreign operations;
our beliefs regarding tax benefits and the timing of future payments, if any, relating to the unrecognized tax benefits, and the adequacy of our tax provisions;
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.


3


PART I. FINANCIAL INFORMATION

Item 1.
Financial Statements (unaudited)

WESTERN DIGITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions, except par value)
(Unaudited)

 
March 31,
2017
 
July 1,
2016
ASSETS
Current assets:
 
 
 
Cash and cash equivalents
$
5,652

 
$
8,151

Short-term investments
25

 
227

Accounts receivable, net
1,948

 
1,461

Inventories
2,254

 
2,129

Other current assets
434

 
616

Total current assets
10,313

 
12,584

Property, plant, and equipment, net
3,099

 
3,503

Notes receivable and investments in Flash Ventures
1,291

 
1,171

Goodwill
10,012

 
9,951

Other intangible assets, net
4,144

 
5,034

Other non-current assets
589

 
619

Total assets
$
29,448

 
$
32,862

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
 
 
 
Accounts payable
$
2,185

 
$
1,888

Accounts payable to related parties
194

 
168

Accrued expenses
1,073

 
995

Accrued compensation
480

 
392

Accrued warranty
196

 
172

Bridge loan

 
2,995

Current portion of long-term debt
181

 
339

Total current liabilities
4,309

 
6,949

Long-term debt
12,907

 
13,660

Other liabilities
1,201

 
1,108

Total liabilities
18,417

 
21,717

Commitments and contingencies (Notes 6, 8, 10, and 14)
 
 
 
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 — 291 and 284 shares, respectively
3

 
3

Additional paid-in capital
4,477

 
4,429

Accumulated other comprehensive income (loss)
(96
)
 
103

Retained earnings
8,507

 
8,848

Treasury stock — common shares at cost; 21 and 28 shares, respectively
(1,860
)
 
(2,238
)
Total shareholders' equity
11,031

 
11,145

Total liabilities and shareholders' equity
$
29,448

 
$
32,862

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

4


WESTERN DIGITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share amounts)
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
March 31,
2017
 
April 1,
2016
 
March 31,
2017
 
April 1,
2016
Revenue, net
$
4,649

 
$
2,822

 
$
14,251

 
$
9,499

Cost of revenue
3,126

 
2,069

 
9,860

 
6,885

Gross profit
1,523

 
753

 
4,391

 
2,614

Operating expenses:
 
 
 
 
 
 
 
Research and development
613

 
359

 
1,837

 
1,133

Selling, general, and administrative
346

 
166

 
1,100

 
597

Employee termination, asset impairment, and other charges
39

 
140

 
152

 
223

Total operating expenses
998

 
665

 
3,089

 
1,953

Operating income
525

 
88

 
1,302

 
661

Interest and other income (expense):
 
 
 
 
 
 
 
Interest income
7

 
6

 
17

 
15

Interest expense
(205
)
 
(14
)
 
(646
)
 
(40
)
Other income (expense), net
(23
)
 

 
(319
)
 
2

Total interest and other expense, net
(221
)
 
(8
)
 
(948
)
 
(23
)
Income before taxes
304

 
80

 
354

 
638

Income tax expense
56

 
6

 
237

 
30

Net income
$
248

 
$
74

 
$
117

 
$
608

Income per common share:
 
 
 
 
 
 
 
Basic
$
0.86

 
$
0.32

 
$
0.41

 
$
2.62

Diluted
$
0.83

 
$
0.32

 
$
0.40

 
$
2.60

Weighted-average shares outstanding:
 
 
 
 
 
 
 
Basic
289

 
233

 
287

 
232

Diluted
299

 
234

 
295

 
234

 
 
 
 
 
 
 
 
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.

5


WESTERN DIGITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in millions)
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
March 31,
2017
 
April 1,
2016
 
March 31,
2017
 
April 1,
2016
Net income
$
248

 
$
74

 
$
117

 
$
608

Other comprehensive income (loss), before tax:
 
 
 
 
 
 
 
Actuarial pension gain
1

 

 
7

 

Foreign currency translation adjustment
58

 

 
(111
)
 

Net unrealized gain (loss) on foreign exchange contracts
45

 
39

 
(95
)
 
52

Total other comprehensive income (loss), before tax
104

 
39

 
(199
)
 
52

Income tax benefit (expense) related to items of other comprehensive income (loss)
(3
)
 

 

 

Other comprehensive income (loss), net of tax
101

 
39

 
(199
)
 
52

Total comprehensive income (loss)
$
349

 
$
113

 
$
(82
)
 
$
660

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

6


WESTERN DIGITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
(Unaudited)
 
Nine Months Ended
 
March 31,
2017
 
April 1,
2016
Cash flows from operating activities
 
 
 
Net income
$
117

 
$
608

Adjustments to reconcile net income to net cash provided by operations:
 
 
 
Depreciation and amortization
1,582

 
734

Stock-based compensation
303

 
121

Deferred income taxes
61

 
(17
)
Loss on disposal of assets
12

 
13

Write-off of issuance costs and amortization of debt discounts
275

 
3

Loss on convertible debt
6

 

Non-cash portion of employee termination, asset impairment and other charges
13

 
36

Other non-cash operating activities, net
58

 

Changes in:
 
 
 
Accounts receivable, net
(489
)
 
278

Inventories
(117
)
 
138

Accounts payable
319

 
(301
)
Accounts payable to related parties
25

 

Accrued expenses
160

 
137

Accrued compensation
90

 
(68
)
Other assets and liabilities, net
83

 
(54
)
Net cash provided by operations
2,498

 
1,628

Cash flows from investing activities
 
 
 
Purchases of property, plant and equipment
(453
)
 
(433
)
Proceeds from the sale of equipment
21

 

Purchases of investments
(274
)
 
(462
)
Proceeds from sale of investments
75

 
604

Proceeds from maturities of investments
430

 
303

Investments in Flash Ventures
(20
)
 

Notes receivable issuances to Flash Ventures
(480
)
 

Notes receivable proceeds from Flash Ventures
276

 

Strategic investments and other, net
(21
)
 
(23
)
Net cash used in investing activities
(446
)
 
(11
)
Cash flows from financing activities
 
 
 
Issuance of stock under employee stock plans
123

 
64

Taxes paid on vested stock awards under employee stock plans
(111
)
 
(45
)
Excess tax benefits from employee stock plans
90

 
(2
)
Proceeds from acquired call option
61

 

Repurchases of common stock

 
(60
)
Dividends paid to shareholders
(428
)
 
(347
)
Repayment of debt
(12,179
)
 
(364
)
Proceeds from debt
7,908

 

Debt issuance costs
(10
)
 

Net cash used in financing activities
(4,546
)
 
(754
)
Effect of exchange rate changes on cash
(5
)
 

Net increase (decrease) in cash and cash equivalents
(2,499
)
 
863

Cash and cash equivalents, beginning of year
8,151

 
5,024

Cash and cash equivalents, end of period
$
5,652

 
$
5,887

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for income taxes
$
117

 
$
38

Cash paid for interest
$
454

 
$
33

Supplemental disclosure of non-cash investing and financing activities:
 
 
 
Accrual of cash dividend declared
$
145

 
$
116

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

7


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

Note 1.
Basis of Presentation

Western Digital Corporation (the “Company” or “Western Digital”) 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 also generates license and royalty revenue related to its intellectual property.

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 July 1, 2016. In the opinion of management, all adjustments necessary to fairly state the unaudited condensed consolidated financial statements have been made. All such adjustments are of a normal, recurring nature. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 1, 2016. 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 2017, which ends on June 30, 2017, and 2016, which ended on July 1, 2016, are both comprised of 52 weeks, with all quarters presented consisting of 13 weeks.

Reclassifications

Certain prior year amounts have been reclassified in the condensed consolidated statements of operations and condensed consolidated statements of cash flows to conform to the current year presentation.

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.

8


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

Note 2.
Recently Adopted Accounting Pronouncements

In April 2015, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-05, “Intangibles — Goodwill and Other — Internal-Use Software (Subtopic 350-40)” (“ASU 2015-05”), which provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The Company’s adoption of ASU 2015-05 at the beginning of the current year did not have a material impact on its condensed consolidated financial statements.

9


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

Note 3.
Supplemental Financial Statement Data

Accounts receivable, net

From time to time, in connection with factoring agreements, the Company sells trade accounts receivable without recourse to third party purchasers in exchange for cash. During the three and nine months ended March 31, 2017, the Company did not sell any trade accounts receivable. During the three and nine months ended April 1, 2016, the Company sold trade accounts receivable and received cash proceeds of $35 million and $235 million, respectively. The discounts on the trade accounts receivable sold during the three and nine months ended April 1, 2016 were not material and were recorded within Other income (expense), net in the condensed consolidated statements of operations.

Inventories
 
March 31,
2017
 
July 1,
2016
 
(in millions)
Inventories:
 
 
 
Raw materials and component parts
$
581

 
$
569

Work-in-process
627

 
589

Finished goods
1,046

 
971

Total inventories
$
2,254

 
$
2,129


Property, plant, and equipment, net
 
March 31,
2017
 
July 1,
2016
 
(in millions)
Property, plant, and equipment:
 
 
 
Land and buildings
$
1,883

 
$
1,900

Machinery and equipment
7,008

 
6,915

Software
181

 
155

Furniture and fixtures
52

 
110

Leasehold improvements
305

 
307

Construction-in-process
115

 
245

Property, plant, and equipment, gross
9,544

 
9,632

Accumulated depreciation
(6,445
)
 
(6,129
)
Property, plant, and equipment, net
$
3,099

 
$
3,503


Goodwill
 
Carrying Amount
 
(in millions)
Balance at July 1, 2016
$
9,951

Purchase price adjustments to goodwill
64

Foreign currency translation adjustment
(3
)
Balance at March 31, 2017
$
10,012


The purchase price adjustments resulted from adjustments to the assessment of fair value for certain acquired intangible assets; inventory; property, plant and equipment; contingent liabilities; and deferred tax liability related to the acquisition of SanDisk Corporation (“SanDisk”).

10


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


Intangible assets
 
March 31,
2017
 
July 1,
2016
 
(in millions)
Finite-lived intangible assets
$
5,203

 
$
3,539

In-process research and development
695

 
2,435

Accumulated amortization
(1,754
)
 
(940
)
Intangible assets, net
$
4,144

 
$
5,034


Acquired in-process research and development (“IPR&D”) is accounted for as an indefinite-lived intangible asset. Upon completion of development, IPR&D is considered to be an amortizable finite-lived intangible asset. During the three months ended December 30, 2016, the Company reclassified $1.7 billion of acquired IPR&D to existing technology 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 31,
2017
 
April 1,
2016
 
March 31,
2017
 
April 1,
2016
 
(in millions)
Warranty accrual, beginning of period
$
313

 
$
225

 
$
279

 
$
221

Charges to operations
43

 
36

 
134

 
124

Utilization
(36
)
 
(43
)
 
(116
)
 
(137
)
Changes in estimate related to pre-existing warranties
3

 
3

 
26

 
13

Warranty accrual, end of period
$
323

 
$
221

 
$
323

 
$
221


The long-term portion of the warranty accrual classified in Other liabilities was $127 million and $107 million as of March 31, 2017 and July 1, 2016, respectively.

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 Foreign Exchange Contracts
 
Total AOCI
 
(in millions)
Balance at July 1, 2016
$
(45
)
 
$
74

 
$
74

 
$
103

OCI before reclassifications
7

 
(111
)
 
(48
)
 
(152
)
Amounts reclassified from AOCI

 

 
(47
)
 
(47
)
Income tax benefit (expense) related to items of OCI
(2
)
 
2

 

 

Net current-period OCI
5

 
(109
)
 
(95
)
 
(199
)
Balance at March 31, 2017
$
(40
)
 
$
(35
)
 
$
(21
)
 
$
(96
)


11


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

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 31,
2017
 
April 1,
2016
 
March 31,
2017
 
April 1,
2016
 
Statement of Operations Line Item
 
 
(in millions)
 
 
Unrealized holding gain (loss) on cash flow hedging activities:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
9

 
$
(8
)
 
$
42

 
$
(61
)
 
Cost of revenue
Foreign exchange contracts
 
(1
)
 

 
1

 

 
Research and development
Foreign exchange contracts
 
(3
)
 

 
4

 

 
Selling, general, and administrative
Unrealized holding gain (loss) on cash flow hedging activities
 
5

 
(8
)
 
47

 
(61
)
 
 
Total reclassifications for the period
 
$
5

 
$
(8
)
 
$
47

 
$
(61
)
 
 

12


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:
 
March 31,
2017
 
July 1,
2016
 
(in millions)
Cash and cash equivalents
$
5,652

 
$
8,151

Short-term marketable securities
25

 
227

Long-term marketable securities
89

 
119

Total cash, cash equivalents and marketable securities
$
5,766

 
$
8,497


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


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 31, 2017 and July 1, 2016, and indicate the fair value hierarchy of the valuation techniques utilized to determine such values:
 
March 31, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in millions)
Assets:
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
1,776

 
$

 
$

 
$
1,776

Certificates of deposit

 
9

 

 
9

Total cash equivalents
1,776

 
9

 

 
1,785

Short-term investments:
 
 
 
 
 
 
 
Corporate notes and bonds

 
13

 

 
13

Asset-backed securities

 
8

 

 
8

Municipal notes and bonds

 
3

 

 
3

Equity securities
1

 

 

 
1

Total short-term investments
1

 
24

 

 
25

Long-term investments:
 
 
 
 
 
 
 
U.S. Treasury securities
4

 

 

 
4

U.S. Government agency securities

 
5

 

 
5

International government securities

 
1

 

 
1

Corporate notes and bonds

 
63

 

 
63

Asset-backed securities

 
7

 

 
7

Municipal notes and bonds

 
9

 

 
9

Total long-term investments
4

 
85

 

 
89

Foreign exchange contracts

 
16

 

 
16

Call options

 

 
1

 
1

Total assets at fair value
$
1,781

 
$
134

 
$
1

 
$
1,916

Liabilities:
 
 
 
 
 
 
 
Foreign exchange contracts
$

 
$
100

 
$

 
$
100

Exchange option

 

 
2

 
2

Total liabilities at fair value
$

 
$
100

 
$
2

 
$
102



14


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

 
July 1, 2016
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in millions)
Assets:
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
2,199

 
$

 
$

 
$
2,199

Certificates of deposit

 
1

 

 
1

Total cash equivalents
2,199

 
1

 

 
2,200

Short-term investments:
 
 
 
 
 
 
 
Certificates of deposit

 
202

 

 
202

Corporate notes and bonds

 
8

 

 
8

Asset-backed securities

 
11

 

 
11

Municipal notes and bonds

 
6

 

 
6

Total short-term investments

 
227

 

 
227

Long-term investments:
 
 
 
 
 
 
 
U.S. Treasury securities
2

 

 

 
2

U.S. Government agency securities

 
10

 

 
10

International government securities

 
1

 

 
1

Corporate notes and bonds

 
89

 

 
89

Asset-backed securities

 
11

 

 
11

Municipal notes and bonds

 
6

 

 
6

Total long-term investments
2

 
117

 

 
119

Foreign exchange contracts

 
126

 

 
126

Call options

 

 
71

 
71

Total assets at fair value
$
2,201

 
$
471

 
$
71

 
$
2,743

Liabilities:
 
 
 
 
 
 
 
Foreign exchange contracts
$

 
$
23

 
$

 
$
23

Exchange option

 

 
155

 
155

Total liabilities at fair value
$

 
$
23

 
$
155

 
$
178


During the three and nine months ended March 31, 2017 and April 1, 2016, the Company had no transfers of financial assets and liabilities between Level 1 and Level 2.

Assets and Liabilities Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs (Level 3)

The fair value measurement of the call options and exchange options arising from the Company’s Convertible Notes (as defined in Note 6 to the condensed consolidated financial statements), which are not actively traded, is determined using unobservable inputs (Level 3). These inputs include (i) the estimated amount and timing of settlement of the underlying debt; (ii) the probability of the achievement of the factor(s) on which the settlement is based; (iii) the risk-adjusted discount rate based on the expected term to maturity of the debt; and (iv) the economic incentive for holders to exercise their exchange option. Significant increases or decreases in any of those inputs in isolation could result in a significantly lower or higher fair value measurement.

There were no transfers of call options or exchange options out of Level 3 for the three and nine months ended March 31, 2017.


15


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

The following table illustrates the changes in the balances of the call options reported in Other current assets and Other non-current assets in the Company’s condensed consolidated balance sheets:
 
2017 Call Options
 
2020 Call Options
 
Total
 
(in millions)
Fair value at July 1, 2016
$
70

 
$
1

 
$
71

Net realized gain (loss)
2

 
(1
)
 
1

Redemptions
(72
)
 

 
(72
)
Net unrealized gain

 
1

 
1

Fair value at March 31, 2017
$

 
$
1

 
$
1


The following table illustrates the changes in the balances of the exchange options reported in Accrued expenses and Other liabilities in the Company’s condensed consolidated balance sheets:
 
2017 Exchange Options
 
2020 Exchange Options
 
Total
 
(in millions)
Fair value at July 1, 2016
$
87

 
$
68

 
$
155

Net realized gain
(3
)
 
(31
)
 
(34
)
Redemptions
(83
)
 
(46
)
 
(129
)
Net unrealized loss

 
10

 
10

Fair value at March 31, 2017
$
1

 
$
1

 
$
2


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 third quarter of 2017 and the fourth quarter of 2016, respectively.
 
March 31, 2017
 
July 1, 2016
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
 
(in millions)
Secured Notes
$
1,833

 
$
2,059

 
$
1,828

 
$
2,044

Unsecured Notes
3,241

 
3,951

 
3,229

 
3,575

Term Loan A
4,071

 
4,140

 
4,061

 
4,161

U.S. Term Loan B

 

 
3,546

 
3,773

U.S. Term Loan B-2
2,976

 
2,998

 

 

Euro Term Loan B(1)

 

 
960

 
981

Euro Term Loan B-2(1)
937

 
942

 

 

Bridge Loan

 

 
2,995

 
3,000

Convertible Debt 2017

 

 
124

 
125

Convertible Debt 2020
30

 
33

 
251

 
264

Total
$
13,088

 
$
14,123

 
$
16,994

 
$
17,923

 
 
(1) 
Euro Term Loan B and Euro Term Loan B-2 outstanding principal amounts as of March 31, 2017 and July 1, 2016 were based upon the Euro to U.S. dollar exchange rate as of those respective dates.


16


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

Cost Method Investments

From time to time, the Company enters into certain strategic investments for the promotion of business and strategic objectives. As of March 31, 2017 and July 1, 2016, the Company had aggregate net investments under the cost method of accounting of $141 million and $135 million, respectively, and these investments consisted of privately-held equity securities without a readily determinable fair value. The Company has determined that it is not practicable to estimate the fair value of these investments. These cost method investments are reported under Other non-current assets in the condensed consolidated balance sheets.

During the three and nine months ended March 31, 2017, the Company recorded impairment charges of $7 million and $11 million, respectively, to Other income (expense), net in the condensed consolidated statements of operations related to its cost method investments.

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 31, 2017 and July 1, 2016.

The cost basis and fair value of the Company’s investments classified as available-for-sale securities as of March 31, 2017, by remaining contractual maturity, were as follows:
 
Cost Basis
 
Fair Value
 
(in millions)
Due in less than one year (short-term investments)
$
25

 
$
25

Due in one to five years (included in other non-current assets)
89

 
89

Total
$
114

 
$
114


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

17


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

Note 5.
Derivatives

The majority of the Company’s transactions are in U.S. dollars; however, some transactions are based in various foreign currencies. The Company purchases short-term, foreign exchange forward contracts to hedge the impact of foreign currency exchange fluctuations on certain underlying assets, liabilities and commitments for operating expenses and product costs denominated in foreign currencies. The purpose of entering into these hedging transactions is to minimize the impact of foreign currency fluctuations on the Company’s results of operations. These contract maturity dates do not exceed 12 months. All foreign exchange forward contracts are for risk management purposes only. The Company does not purchase foreign exchange forward contracts for speculative or trading purposes. As of March 31, 2017, the Company had outstanding foreign exchange forward contracts with commercial banks for British pound sterling, Euro, Japanese yen, Malaysian ringgit, Philippine peso, Singapore dollar and Thai baht, which were designated as either cash flow hedges or non-designated hedges.

If the derivative is designated as a cash flow hedge, the effective portion of the change in fair value of the derivative is initially deferred in AOCI, net of tax. These amounts are subsequently recognized into earnings when the underlying cash flow being hedged is recognized into earnings. Recognized gains and losses on foreign exchange forward contracts entered into for manufacturing-related activities are reported in cost of revenue and presented within cash flow from operations. Hedge effectiveness is measured by comparing the hedging instrument’s cumulative change in fair value from inception to maturity to the underlying exposure’s terminal value. The Company determined the ineffectiveness associated with its cash flow hedges to be immaterial to the condensed consolidated financial statements for the three and nine months ended March 31, 2017 and April 1, 2016.

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 during the three and nine months ended March 31, 2017 and April 1, 2016.

As of March 31, 2017, the amount of existing net losses related to cash flow hedges recorded in Accumulated other comprehensive income (loss) that are expected to be reclassified into earnings over the next twelve months was $21 million. In addition, as of March 31, 2017, the Company did not have any foreign exchange forward contracts with credit-risk-related contingent features.

See Note 4 to the condensed consolidated financial statements for additional disclosures related to the fair value of the Company’s foreign exchange forward contracts.

Derivative Instruments

The fair value and balance sheet location of the Company’s derivative instruments were as follows:
 
Derivative Assets Reported in
 
Other Current Assets
 
Other Non-current Assets
 
March 31,
2017
 
July 1,
2016
 
March 31,
2017
 
July 1,
2016
 
(in millions)
Foreign exchange forward contracts designated
$
4

 
$
114

 
$

 
$

Foreign exchange forward contracts not designated
12

 
12

 

 

Call options
1

 
70

 

 
1

Total derivatives
$
17

 
$
196

 
$

 
$
1



18


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

 
Derivative Liabilities Reported in
 
Accrued Expenses
 
Other Liabilities
 
March 31,
2017
 
July 1,
2016
 
March 31,
2017
 
July 1,
2016
 
(in millions)
Foreign exchange forward contracts designated
$

 
$
23

 
$

 
$

Foreign exchange forward contracts not designated
100

 

 

 

Exchange option
1

 
141

 
1

 
14

Total derivatives
$
101

 
$
164

 
$
1

 
$
14


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 set-off 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 31, 2017, the Company did not offset or net the fair value amounts of derivative instruments in its condensed consolidated balance sheets and separately disclosed the gross fair value amounts of the derivative instruments as either assets or liabilities. As of March 31, 2017, the potential effect of rights of set-off associated with the Company’s foreign exchange forward contracts would result in a net derivative asset balance of $4 million and a net derivative liability balance of $88 million. As of July 1, 2016, the effect of rights of set-off was not material.

Effect of Foreign Exchange Forward Contracts on the Condensed Consolidated Statements of Operations

The impact of foreign exchange forward contracts on the condensed consolidated financial statements was as follows:
 
 
Three Months Ended
Derivatives in Cash Flow Hedging Relationships
 
Amount of Gain (Loss) Recognized in AOCI on Derivatives
 
Amount of Gain (Loss) Reclassified from AOCI into Earnings
 
March 31,
2017
 
April 1,
2016
 
March 31,
2017
 
April 1,
2016
 
 
(in millions)
Foreign exchange forward contracts
 
$
50

 
$
31

 
$
5

 
$
(8
)

 
 
Nine Months Ended
Derivatives in Cash Flow Hedging Relationships
 
Amount of Gain (Loss) Recognized in AOCI on Derivatives
 
Amount of Gain (Loss) Reclassified from AOCI into Earnings
 
March 31,
2017
 
April 1,
2016
 
March 31,
2017
 
April 1,
2016
 
 
(in millions)
Foreign exchange forward contracts
 
$
(48
)
 
$
(9
)
 
$
47

 
$
(61
)

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 nine months ended March 31, 2017 and April 1, 2016.

19


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

Note 6.
Debt

Debt consisted of the following as of March 31, 2017 and July 1, 2016:
 
March 31,
2017
 
July 1,
2016
 
(in millions)
Variable interest rate Term Loan A maturing 2021
$
4,125

 
$
4,125

Variable interest rate U.S. Term Loan B maturing 2023

 
3,750

Variable interest rate U.S. Term Loan B-2 maturing 2023
2,978

 

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

 
987

Variable interest rate Euro Term Loan B-2 maturing 2023(1)
938

 

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

 
439

Bridge loans

 
3,000

Total debt
13,301

 
17,526

Issuance costs and debt discounts
(213
)
 
(532
)
Subtotal
13,088

 
16,994

Less bridge loans and current portion of long-term debt
(181
)
 
(3,334
)
Long-term debt
$
12,907

 
$
13,660

 
 
(1) 
Euro Term Loan B and Euro Term Loan B-2 outstanding principal amounts as of March 31, 2017 and July 1, 2016 were based upon the Euro to U.S. dollar exchange rate as of those respective dates.

Credit Agreement – Term Loans and Revolving Credit Facility

On April 29, 2016, the Company entered into a credit agreement (the “Credit Agreement”) that provided for a $4.125 billion Term Loan A, a $3.750 billion U.S. Term Loan B, a €885 million Euro Term Loan B and a $1.0 billion revolving credit facility. The revolving credit facility includes a $200 million sublimit for letters of credit.

On August 17, 2016, the Company borrowed $3.0 billion under a new U.S. dollar-denominated term loan (“U.S. Term Loan B-1”) under the Credit Agreement and used the proceeds of this new loan and cash of $750 million to prepay in full the U.S. Term Loan B previously outstanding under the Credit Agreement. On September 22, 2016, the Company borrowed €885 million under a new Euro-denominated term loan (“Euro Term Loan B-1”) under the Credit Agreement and used the proceeds of this new loan to prepay in full the Euro Term Loan B previously outstanding under the Credit Agreement. In connection with the settlement of the U.S. Term Loan B and Euro Term Loan B, the Company recognized a loss on debt extinguishment of $227 million consisting of unamortized issuance costs and debt discount fees.

On March 14, 2017, the Company borrowed $2.985 billion under a new U.S. dollar-denominated term loan (“U.S. Term Loan B-2”) under the Credit Agreement and used the proceeds of this new loan to prepay in full the U.S. Term Loan B-1 previously outstanding under the Credit Agreement. The U.S. Term Loan B-2 has an interest rate equal to, at the Company’s option, either an adjusted LIBOR rate, subject to a 0.75% floor, plus 2.75% or a base rate plus 1.75% (3.73% as of March 31, 2017). Principal payments on U.S. Term Loan B-2 of 0.25% are due quarterly and began on March 31, 2017 with the balance due on April 29, 2023. The U.S. Term Loan B-2 issuance costs of $2 million are amortized to interest expense over the term of the loan. As of March 31, 2017, issuance costs of $2 million remain unamortized.


20


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

On March 23, 2017, the Company borrowed €881 million under a new Euro-denominated term loan (“Euro Term Loan B-2”) under the Credit Agreement and used the proceeds of this new loan to prepay in full the Euro Term Loan B-1 previously outstanding under the Credit Agreement. The Euro Term Loan B-2 has an interest rate equal to an adjusted EURIBOR rate, subject to a 0.75% floor, plus 2.00% (2.75% as of March 31, 2017). Principal payments on Euro Term Loan B-2 of 0.25% are due quarterly and began on March 31, 2017 with the balance due on April 29, 2023. The Euro Term Loan B-2 issuance costs of $1 million are amortized to interest expense over the term of the loan. As of March 31, 2017, issuance costs of $1 million remain unamortized.

In connection with the settlement of the U.S. Term Loan B-1 and Euro Term Loan B-1, the Company recognized a loss of $7 million consisting of unamortized issuance costs and debt discount fees.

As of March 31, 2017, the revolving credit facility was not drawn upon, and there was no outstanding balance.

Beginning in September 2017, the Company is required to make quarterly principal payments on Term Loan A totaling $206 million in 2018, $309 million in 2019, $413 million in 2020 and the remaining balance of $3.197 billion due in 2021. As of March 31, 2017, Term Loan A had an outstanding balance of $4.125 billion with a variable interest rate of 2.98%.

The obligations under the Credit Agreement are guaranteed by HGST, Inc., WD Media, LLC, Western Digital (Fremont), LLC and Western Digital Technologies, Inc. (“WDT”) (together referred to as the “WD Guarantors”), and are secured on a first-priority basis by a lien on substantially all the assets and properties of the Company and the WD Guarantors, including all of the capital stock held by these entities (subject to a 65% limitation on pledges of capital stock of foreign subsidiaries and domestic holding companies of foreign subsidiaries), subject to certain exceptions.

The term loans and the revolving credit loans under the Credit Agreement may be prepaid in whole or in part at any time without premium or penalty, subject to certain conditions, except that the U.S. Term Loan B-2 and the Euro Term Loan B-2 require the Company to pay a 1.0% prepayment fee if the loans thereunder are repaid in connection with certain “repricing” transactions on or before September 14, 2017, with respect to U.S. Term Loan B-2, and September 23, 2017, with respect to Euro Term Loan B-2.

The Credit Agreement requires the Company to comply with certain financial covenants, such as a leverage ratio and an interest coverage ratio. 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.

Additional Bridge Facility

On May 12, 2016, WDT entered into a short-term senior secured bridge credit agreement providing for $3.0 billion in aggregate principal amount of senior secured bridge loans. On July 21, 2016, the Company repaid in full the $3.0 billion aggregate principal amount outstanding, together with accrued interest.

Senior Notes

On April 13, 2016, the Company completed an offering of its $1.875 billion aggregate principal amount of 7.375% senior secured notes due 2023 (the “Secured Notes”) and $3.350 billion aggregate principal amount of 10.500% senior unsecured notes due 2024 (the “Initial Unsecured Notes”). On January 6, 2017, to fulfill the Company’s obligations under the registration rights agreement associated with the Initial Unsecured Notes, the Company commenced an exchange offer to exchange all of these outstanding unsecured notes for an equal principal amount of new 10.500% senior unsecured notes due 2024 (the “New Unsecured Notes”), with substantially the same terms as the Initial Unsecured Notes. On February 6, 2017, the exchange offer expired and substantially all of the outstanding Initial Unsecured Notes were tendered in the exchange offer and accepted by the Company. The New Unsecured Notes are registered under the Securities Act of 1933, as amended, and have no transfer restrictions or rights to additional interest. The Initial Unsecured Notes, the New Unsecured Notes and the Secured Notes are collectively referred to as the “Notes”.


21


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

The Company is not required to make principal payments on the Notes prior to their respective maturity dates, except that the Company may be required to offer to purchase the Notes upon the occurrence of a change of control (as defined in the indentures governing the Notes) or with the proceeds of certain non-ordinary course asset sales. Interest payments on the Notes are due semi-annually in arrears.

The Notes are guaranteed by the WD Guarantors, and the Secured Notes and related guarantees are secured on an equal and ratable basis by liens on the same assets that secure indebtedness under the Credit Agreement.

Convertible Notes, Exchange Options and Call Options

As of July 1, 2016, the Company had outstanding, through the acquisition of SanDisk, $129 million aggregate principal amount of its 1.5% Convertible Senior Notes due 2017 (the “2017 Notes”) and $310 million aggregate principal amount of its 0.5% Convertible Senior Notes due 2020 (the “2020 Notes” and, together with the 2017 Notes, the “Convertible Notes”). The 2017 Notes mature on August 15, 2017 and the 2020 Notes mature on November 15, 2020.

During the three months ended March 31, 2017, the Company repurchased an immaterial amount of the 2017 Notes. During the nine months ended March 31, 2017, the Company paid to the holders of the Convertible Notes for conversion and repurchase, $494 million of cash and 0.3 million shares of the Company’s common stock with an aggregate value of $16 million.

As of March 31, 2017, $35 million principal amount of the 2020 Notes and an immaterial principal amount of the 2017 Notes were outstanding. For the 2020 Notes that remain outstanding, the conversion rate is 10.9006 units of reference property per $1,000 principal amount of the 2020 Notes, corresponding to 2.6020 shares of the Company’s common stock and $735.79 of cash, subject to adjustments under the indenture. The 2020 Notes are not currently exchangeable into reference property.

The Convertible Notes were bifurcated into a debt host and exchange option for accounting purposes. The exchange options are accounted for as a derivative liability because they are predominantly settled in cash. Changes in the fair value of the exchange options are reported, and will be reported until the Company extinguishes the related debt, in Other income (expense), net in the condensed consolidated statements of operations. The exchange options are measured and reported at fair value on a recurring basis, within Level 3 of the fair value hierarchy. The fair value of the unredeemed and unsettled exchange options was reported in Accrued expenses and Other liabilities in the condensed consolidated balance sheets. See Note 4 to the condensed consolidated financial statements for additional disclosures related to the fair values of the exchange options. For the three and nine months ended March 31, 2017, the change in the fair value of the outstanding exchange options related to the Convertible Notes resulted in an immaterial loss.

In connection with the SanDisk acquisition, the Company assumed the outstanding call options entered into by SanDisk at the inception of the respective Convertible Notes, which were structured to reduce the potential economic dilution associated with the conversion of Convertible Notes. The call options are derivative instruments classified as an asset that result in the Company receiving cash and shares that partially offset the Company’s obligation upon conversion of the Convertible Notes. The fair value of the unredeemed and unsettled call options was reported in Other current assets and Other non-current assets in the condensed consolidated balance sheets. During the nine months ended March 31, 2017, under the call options, the Company received $61 million of cash and 0.1 million shares of the Company’s common stock which had an aggregate value of $11 million. During the three and nine months ended March 31, 2017, the Company recognized an immaterial non-cash loss related to the change in value in the outstanding call options. The value of the call options as of March 31, 2017 was immaterial.

The conversion and repurchase of the Convertible Notes and related settlement of the call options during the three and nine months ended March 31, 2017 resulted in an immaterial net loss.

22


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 Company’s 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 were as follows:
 
March 31,
2017
 
July 1,
2016
 
(in millions)
Benefit obligations
$
273

 
$
326

Fair value of plan assets
179

 
212

Unfunded status
$
94

 
$
114


The following table presents the unfunded amounts related to the Japanese Plan as recognized on the Company’s condensed consolidated balance sheets:
 
March 31,
2017
 
July 1,
2016
 
(in millions)
Non-current liabilities
$
94

 
$
114

Net amount recognized
$
94

 
$
114


23


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 Corporation (“Toshiba”) consist of three separate legal entities: Flash Partners Ltd. (“Flash Partners”), Flash Alliance Ltd. (“Flash Alliance”) and Flash Forward Ltd (“Flash Forward” and together with Flash Partners and Flash Alliance, referred to as “Flash Ventures”). The Company has a 49.9% ownership interest and Toshiba has a 50.1% ownership interest in each of these entities. Through Flash Ventures, the Company and Toshiba collaborate in the development and manufacture of NAND flash memory products, which are manufactured by Toshiba at its wafer fabrication facilities located in Yokkaichi, Japan, using semiconductor manufacturing equipment individually owned or leased by each Flash Ventures entity. The entities within Flash Ventures purchase wafers from Toshiba at cost and then resell those wafers to the Company and Toshiba at cost plus a markup.

The Company accounts for its ownership position of each entity with Flash Ventures under the equity method of accounting. The financial and other support provided by the Company in all periods presented was either contractually required or the result of a joint decision to expand wafer capacity, transition to new technologies or refinance existing equipment lease commitments. Entities within Flash Ventures are variable interest entities (“VIEs”). The Company evaluated whether it is the primary beneficiary of any of the entities within Flash Ventures for all periods presented and determined that it is not the primary beneficiary of any of the entities within Flash Ventures because it does not have a controlling financial interest in any of those entities. In determining whether the Company is the primary beneficiary, the Company analyzed the primary purpose and design of Flash Ventures, the activities that most significantly impact Flash Ventures’ economic performance, and whether the Company had the power to direct those activities. The Company concluded, based upon its 49.9% ownership, the voting structure and the manner in which the day-to-day operations are conducted for each entity within Flash Ventures, that the Company lacked the power to direct most of the activities that most significantly impact the economic performance of each entity within Flash Ventures.

The following table presents the notes receivable from, and equity investments in, Flash Ventures as of March 31, 2017 and July 1, 2016:
 
March 31,
2017
 
July 1,
2016
 
(in millions)
Notes receivable, Flash Partners
$
232

 
$
65

Notes receivable, Flash Alliance
126

 
235

Notes receivable, Flash Forward
354

 
263

Investment in Flash Partners
187

 
202

Investment in Flash Alliance
280

 
306

Investment in Flash Forward
112

 
100

Total notes receivable and investments in Flash Ventures
$
1,291

 
$
1,171


During the three and nine months ended March 31, 2017, the Company made net payments to Flash Ventures of $727 million and $2.0 billion, respectively, for purchased NAND flash memory wafers and net loans and investments.

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.


24


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

As of March 31, 2017 and July 1, 2016, the Company had accounts payable balances due to Flash Ventures of $194 million and $168 million, respectively.

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 31, 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.
 
March 31,
2017
 
(in millions)
Notes receivable
$
712

Equity investments
579

Operating lease guarantees
1,048

Prepayments
23

Maximum estimable loss exposure
$
2,362


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 March 31, 2017.
 
Lease Amounts
 
(Japanese yen, in billions)
 
(U.S. dollar, in millions)
Total guarantee obligations
¥
117

 
$
1,048



25


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 31, 2017 in U.S. dollars based upon the Japanese yen to U.S. dollar exchange rate as of March 31, 2017:
Annual Installments
 
Payment of Principal Amortization
 
Purchase Option Exercise Price at Final Lease Terms
 
Guarantee Amount
 
 
(in millions)
Year 1
 
$
268

 
$
22

 
$
290

Year 2
 
231

 
15

 
246

Year 3
 
173

 
59

 
232

Year 4
 
93

 
97

 
190

Year 5
 
20

 
70

 
90

Total guarantee obligations
 
$
785

 
$
263

 
$
1,048


The Company and Toshiba 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 31, 2017, no amounts have been accrued in the condensed consolidated financial statements with respect to these indemnification guarantees.

26


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 and related tax benefit by type and financial statement line included in the Company’s condensed consolidated statements of operations:
 
Three Months Ended
 
Nine Months Ended
 
March 31,
2017
 
April 1,
2016
 
March 31,
2017
 
April 1,
2016
 
(in millions)
Options
$
10

 
$
16

 
$
33

 
$
42

Employee stock purchase plan
7

 
3

 
16

 
9

Restricted and performance stock units
85

 
23

 
254

 
70

Subtotal
102

 
42

 
303

 
121

Tax benefit
(26
)
 
(11
)
 
(80
)
 
(31
)
Total
$
76

 
$
31

 
$
223

 
$
90


 
Three Months Ended
 
Nine Months Ended
 
March 31,
2017
 
April 1,
2016
 
March 31,
2017
 
April 1,
2016
 
(in millions)
Cost of revenue
$
13

 
$
4

 
$
37

 
$
13

Research and development
45

 
17

 
132

 
46

Selling, general, and administrative
40

 
15

 
125

 
53

Employee termination, asset impairment, and other charges
4

 
6

 
9

 
9

Subtotal
102

 
42

 
303

 
121

Tax benefit
(26
)
 
(11
)
 
(80
)
 
(31
)
Total
$
76

 
$
31

 
$
223

 
$
90


As of March 31, 2017, compensation cost related to unvested stock options was $71 million and will be amortized on a straight-line basis over a weighted average service period of approximately 2.7 years. As of March 31, 2017, compensation cost related to the Company’s Employee Stock Purchase Plan (“ESPP”) rights issued to employees but not yet recognized was $34 million and will be amortized on a straight-line basis over a weighted average service period of approximately 1.2 years.

As of March 31, 2017, the aggregate unamortized fair value of all unvested restricted stock units (“RSUs”) and performance stock units (“PSUs”) was $537 million, which will be recognized on a straight-line basis over a weighted average vesting period of approximately 2.5 years, assuming the performance metrics are met for the PSUs.


27


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

Stock Option Activity

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 July 1, 2016
9.0

 
$
55.74

 
3.9

 
$
60

Granted
2.8

 
44.83

 
 
 
 
Exercised
(2.4
)
 
34.27

 
 
 
 
Canceled or expired
(0.8
)
 
73.01

 
 
 
 
Options outstanding at March 31, 2017
8.6

 
56.66

 
4.4

 
245

Exercisable at March 31, 2017
4.0

 
57.96

 
3.0

 
115

Vested and expected to vest after March 31, 2017
8.3

 
56.88

 
4.4

 
235


As of March 31, 2017, the Company had options outstanding to purchase an aggregate of 6.4 million shares with an exercise price below the quoted price of the Company’s stock on that date resulting in an aggregate intrinsic value of $245 million at that date.

RSU and PSU Activity

The following table summarizes RSU and PSU activity under the Company’s incentive plans:
 
Number of Shares
 
Weighted Average Grant Date Fair Value
 
(in millions)
 
 
RSUs and PSUs outstanding at July 1, 2016
15.7

 
$
41.92

Granted
5.7

 
45.94

Vested
(5.5
)
 
47.44

Forfeited
(1.7
)
 
44.08

RSUs and PSUs outstanding at March 31, 2017
14.2

 
44.43

Expected to vest after March 31, 2017
13.3

 
44.55


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. The aggregate value of RSUs and PSUs that became fully-vested during the nine months ended March 31, 2017 was $363 million, determined as of the vest date.

28


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


SARs Activity

As of March 31, 2017, all outstanding stock appreciation rights (“SARs”) issued to employees were fully vested and will be settled in cash upon exercise. The fair value of SARs is solely subject to market price fluctuations. The following table presents the adjustments to the fair market value of SARs for the three and nine months ended March 31, 2017 and April 1, 2016:
 
Three Months Ended
 
Nine Months Ended
 
March 31,
2017
 
April 1,
2016
 
March 31,
2017
 
April 1,
2016
 
(in millions)
SAR expense (benefit)
$
(1
)
 
$
(7
)
 
$
7

 
$
(18
)
Tax expense (benefit)
1

 
1

 
(1
)
 
2

Total SAR expense (benefit)
$

 
$
(6
)
 
$
6

 
$
(16
)

The Company had a total liability of $6 million and $20 million related to SARs included in Accrued expenses in the Company’s condensed consolidated balance sheet as of March 31, 2017 and July 1, 2016, respectively. As of March 31, 2017, an immaterial number of SARs were outstanding with a weighted average exercise price of $24.10.

Stock Repurchase Program

The Company’s Board of Directors (the “Board”) has authorized $5.0 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 and nine months ended March 31, 2017. The remaining amount available to be purchased under the Company’s stock repurchase program as of March 31, 2017 was $2.1 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. During the three and nine months ended March 31, 2017, the Company paid dividends of $144 million and $428 million, respectively.

On February 1, 2017, the Board declared a cash dividend for the quarter ended March 31, 2017 of $0.50 per share of the Company’s common stock. The cash dividend of $145 million was paid on April 17, 2017 to the Company’s shareholders of record as of March 31, 2017.

On May 3, 2017, the Board declared a cash dividend for the quarter ending June 30, 2017 of $0.50 per share of the Company’s common stock. The cash dividend will be paid on July 17, 2017 to shareholders of record as of June 30, 2017.

The Company may modify, suspend or cancel its cash dividend policy in any manner and at any time.


29


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

Note 10.
Income Tax Expense

The following table presents the income tax expense and the effective tax rate:
 
Three Months Ended
 
Nine Months Ended
 
March 31,
2017
 
April 1,
2016
 
March 31,
2017
 
April 1,
2016
 
(in millions)
Income tax expense
$
56

 
$
6

 
$
237

 
$
30

Effective tax rate
18
%
 
8
%
 
67
%
 
5
%

Income tax expense of $237 million for the nine months ended March 31, 2017 includes discrete effects consisting of income tax expense from the integration of SanDisk of $91 million and a valuation allowance on acquired tax attributes of $111 million. Income tax expense related to the SanDisk integration is partially offset by an income tax benefit of $98 million from deductible debt issuance costs, debt discounts and prepayment fees from debt refinancing.

The primary drivers for the 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 the current year generation of tax credits, tax holidays in Malaysia, the Philippines, Singapore and Thailand that expire at various dates from 2017 through 2029, for both periods, and the discrete items described above for the nine months ended March 31, 2017. For the three and nine months ended April 1, 2016, the difference between the effective tax rate and the U.S. Federal statutory rate of 35% is primarily due to current year generation of tax credits and tax holidays in Malaysia, the Philippines, Singapore and Thailand that expire at various dates from 2017 through 2029.

During the nine months ended March 31, 2017, the Company recorded a net increase of $14 million in its liability for unrecognized tax benefits. As of March 31, 2017, the Company’s liability for unrecognized tax benefits was approximately $505 million. Accrued interest and penalties related to unrecognized tax benefits as of March 31, 2017 was $92 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 31, 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.

30


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

Note 11.
Net Income Per Common Share

The following table presents the computation of basic and diluted income per common share:
 
Three Months Ended
 
Nine Months Ended
 
March 31,
2017
 
April 1,
2016
 
March 31,
2017
 
April 1,
2016
 
(in millions, except per share data)
Net income
$
248

 
$
74

 
$
117

 
$
608