FORM 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended March 30, 2012

Or

 

¨ 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

 

 

 

LOGO

WESTERN DIGITAL CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware   33-0956711

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

3355 Michelson Drive, Suite 100

Irvine, California

  92612
(Address of principal executive offices)   (Zip Code)

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

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x  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  x    No  ¨

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

 

Large accelerated filer x

  Accelerated filer ¨  

Non-accelerated filer ¨

  Smaller reporting company ¨
  (Do not check if a smaller reporting company)    

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of the close of business on May 4, 2012, 260,026,442 shares of common stock, par value $.01 per share, were outstanding.

 

 

 


Table of Contents

WESTERN DIGITAL CORPORATION

INDEX

 

     PAGE NO.  

PART I. FINANCIAL INFORMATION

     3   

Item 1. Financial Statements (unaudited)

     3   

Condensed Consolidated Balance Sheets — March 30, 2012 and July 1, 2011

     3   

Condensed Consolidated Statements of Income — Three and Nine Months Ended March  30, 2012 and April 1, 2011

     4   

Condensed Consolidated Statements of Cash Flows — Nine Months Ended March 30, 2012 and April  1, 2011

     5   

Notes to Condensed Consolidated Financial Statements

     6   

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

     22   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     34   

Item 4. Controls and Procedures

     35   

PART II. OTHER INFORMATION

     35   

Item 1. Legal Proceedings

     35   

Item 1A. Risk Factors

     35   

Item 6. Exhibits

     51   

Our fiscal year ends on the Friday nearest to June 30 and typically consists of 52 weeks. Approximately every five years, we report a 53-week fiscal year to align our fiscal year with the foregoing policy. Our fiscal third quarters ended March 30, 2012 and April 1, 2011 both consisted of 13 weeks. Fiscal year 2011 was comprised of 52 weeks and ended on July 1, 2011. Fiscal year 2012 will be comprised of 52 weeks and will end on June 29, 2012. 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” and “WD” refer to Western Digital Corporation and its subsidiaries.

We are a Delaware corporation that operates as the parent company of our hard drive business, Western Digital Technologies, Inc., which was formed in 1970.

Our principal executive offices are located at 3355 Michelson Drive, Suite 100, Irvine, California 92612. Our telephone number is (949) 672-7000 and our Web site is www.westerndigital.com. The information on our Web site is not incorporated in this Quarterly Report on Form 10-Q.

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

 

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Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. FINANCIAL STATEMENTS

WESTERN DIGITAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in millions, except par values; unaudited)

 

     Mar. 30,
2012
    Jul. 1,
2011
 

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 3,377      $ 3,490   

Accounts receivable, net

     2,377        1,206   

Inventories

     1,282        577   

Other current assets

     409        214   
  

 

 

   

 

 

 

Total current assets

     7,445        5,487   

Property, plant and equipment, net

     4,171        2,224   

Goodwill

     1,851        151   

Other intangible assets, net

     840        71   

Other non-current assets

     203        185   
  

 

 

   

 

 

 

Total assets

   $ 14,510      $ 8,118   
  

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Current liabilities:

    

Accounts payable

   $ 2,774      $ 1,545   

Accrued expenses

     837        349   

Accrued warranty

     194        132   

Short-term debt

     500        —     

Current portion of long-term debt

     230        144   
  

 

 

   

 

 

 

Total current liabilities

     4,535        2,170   

Long-term debt

     2,013        150   

Other liabilities

     546        310   
  

 

 

   

 

 

 

Total liabilities

     7,094        2,630   

Commitments and contingencies (Notes 4, 5 and 12)

    

Shareholders’ equity:

    

Preferred stock, $.01 par value; authorized — 5 shares; issued and outstanding — none

     —          —     

Common stock, $.01 par value; authorized — 450 shares; issued and outstanding 261 and 233 shares, respectively

     3        2   

Additional paid-in capital

     2,150        1,091   

Accumulated other comprehensive loss

     (4     (5

Retained earnings

     5,267        4,400   
  

 

 

   

 

 

 

Total shareholders’ equity

     7,416        5,488   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 14,510      $ 8,118   
  

 

 

   

 

 

 

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

 

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WESTERN DIGITAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(in millions, except per share amounts; unaudited)

 

     Three Months Ended     Nine Months Ended  
     Mar. 30,
2012
    Apr. 1,
2011
    Mar. 30,
2012
    Apr. 1,
2011
 

Revenue, net

   $ 3,035      $ 2,252      $ 7,724      $ 7,123   

Cost of revenue

     2,058        1,842        5,558        5,801   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross margin

     977        410        2,166        1,322   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Research and development

     265        179        649        515   

Selling, general and administrative

     155        73        340        198   

Charges related to flooding, net

     15        —          214        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     435        252        1,203        713   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     542        158        963        609   

Other income (expense):

        

Interest income

     3        2        9        6   

Interest and other expense

     (7     (1     (17     (6
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expense), net

     (4     1        (8     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     538        159        955        609   

Income tax provision

     55        13        88        41   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 483      $ 146      $ 867      $ 568   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income per common share:

        

Basic

   $ 2.00      $ 0.63      $ 3.67      $ 2.46   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 1.96      $ 0.62      $ 3.61      $ 2.42   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding:

        

Basic

     241        232        236        231   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     246        236        240        235   
  

 

 

   

 

 

   

 

 

   

 

 

 

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  
     Mar. 30,
2012
    Apr. 1,
2011
 

Cash flows from operating activities

    

Net income

   $ 867      $ 568   

Adjustments to reconcile net income to net cash provided by operations:

    

Depreciation and amortization

     486        452   

Stock-based compensation

     61        54   

Deferred income taxes

     42        4   

Non-cash portion of charges related to flooding

     119        —     

Changes in:

    

Accounts receivable, net

     122        86   

Inventories

     17        (14

Accounts payable

     227        71   

Accrued expenses

     (27     (26

Other assets and liabilities

     24        13   
  

 

 

   

 

 

 

Net cash provided by operating activities

     1,938        1,208   
  

 

 

   

 

 

 

Cash flows from investing activities

    

Purchases of property, plant and equipment

     (393     (625

Acquisition, net of cash acquired

     (3,541     —     
  

 

 

   

 

 

 

Net cash used in investing activities

     (3,934     (625
  

 

 

   

 

 

 

Cash flows from financing activities

    

Issuance of stock under employee stock plans

     41        35   

Taxes paid on vested stock awards under employee stock plans

     (14     (8

Excess tax benefits from employee stock plans

     22        11   

Repurchases of common stock

     —          (50

Proceeds from debt, net of issuance costs

     2,775        —     

Repayment of assumed debt

     (585     —     

Repayment of debt

     (350     (75
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     1,889        (87
  

 

 

   

 

 

 

Effect of exchange rate changes on cash

     (6     —     
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     (113     496   
  

 

 

   

 

 

 

Cash and cash equivalents, beginning of period

     3,490        2,734   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 3,377      $ 3,230   
  

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

    

Cash paid for income taxes

   $ 10      $ 10   

Cash paid for interest

   $ 7      $ 4   

Supplemental disclosure of non-cash financing activities:

    

Common stock issued in connection with acquisition

   $ 877      $ —     

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

 

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WESTERN DIGITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Basis of Presentation

The accounting policies followed by Western Digital Corporation (the “Company”) are set forth in Part II, Item 8, Note 1 of the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended July 1, 2011. In the opinion of management, all adjustments necessary to fairly state the unaudited condensed consolidated financial statements have been made. All such adjustments are of a normal, recurring nature. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended July 1, 2011. The results of operations for interim periods are not necessarily indicative of results to be expected for the full year.

On March 8, 2012 (“Closing Date”), the Company completed its acquisition (the “Acquisition”) of all the issued and outstanding paid-up share capital of Viviti Technologies Ltd., until recently known as Hitachi Global Storage Technologies Holdings Pte. Ltd (“HGST”), from Hitachi Ltd. (“Hitachi”). The Acquisition is further described in Note 11 below. In connection with the Acquisition, HGST became an indirect wholly-owned subsidiary of the Company. HGST’s results of operations since the date of the Acquisition are included in the condensed consolidated financial statements. The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, including HGST. All significant intercompany accounts and transactions have been eliminated in consolidation.

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

2. Supplemental Financial Statement Data

Inventories

 

 

     Mar. 30,
2012
     Jul. 1,
2011
 
     (in millions)  

Raw materials and component parts

   $ 329       $ 172   

Work-in-process

     667         263   

Finished goods

     286         142   
  

 

 

    

 

 

 

Total inventories

   $ 1,282       $ 577   
  

 

 

    

 

 

 

See Note 11 below for a discussion of inventories acquired as a result of the Acquisition.

Warranty

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

 

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     Three Months
Ended
    Nine Months
Ended
 
     Mar.  30,
2012
    Apr. 1,
2011
    Mar.  30,
2012
    Apr. 1,
2011
 

Warranty accrual, beginning of period

   $ 156      $ 176      $ 170      $ 170   

Warranty liabilities assumed as a result of the Acquisition

     139        —          139        —     

Charges to operations

     34        42        104        132   

Utilization

     (51     (41     (135     (120

Changes in estimate related to pre-existing warranties

     —          (3     —          (8
  

 

 

   

 

 

   

 

 

   

 

 

 

Warranty accrual, end of period

   $ 278      $ 174      $ 278      $ 174   
  

 

 

   

 

 

   

 

 

   

 

 

 

Accrued warranty also includes amounts classified in other liabilities of $84 million at March 30, 2012 and $38 million at July 1, 2011. See Note 11 below for a discussion of the warranty liabilities assumed as a result of the Acquisition.

3. Income per Common Share

The Company computes basic income per common share using net income and the weighted average number of common shares outstanding during the period. Diluted income per common share is computed using net income and the weighted average number of common shares and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares include certain dilutive outstanding employee stock options, rights to purchase shares of common stock under the Company’s Employee Stock Purchase Plan (“ESPP”) and restricted stock unit awards.

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

 

 

     Three Months
Ended
     Nine Months
Ended
 
     Mar.  30,
2012
     Apr. 1,
2011
     Mar.  30,
2012
     Apr. 1,
2011
 

Net income

   $ 483       $ 146       $ 867       $ 568   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding:

           

Basic

     241         232         236         231   

Employee stock options and other

     5         4         4         4   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted

     246         236         240         235   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income per common share:

           

Basic

   $ 2.00       $ 0.63       $ 3.67       $ 2.46   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted

   $ 1.96       $ 0.62       $ 3.61       $ 2.42   
  

 

 

    

 

 

    

 

 

    

 

 

 

Anti-dilutive potential common shares excluded*

     3         4         5         4   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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

4. Debt

On the Closing Date, the Company, in its capacity as the parent entity and guarantor, Western Digital Technologies, Inc. (“WDT”) and Western Digital Ireland, Ltd. (“WDI”), an indirect wholly owned subsidiary of the Company, entered into a five-year credit agreement (“the Credit Facility”) with Bank of America, N.A., as administrative agent, swing line lender and letter of credit issuer and the other lenders party thereto from time to time (collectively, the “Lenders”). The Credit Facility provides for $2.8 billion of unsecured loan facilities consisting of a $2.3 billion term loan facility and a $500 million revolving credit facility. The only borrower under the term loan facility is WDI and the revolving credit facility is available to both WDI and WDT (WDI and WDT are referred to as “the Borrowers”). The revolving credit facility includes a $50 million sublimit for letters of credit and a $20 million sublimit for swing line loans. In addition, the Borrowers may elect to expand the credit facilities by up to $500 million if existing or new lenders provide additional term or revolving commitments.

The $2.3 billion term loan and $500 million revolving loan were borrowed by WDI on the Closing Date and were used together with existing cash and 25 million newly issued shares of the Company’s common stock to fund the Acquisition, to repay the existing term loans of WDT, to repay the debt assumed with the Acquisition and to pay related fees, costs and expenses.

 

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Borrowings under the Credit Facility bear interest at a rate equal to, at the option of the applicable Borrowers, either (a) a LIBOR rate determined by reference to the British Bankers Association LIBOR Rate for the interest period relevant to such borrowing, subject to certain exceptions (the “Eurodollar Rate”) or (b) a base rate determined by reference to the higher of (i) the federal funds rate plus 0.50%, (ii) the prime rate as announced by Bank of America, N.A. and (iii) the Eurodollar Rate plus 1.00% (the “Base Rate”), in each case plus an applicable margin. The applicable margin for borrowings under the Credit Facility ranges from 1.50% to 2.50% with respect to borrowings at the Eurodollar Rate and 0.50% to 1.50% with respect to borrowings at the Base Rate. The applicable margins for borrowings under the Credit Facility are determined based upon a leverage ratio of the Company and its subsidiaries calculated on a consolidated basis. The interest rate at March 30, 2012 was 2.24%.

In addition to paying interest on outstanding principal under the Credit Facility, the applicable Borrower is required to pay a facility fee to the lenders under the revolving credit facility in respect of the aggregate, available revolving commitments thereunder. The facility fee rate ranges from 0.25% to 0.50% per annum and is determined based upon a leverage ratio of the Company and its subsidiaries calculated on a consolidated basis. The applicable Borrower is also required to pay letter of credit fees (a) to the revolving credit facility lenders, on the aggregate face amount of all outstanding letters of credit equal to an applicable margin in effect with respect to the Eurodollar Rate borrowings and (b) to the letter of credit issuer, computed at a rate equal to 0.125% per annum on the face amount of the letter of credit, plus such letter of credit issuer’s customary documentary and processing fees and charges.

The term loans and the revolving credit loans may be prepaid in whole or in part at any time without premium or penalty, subject to certain conditions. As of March 30, 2012, the outstanding balance of the term loan facility was $2.2 billion. The Company is required to make principal payments on the term loan facility totaling $58 million through the remainder of fiscal 2012, $230 million a year for fiscal 2013 through fiscal 2016, and the remaining $1.3 billion balance (subject to adjustment to reflect prepayments or an increase to its term loan facility) in fiscal 2017, with the term loan facility balance due and payable in full on March 8, 2017 (the “Maturity Date”). The outstanding amount of revolving credit loans are also required to be repaid on the Maturity Date. The Company intends to repay the revolving credit facility within one year; therefore, the outstanding balance of $500 million under the revolving credit facility is classified as a current liability on the condensed consolidated balance sheets.

The Credit Facility requires the Company to comply with a leverage ratio and an interest coverage ratio calculated on a consolidated basis for the Company and its subsidiaries. In addition, the Credit Facility contains customary covenants, including covenants that limit or restrict, subject to certain exceptions, the Company’s and its subsidiaries’ ability to incur liens, incur indebtedness, make certain restricted payments, merge, consolidate or dispose of substantially all of its assets, and enter into certain speculative hedging arrangements and make any material change in the nature of its business. Upon the occurrence of an event of default under the Credit Facility, the Administrative Agent at the request, or with the consent, of the Required Lenders (as defined in the Credit Facility) may cease making loans, terminate the Credit Facility and declare all amounts outstanding to be immediately due and payable, require the cash collateralization of letters of credit and/or exercise all other rights and remedies available to it, the Lenders and the letter of credit issuer. The Credit Facility specifies a number of events of default (some of which are subject to applicable grace or cure periods), including, among other things, non-payment defaults, covenant defaults, cross-defaults to other material indebtedness, bankruptcy and insolvency defaults, material judgment defaults and a change of control default. As of March 30, 2012, the Company was in compliance with all covenants.

The obligations of the Borrowers under the Credit Facility are guaranteed by the Company and the Company’s material domestic subsidiaries, and the obligations of WDI under the Credit Facility are also guaranteed by WDT.

The Company was required to pay a commitment fee at the rate of 0.35%, per annum of the aggregate unfunded amount committed to be borrowed under the Credit Facility from the date of commitment on March 7, 2011 through the Closing Date. During the three and nine months ended March 30, 2012 through the Closing Date, the Company incurred debt commitment fees of $1 million and $7 million, respectively, which are included within interest and other expense in the condensed consolidated statements of income.

On the Closing Date, the Company repaid the entire outstanding principal amount of $231 million on its previously existing term loan facility originally scheduled to mature on February 11, 2013, plus accrued and unpaid interest, as well as $585 million of debt assumed in the Acquisition.

 

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5. Legal Proceedings

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

Solely for purposes of this footnote, “WD” refers to Western Digital Corporation or one or more of its subsidiaries prior to the acquisition of HGST, “HGST” refers to HGST or one or more of its subsidiaries as of the Closing Date, and “the Company” refers to Western Digital Corporation and all of its subsidiaries on a consolidated basis including HGST.

Intellectual Property Litigation

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

On December 8, 2008, plaintiffs MagSil Corporation and the Massachusetts Institute of Technology filed a complaint in the District of Delaware against WD, HGST and six other companies in the disk drive industry alleging infringement of U.S. Patent Nos. 5,629,922 and 5,835,314. The complaint seeks unspecified monetary damages and injunctive relief. The asserted patents allegedly relate to tunneling magneto resistive technology. In January 2010, MagSil amended its complaint to allege infringement of only the ‘922 patent. As disclosed in the Company’s Annual Report on Form 10-K, filed with the SEC on August 13, 2010, MagSil and WD settled the matter for an amount that was not material to the Company’s financial position, results of operations or cash flows. With respect to the claim pending against HGST, in February 2011, HGST obtained a ruling invalidating the patent on summary judgment. MagSil has appealed the decision. HGST intends to defend itself vigorously in this matter.

On July 15, 2009, plaintiffs Carl B. Collins and Farzin Davanloo filed a complaint in the Eastern District of Texas against WD, HGST and nine other companies alleging infringement of U.S. Patent Nos. 5,411,797 and 5,478,650. Plaintiffs are seeking injunctive relief and unspecified monetary damages, fees and costs. The asserted patents allegedly relate to nanophase diamond films. On October 11, 2011, plaintiffs and WD filed a joint motion to stay all deadlines applicable to claims involving WD, indicating that the parties had reached an agreement in principle that would resolve the case for an immaterial amount that was accrued by the Company in the first quarter of fiscal 2012. The court approved the motion on October 13, 2011. Plaintiffs and WD entered into a formal written settlement agreement on November 18, 2011, and the court granted an order dismissing the case as to WD with prejudice on December 7, 2011. With respect to the claim pending against HGST, mediation in the matter was held on March 20, 2012, and the parties reached an agreement in principle to settle the case for an immaterial amount that was accrued by the Company in the third quarter of fiscal 2012. No formal settlement agreement has been entered into, however, and there is no assurance that settlement will be reached. Any such settlement would require court approval before it can become final. Absent settlement, HGST intends to continue to defend itself vigorously in this matter.

 

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On December 7, 2009, plaintiff Nazomi Communications filed a complaint in the Eastern District of Texas against WD and seven other companies alleging infringement of U.S. Patent Nos. 7,080,362 and 7,225,436. Plaintiffs dismissed the Eastern District of Texas suit after filing a similar complaint in the Central District of California on February 8, 2010. The case was subsequently transferred to the Northern District of California on October 14, 2010. Plaintiffs are seeking injunctive relief and unspecified monetary damages, fees and costs. The asserted patents allegedly relate to processor cores capable of Java hardware acceleration. WD intends to defend itself vigorously in this matter.

On January 5, 2010, plaintiff Enova Technology Corporation filed a complaint in the District of Delaware against WD and Initio Corporation alleging infringement of U.S. Patent Nos. 7,136,995 and 7,386,734. Plaintiff subsequently amended its complaint to include an additional party and additionally allege infringement of U.S. Patent No. 7,900,057. Plaintiff is seeking injunctive relief and unspecified monetary damages, fees and costs. The asserted patents allegedly relate to real time full disk encryption application specific integrated circuits, or ASICs. WD intends to defend itself vigorously in this matter.

On November 10, 2010, plaintiff Rembrandt Data Storage filed a complaint in the Western District of Wisconsin against WD alleging infringement of U.S. Patent Nos. 5,995,342 and 6,195,232. Plaintiff is seeking injunctive relief and unspecified monetary damages, fees and costs. The asserted patents allegedly relate to specific thin film heads having solenoid coils. After a favorable claim construction ruling by the court, WD secured a stipulation from plaintiff to dismiss the case. Plaintiff has indicated it will appeal the court’s claim construction ruling. WD intends to continue to defend itself vigorously in this matter.

On December 1, 2010, Rambus, Inc. filed a complaint with the U.S. International Trade Commission pursuant to 19 U.S.C. Section 1337 alleging that six “Primary Respondent” semiconductor chip companies and twenty-seven “Customer Respondents,” including HGST, infringe various U.S. patents. On December 29, 2010, the U.S. International Trade Commission initiated an investigation into Rambus’s allegations in response to the complaint. HGST is accused of infringing U.S. Patent Nos. 6,591,353; 7,287,109; 7,602,857; 7,602,858; and 7,715,494. The complaint alleges that certain of HGST’s hard drives that contain Double data rate-type memory controllers, Serial Advanced Technology Attachment interfaces, Peripheral Component Interconnect Express interfaces, DisplayPort interfaces, or Serial Attached SCSI interfaces infringe the patents. The complaint seeks to enjoin the importation into the U.S. of the allegedly infringing semiconductor chips and products. It also requests a cease-and-desist order preventing the parties from exhausting allegedly infringing inventory in the U.S. HGST intends to defend itself vigorously in this matter.

On August 1, 2011, plaintiff Guzik Technical Enterprises filed a complaint in the Northern District of California against WD and various of its subsidiaries alleging infringement of U.S. Patent Nos. 6,023,145 and 6,785,085, breach of contract and misappropriation of trade secrets. Plaintiff is seeking injunctive relief and unspecified monetary damages, fees and costs. The patents asserted by plaintiff allegedly relate to devices used to test hard disk drive heads and media. WD has filed counterclaims against plaintiff for patent infringement of U.S. Patent Nos. 5,844,420; 5,640,089; 6,891,696; and 7,480,116. The patents asserted by WD relate to devices and methods used in the testing of hard disk drive heads and media. WD intends to defend itself vigorously in this matter.

On September 6, 2011, plaintiff Powerline Innovations filed a complaint in the Eastern District of Texas against WD alleging infringement of U.S. Patent No. 5,471,190. Plaintiff is seeking unspecified monetary damages, fees and costs. The asserted patent allegedly relates to power line Ethernet communications. The Company is being indemnified by a third party. All three parties entered into a formal written settlement agreement on January 9, 2012, and the court granted an order dismissing the case as to WD with prejudice on February 6, 2012.

Seagate Matter

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

 

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

The Company believes the arbitrator exceeded his authority and refused to consider material evidence and that confirmation of the award would violate public policy. The Company strongly disputes the arbitrator’s conclusion that WD “had to know” of the alleged fabrication and believes that if all of its evidence had been properly considered it would have prevailed on all remaining claims. WD intends to pursue vigorously its motion to vacate the award and, if necessary, to appeal the award if it is confirmed by the District Court of Hennepin County, Minnesota. The Company does not believe it is probable that the arbitrator’s award will be sustained and accordingly has not recorded any cost or liability for the arbitrator’s award in excess of the amount previously accrued by the Company ($25 million). There is no assurance that WD’s efforts to vacate the award or to overturn the award on appeal if it is confirmed by the District Court of Hennepin County, Minnesota will be successful. It is reasonably possible that losses with respect to this matter could range from $0 to $605.4 million in excess of the amount previously accrued ($25 million). This estimate does not include additional interest (as simple interest, not compounding) at the Minnesota statutory rate of 10% per year, which will continue to accrue on the amount of the final award ($630.4 million) while WD pursues its motion to vacate the award, and if necessary, an appeal if the motion to vacate the award is unsuccessful.

Other Matters

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

6. Income Taxes

The Company’s income tax provision for the three months ended March 30, 2012 was $55 million as compared to $13 million in the prior-year period. The Company’s income tax provision for the nine months ended March 30, 2012 was $88 million as compared to $41 million in the prior-year period. The differences between the effective tax rate and the U.S. Federal statutory rate are primarily due to tax holidays in Malaysia, the Philippines, Singapore and Thailand that expire at various dates through 2023 and the current year generation of income tax credits.

In the three months ended March 30, 2012, the Company recorded a net increase of $45 million in its liability for unrecognized tax benefits. This includes $41 million related to the Acquisition. As of March 30, 2012, the Company had a recorded liability for unrecognized tax benefits of approximately $277 million. Interest and penalties recognized on such amounts were not material.

The Internal Revenue Service (“IRS”) has completed its field examination of the federal income tax returns for fiscal years 2006 and 2007 for the Company and calendar years 2005 and 2006 for Komag, Incorporated (“Komag”), which was acquired by the Company on September 5, 2007. In September 2011, the Company received a final Revenue Agent Report (“RAR”) and Closing Agreement with respect to the years under examination for Komag. This agreement resulted in an immaterial benefit to the Company’s income tax provision. The Company has also received RARs from the IRS that seek adjustments to income before income taxes of approximately $970 million in connection with unresolved issues related primarily to transfer pricing and certain other intercompany transactions. The Company disagrees with the proposed adjustments. In May 2011, the Company filed a protest with the IRS Appeals Office regarding the proposed adjustments. Meetings with the Appeals Office began in February 2012. In January 2012, the IRS commenced an examination of the Company’s fiscal years 2008 and 2009 and Komag’s fiscal year ended September 5, 2007.

 

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The Company believes that adequate provision has been made for any adjustments that may result from tax audits. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in the Company’s tax audits are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs. As of March 30, 2012, 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 unrecognized tax benefits would most likely result from additional information or settlements relating to the examination of the Company’s tax returns.

7. Fair Value Measurements

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

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

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

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

The following table presents information about the Company’s financial assets and liabilities that are measured at fair value on a recurring basis as of March 30, 2012, and indicates the fair value hierarchy of the valuation techniques utilized to determine such value (in millions):

 

 

     Fair Value Measurements at
Reporting Date Using
 
     Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
     Total  

Assets:

          

Cash equivalents

          

Money market funds

   $ 869       $ —        $ —         $ 869   

U.S. Treasury securities

     —           33        —           33   

U.S. Government agency securities

     —           63        —           63   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total cash equivalents

     869         96        —           965   
  

 

 

    

 

 

   

 

 

    

 

 

 

Foreign exchange contracts

     —           6        —           6   

Auction-rate securities

     —           —          14         14   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total assets at fair value

   $ 869       $ 102      $ 14       $ 985   
  

 

 

    

 

 

   

 

 

    

 

 

 

Liabilities:

          

Foreign exchange contracts

     —           (3     —           (3
  

 

 

    

 

 

   

 

 

    

 

 

 

Total liabilities at fair value

   $ —         $ (3   $ —         $ (3
  

 

 

    

 

 

   

 

 

    

 

 

 

 

 

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The following table presents information about the Company’s financial assets and liabilities that are measured at fair value on a recurring basis as of July 1, 2011, and indicates the fair value hierarchy of the valuation techniques utilized to determine such value (in millions):

 

 

     Fair Value Measurements at
Reporting Date Using
 
     Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
     Total  

Assets:

          

Cash equivalents

          

Money market funds

   $ 721       $ —        $ —         $ 721   

U.S. Treasury securities

     —           60        —           60   

U.S. Government agency securities

     —           78        —           78   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total cash equivalents

     721         138        —           859   

Auction-rate securities

     —           —          15         15   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total assets at fair value

   $ 721       $ 138      $ 15       $ 874   
  

 

 

    

 

 

   

 

 

    

 

 

 

Liabilities:

          

Foreign exchange contracts

     —           (5     —           (5
  

 

 

    

 

 

   

 

 

    

 

 

 

Total liabilities at fair value

   $ —         $ (5   $ —         $ (5
  

 

 

    

 

 

   

 

 

    

 

 

 

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

U.S. Treasury Securities. The Company’s U.S. Treasury securities are investments in Treasury bills with original maturities of three months or less, are held in custody by a third party and are recorded within cash and cash equivalents in the condensed consolidated balance sheets. U.S. Treasury securities are valued using a market approach which is based on observable inputs including market interest rates from multiple pricing sources.

U.S. Government Agency Securities. The Company’s U.S. Government agency securities are investments in fixed income securities sponsored by the U.S. Government with original maturities of three months or less, are held in custody by a third party and are recorded within cash and cash equivalents in the condensed consolidated balance sheets. U.S. Government agency securities are valued using a market approach which is based on observable inputs including market interest rates from multiple pricing sources.

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

Foreign Exchange Contracts. The Company’s foreign exchange contracts are short-term contracts to hedge the Company’s foreign currency risk related to the Thai Baht, Malaysian Ringgit, Japanese Yen, Singapore Dollar, Philippine Peso, Euro and British Pound Sterling. Foreign exchange contracts are classified within other current liabilities in the condensed consolidated balance sheets. Foreign exchange contracts are valued using an income approach that is based on a present value of future cash flows model. The market-based observable inputs for the model include forward rates and credit default swap rates.

In the three months ended March 30, 2012, the Company had a $1 million settlement in its Level 3 financial assets measured on a recurring basis, reducing the balance from $15 million to $14 million. In the six months ended December 30, 2011, there were no changes in Level 3 financial assets measured on a recurring basis.

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

8. Foreign Exchange Contracts

Although the majority of the Company’s transactions are in U.S. dollars, some transactions are based in various foreign currencies. The Company purchases short-term, foreign exchange contracts to hedge the impact of foreign currency exchange fluctuations on certain underlying assets, revenue, liabilities and commitments for operating expenses and product costs denominated in foreign currencies. The purpose of entering into these hedging transactions is to minimize the impact of foreign currency fluctuations on the Company’s results of operations. These contract maturity dates do not exceed 12 months. All foreign exchange contracts are for risk management purposes only. The Company does not purchase foreign exchange contracts for trading or speculative purposes. As of March 30, 2012, the Company had outstanding foreign exchange contracts with commercial banks for Thai Baht, Malaysian Ringgit, Japanese Yen, Singapore Dollar, Philippine Peso, Euro and British Pound Sterling. Thai Baht contracts are designated as either cash flow or fair value hedges. Malaysian Ringgit and Japanese Yen contracts are designated as cash flow hedges. Singapore Dollar, Philippine Peso, Euro and British Pound Sterling contracts are designated as fair value hedges.

 

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If the derivative is designated as a cash flow hedge, the effective portion of the change in fair value of the derivative is initially deferred in other comprehensive income (loss), net of tax. These amounts are subsequently recognized into earnings when the underlying cash flow being hedged is recognized into earnings. Recognized gains and losses on foreign exchange contracts entered into for manufacturing-related activities are reported in cost of revenue. 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. As of March 30, 2012, the net amount of unrealized gains expected to be reclassified into earnings within the next 12 months was $2 million.

A change in the fair value of fair value hedges is recognized in earnings in the period incurred and is reported as a component of operating expenses. All fair value hedges were determined to be effective. The fair value and the changes in fair value on these contracts were not material to the condensed consolidated financial statements during the three and nine months ended March 30, 2012 and April 1, 2011.

As of March 30, 2012, the Company did not have any foreign exchange contracts with credit-risk-related contingent features. The Company opened $680 million and $2.1 billion, and closed $598 million and $2.2 billion in foreign exchange contracts in the three and nine months ended March 30, 2012, respectively. The fair value and balance sheet location of such contracts were as follows (in millions):

 

 

    

Asset Derivatives

     Liability Derivatives  
    

Mar. 30, 2012

     Jul. 1, 2011      Mar. 30, 2012      Jul. 1, 2011  

Derivatives Designated as

Hedging Instruments

  

Balance Sheet

Location

   Fair
Value
     Balance  Sheet
Location
     Fair
Value
     Balance  Sheet
Location
     Fair
Value
     Balance  Sheet
Location
     Fair
Value
 

Foreign exchange contracts

   Other current assets    $ 6         —           —           Accrued expenses       $ 3         Accrued expenses       $ 5   

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

 

 

     Amount of Gain Recognized in
Accumulated OCI on Derivatives
     Location of
Gain (Loss)
Reclassified from
Accumulated
OCI into Income
     Amount of Gain (Loss) Reclassified
From Accumulated OCI into Income
 

Derivatives in Cash

Flow Hedging Relationships

   Three
Months
Ended
     Nine
Months
Ended
     Three
Months
Ended
     Nine
Months
Ended
        Three
Months
Ended
    Nine
Months
Ended
     Three
Months
Ended
     Nine
Months
Ended
 
   Mar. 30, 2012      Apr 1, 2011         Mar. 30, 2012      Apr 1, 2011  

Foreign exchange contracts

   $ 15       $ 9       $ 2       $ 76         Cost of revenue       $ (1   $ 2       $ 15       $ 79   

The total net realized transaction and foreign exchange contract currency gains and losses were not material to the condensed consolidated financial statements during the three and nine months ended March 30, 2012 and April 1, 2011.

9. Stock-Based Compensation

In connection with the Acquisition, the Company assumed all of the unvested stock options, stock appreciation rights (“SARs”), and restricted stock unit awards (“RSUs”) outstanding under HGST’s stock plans as of the Closing Date. The assumed stock options, SARs and RSUs were converted into equivalent stock options, SARs and RSUs with respect to shares of the Company’s common stock using an equity award exchange ratio. As of the Closing Date, March 8, 2012, options to purchase 4.2 million shares of the Company’s common stock, 0.4 million RSUs, and 1.9 million SARs were outstanding under these assumed awards. No new awards may be granted under the HGST stock plans

During the three and nine months ended March 30, 2012, the Company recognized in expense $11 million and $35 million, respectively, for stock-based compensation related to the ESPP and the vesting of options issued under the Company’s stock option plans or assumed in connection with the Acquisition, compared to $9 million and $29 million in the comparative prior-year periods. As of March 30, 2012, total compensation cost related to unvested stock options and ESPP rights issued to employees but not yet recognized was $137 million and will be amortized on a straight-line basis over a weighted average service period of approximately 2.3 years.

 

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During the three months ended March 30, 2012, the Company recognized in expense $1 million related to the vesting of cash-settled SARs assumed under the HGST stock plans. As of March 30, 2012, the Company had a total liability of $32 million related to SARs included in accrued liabilities in the accompanying condensed consolidated balance sheet. As of March 30, 2012, total compensation cost related to unvested SARs issued to employees but not yet recognized was $32 million and will be accrued on a straight-line basis over a weighted average service period of approximately 2.0 years.

As indicated above, approximately 0.4 million RSUs were outstanding at the Closing Date in connection with the RSUs assumed in the Acquisition. In addition, the Company granted approximately 1.1 million RSUs during the nine months ended March 30, 2012, which are payable in an equal number of shares of the Company’s common stock at the time of vesting of the units. The aggregate market value of the shares underlying the RSUs was $49 million at the date of grant or, in the case of the RSUs assumed in the Acquisition, at the date of assumption. The compensation expense for granted and assumed RSUs is being recognized as expense over the corresponding vesting periods of the awards. For purposes of recognizing awards granted, the Company has assumed a forfeiture rate of 2.29% based on a historical analysis indicating forfeitures for these types of awards. During the three and nine months ended March 30, 2012, the Company recognized in expense $9 million and $25 million, respectively, related to the vesting of awards of RSUs compared to $8 million and $25 million in the comparative prior-year periods. As of March 30, 2012, the aggregate unamortized fair value of all unvested RSUs was $53 million, which will be recognized on a straight-line basis over a weighted average vesting period of approximately 1.6 years.

Stock Option Activity

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

 

 

     Number
of Shares
    Weighted Average
Exercise Price
Per Share
     Weighted  Average
Remaining
Contractual Life
(in years)
     Aggregate
Intrinsic
Value
 

Options outstanding at July 1, 2011

     10.2      $ 22.49         

Granted

     2.5        29.64         

Exercised

     (0.2     7.99         
  

 

 

         

Options outstanding at September 30, 2011

     12.5      $ 24.20         

Granted

     0.2        26.20         

Exercised

     (0.2     15.38         
  

 

 

         

Options outstanding at December 30, 2011

     12.5      $ 24.34         

Granted

     0.1        38.33         

Assumed

     4.2        8.47         

Exercised

     (0.9     20.99         
  

 

 

         

Options outstanding at March 30, 2012

     15.9      $ 20.49         4.7       $ 333   
  

 

 

   

 

 

    

 

 

    

 

 

 

Exercisable at March 30, 2012

     7.3      $ 19.43         3.8       $ 160   
  

 

 

   

 

 

    

 

 

    

 

 

 

Vested and expected to vest after March 30, 2012

     13.1      $ 20.24         4.5       $ 276   
  

 

 

   

 

 

    

 

 

    

 

 

 

If an option has an exercise price that is less than the quoted price of the Company’s common stock at the particular time, the aggregate intrinsic value of that option at that time is calculated based on the difference between the exercise price of the underlying options and the quoted price of the Company’s common stock at that time. As of March 30, 2012, the Company had options outstanding to purchase an aggregate of 15.9 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 $333 million at that date. During the three and nine months ended March 30, 2012, the aggregate intrinsic value of options exercised under the Company’s stock option plans was $15 million and $23 million, respectively, determined as of the date of exercise, compared to $9 million and $20 million in the comparative prior-year periods.

SARs Activity

The share-based compensation liability for SARs assumed is recognized for the portion of fair value for which service has been rendered at the reporting date. The share-based liability is remeasured at each reporting date through the requisite service period. The Company uses estimated forfeiture rates on unvested awards to calculate a liability only for those SARs expected to vest. The total vested portion of the SARs represents the proportion of the fair value of the SARs vested based upon the percentage of the required service rendered at the reporting date. As of March 30, 2012, 1.8 million SARs were outstanding with a weighted average exercise price of $7.61. SARs activity was immaterial to the condensed consolidated financial statements for the three and nine months ended March 30, 2012.

 

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Fair Value Disclosure — Binomial Model

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

 

 

     Three Months Ended    Nine Months Ended
     Mar. 30,
2012
   Apr. 1,
2011
   Mar. 30,
2012
   Apr. 1,
2011

Suboptimal exercise factor

   1.80    1.81    1.81    1.81

Range of risk-free interest rates

   0.19% to 1.61%    0.27% to 2.90%    0.12% to 1.61%    0.26% to 2.90%

Range of expected stock price volatility

   0.43 to 0.53    0.41 to 0.56    0.41 to 0.55    0.41 to 0.59

Weighted average expected volatility

   0.48    0.49    0.48    0.52

Post-vesting termination rate

   2.51%    2.95%    2.62%    2.44%

Dividend yield

   —      —      —      —  

Fair value

   $15.46    $14.71    $12.09    $11.39

The weighted average expected term of the Company’s stock options and SARs granted or assumed during the three and nine months ended March 30, 2012 was 5.0 years and 4.9 years, compared to 5.0 years and 4.7 years, respectively, in the comparative prior-year periods.

Fair Value Disclosure — Black-Scholes-Merton Model

The fair value of ESPP purchase rights issued is estimated at the date of grant of the purchase rights using the Black-Scholes-Merton option-pricing model. The Black-Scholes-Merton option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. The Black-Scholes-Merton option-pricing model requires the input of highly subjective assumptions such as the expected stock price volatility and the expected period until options are exercised. Purchase rights under the current ESPP provisions are granted on either June 1 or December 1. ESPP activity was immaterial to the condensed consolidated financial statements for the three and nine months ended March 30, 2012 and April 1, 2011.

RSU Activity

The following table summarizes RSU activity (in millions, except weighted average grant date fair value):

 

 

     Number
of  Shares
    Weighted  Average
Grant-Date
Fair Value
 

RSUs outstanding at July 1, 2011

     3.1      $ 28.85   

Granted

     0.9        29.64   

Vested

     (0.6     23.94   
  

 

 

   

RSUs outstanding at September 30, 2011

     3.4      $ 29.83   

Granted

     0.1        26.30   

Vested

     (0.1     19.54   
  

 

 

   

RSUs outstanding at December 30, 2011

     3.4      $ 30.00   

Granted

     0.1        38.38   

Assumed

     0.4        38.98   

Vested

     (0.6     34.17   
  

 

 

   

RSUs outstanding at March 30, 2012

     3.3      $ 32.33   
  

 

 

   

 

 

 

Expected to vest after March 30, 2012

     3.2      $ 32.44   
  

 

 

   

 

 

 

 

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10. Pensions and Other Post-retirement Benefit Plans

In connection with the Acquisition, the Company assumed pension and other post-retirement benefit plans in various countries, including Japan, the Philippines, Thailand and Taiwan. The values assigned to the plan assets and benefit plan liabilities are preliminary and may be adjusted as further information becomes available (see also Note 11). The expected long-term rate of return on plan assets is 3.5%.

The following table presents the unfunded status of the benefit obligations and plan assets as of March 30, 2012 (in millions):

 

 

     Mar. 30, 2012  
     Japan  Pension
Benefits
    Other
Benefits
 

Benefit obligation

   $ 288      $ 29   

Fair value of plan assets

     (163     —     
  

 

 

   

 

 

 

Unfunded status

   $ 125      $ 29   
  

 

 

   

 

 

 

The following table presents the unfunded amounts as recognized on the Company’s condensed consolidated balance sheets as of March 30, 2012 (in millions):

 

 

     Mar. 30, 2012  
     Japan  Pension
Benefits
     Other
Benefits
 

Current liabilities

   $ 3       $ 1   

Non-current liabilities

     122         28   
  

 

 

    

 

 

 

Net amount recognized

   $ 125       $ 29   
  

 

 

    

 

 

 

The net periodic benefit cost of the Company’s assumed pension plans was not material to the condensed consolidated financial statements in the three and nine months ended March 30, 2012 and April 1, 2011. In fiscal 2012, the Company expects to pay contributions of $4 million for its Japanese pension plans.

11. HGST Acquisition

On March 8, 2012, the Company, through Western Digital Ireland (“WDI”), its indirect wholly-owned subsidiary, completed the Acquisition pursuant to a Stock Purchase Agreement, dated March 7, 2011 (the “SPA”). HGST is a developer and manufacturer of storage devices. As a result of the Acquisition, HGST became an indirect wholly-owned subsidiary of the Company. The preliminary, aggregate purchase price of the Acquisition was approximately $4.7 billion, which was paid on the Closing Date and funded with $3.7 billion of existing cash and cash from new debt, as well as 25 million newly issued shares of the Company’s common stock with a fair value of $877 million. The fair value of the newly issued shares of the Company’s common stock was determined based on the closing market price of the Company’s shares of common stock on the date of the Acquisition, less a 10% discount for lack of marketability as the shares issued are subject to a restriction that limits their trade or transfer for one year from the Closing Date. The purchase price consideration included preliminary estimates of the working capital assets acquired and liabilities assumed, and therefore, may be adjusted when finalized. The Acquisition is intended over time, and subject to compliance with applicable regulatory conditions imposed on the Acquisition, to result in a more efficient and innovative customer-focused storage company with significant operating scale, strong global talent and a broad product lineup backed by a rich technology portfolio. HGST’s results of operations since the date of the Acquisition are included in the accompanying condensed consolidated financial statements.

The total preliminary purchase price for HGST was approximately $4.7 billion and was comprised of:

 

 

     Mar. 8,  
     2012  
(in millions)       

Acquisition of all issued and outstanding paid-up share capital of HGST

   $ 4,612   

Preliminary fair value of stock options, restricted stock-based awards and SARs assumed

     102   
  

 

 

 

Total

   $ 4,714   
  

 

 

 

 

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The preliminary fair values of stock options and SARs assumed were estimated using a Binomial option-pricing model. See “Stock-Based Compensation” included below in this Note 11 for a further discussion concerning stock awards assumed as a result of the Acquisition.

The Company identified and recorded the assets acquired and liabilities assumed at their estimated fair values at the Closing Date, and allocated the remaining value of approximately $1.7 billion to goodwill. The values assigned to certain acquired assets and liabilities are preliminary, are based on information available as of the date of this Quarterly Report on Form 10-Q, and may be adjusted as further information becomes available during the measurement period of up to 12 months from the date of the Acquisition. Additional information that may become available subsequently and may result in changes in the values allocated to various assets and liabilities, including, but is not limited to, unidentified claims from suppliers or other contingent obligations, the amounts required to settle them, the progress or outcomes of various litigation, pension plans and the value of deferred taxes. Any changes in the fair values of the assets acquired and liabilities assumed during the measurement period may result in material adjustments to goodwill. The preliminary purchase price allocation was as follows (in millions):

 

 

     Mar. 8,  
     2012  

Tangible assets acquired and liabilities assumed:

  

Cash and cash equivalents

   $ 194   

Accounts receivable

     1,293   

Inventories

     723   

Other current assets

     187   

Property, plant and equipment

     1,974   

Other non-current assets

     106   

Accounts payable

     (841

Accrued liabilities

     (585

Debt assumed

     (585

Pension and other post-retirement benefit liabilities

     (145

Other liabilities

     (100

Intangible assets

     793   

Goodwill

     1,700   
  

 

 

 

Total

   $ 4,714   
  

 

 

 

During the three and nine months ended March 30, 2012, through the Closing Date, the Company incurred $34 million and $61 million, respectively, of expenses related to the Acquisition, of which $33 million and $54 million are included within selling, general and administrative expense in the condensed consolidated statements of income. The remaining $1 million and $7 million of expenses related to the Acquisition in the three and nine months ended March 30, 2012 through the Closing date, related to debt commitment fees, which are included within interest and other expense in the condensed consolidated statements of income.

Property, Plant and Equipment

The property, plant and equipment acquired as part of the Acquisition were valued using either the replacement cost or market value approach, as appropriate, as of the Closing Date. The following table summarizes the preliminary estimated fair value of the property, plant and equipment acquired from HGST and their estimated useful lives:

 

 

            Estimated  
     Estimated  Fair
Value
     Weighted-Average
Useful Life
 
     (In millions)      (In years)  

Land

   $ 342         —     

Buildings

     239         30.0   

Machinery and equipment

     1,354         3.0   

Furniture and fixtures

     5         2.9   

Leasehold improvements

     34         4.8   
  

 

 

    

Total property, plant and equipment

   $ 1,974      
  

 

 

    

 

 

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Inventories

The Company acquired $723 million of inventories as a result of the Acquisition. Finished goods were valued at estimated selling prices less costs of disposal and a reasonable profit allowance for the selling effort. Work-in-process inventory was valued at estimated selling prices less costs to complete, costs of disposal and a reasonable profit allowance for the completion and selling effort, or at estimated replacement costs for certain components. Raw materials were valued at estimated replacement cost at the Closing Date.

Warranty

The product warranty obligation assumed as a result of Acquisition was recognized at its estimated fair value of $139 million.

Stock-Based Compensation

In connection with the Acquisition, each outstanding HGST option, cash-settled SAR and RSU that was unvested as of the Closing Date was converted into equivalent options, cash-settled SARs and RSUs, with respect to shares of the Company’s common stock, using an equity award exchange ratio in accordance with the SPA. All awards will be recognized by the Company over the remaining service periods. As of March 30, 2012, the future expense for the converted HGST unvested options, SARs and RSUs was $103 million, which will be recognized over a weighted average service period of approximately 2.1 years.

Identifiable Intangible Assets Acquired

The following table summarizes the preliminary fair values and estimated useful lives of the intangibles acquired from HGST:

 

 

            Estimated  
     Estimated  Fair
Value
     Weighted-
Average
Useful
Life
 
     (In millions)      (In years)  

Existing technology

   $ 431         3.7   

Customer relationships

     146         3.4   

Joint development agreement

     35         2.5   

Trade names

     26         3.0   

Non-compete agreement

     3         5.0   

In-process research and development

     140         —     

Leasehold interests

     12         5.0   
  

 

 

    

Total acquired identifiable intangible assets

   $ 793      
  

 

 

    

The fair values of the identifiable intangible assets acquired from HGST were estimated using an income approach. The fair value of the intangible assets will be amortized to cost of revenue over their weighted average useful lives, with the exception of intangible assets related to customer relationships and acquired in-process research and development projects. Customer relationship intangible assets will be amortized to operating expense over their weighted average useful lives. HGST had in-process research and development projects associated with areal density improvements that had not yet reached technological feasibility as of the Closing Date. These projects are expected to incorporate significant changes in the magnetic structure of the media to achieve higher recording density for the Company. Accordingly, the Company recorded indefinite-lived intangible assets of $140 million for the fair value of these projects, which will not initially be amortized. Instead, the projects will be tested on an annual basis or more frequently whenever events or changes in circumstances indicate that the projects may be impaired or may have reached technological feasibility. Once a project reaches technological feasibility, the Company will begin to amortize the intangible asset over its estimated useful life.

Adverse/Favorable Leasehold Interests

The Company analyzed the contractual facility leases assumed as part of the Acquisition to determine the fair value of the leasehold interests. An adverse leasehold position exists when the present value of the contractual rental obligation is greater than the present value of the market rental obligation, and conversely for a favorable leasehold interest. The Company recorded a net favorable leasehold interest of $12 million, which is classified within intangible assets in the preliminary purchase price allocation table above in this Note 11. The $12 million will be amortized to cost of revenue over the average lease term of five years.

 

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Goodwill

The $1.7 billion of goodwill recognized is primarily attributable to the benefits, subject to compliance with applicable regulatory conditions imposed on the Acquisition, the Company expects to derive from a more efficient and innovative customer-focused storage company with significant operating scale, strong global talent and a broad product lineup backed by a rich technology portfolio. None of the goodwill is expected to be deductible for tax purposes.

The changes in the carrying amount of goodwill for the nine months ended March 30, 2012 are as follows (in millions):

 

 

Balance at July 1, 2011

   $ 151   

Goodwill acquired from the Acquisition

     1,700   
  

 

 

 

Balance at March 30, 2012

   $ 1,851   
  

 

 

 

The Company is currently assessing the number of reporting units under which goodwill will be allocated and tested for impairment.

HGST Revenue and Net Income

The amount of revenue and earnings attributable to HGST in the Company’s condensed consolidated statement of income during the three and nine months ended March 30, 2012 from the Closing Date were as follows:

 

 

     Three Months
Ended
     Nine Months
Ended
 
     Mar. 30, 2012      Mar. 30, 2012  
(in millions)       

Revenue

   $ 614       $ 614   

Net income

   $ 40       $ 40   

Regulatory Conditions

In connection with the regulatory approval process, the Company announced on February 28, 2012 that it had reached an agreement with Toshiba Corporation (“Toshiba”) to, subject to regulatory approval, divest certain assets related to the production of 3.5-inch hard drives to address the requirements of regulatory agencies that had conditionally approved the Acquisition. In addition, subject to completion of the divestiture transaction, the Company agreed to the purchase of Toshiba Storage Device (Thailand) Company Limited (“TSDT”) by WDI. The net assets of TSDT consist primarily of real estate and receivables. The divestiture transaction and the acquisition of TSDT are not expected to have a material impact on the Company’s consolidated financial statements. This divestiture transaction has received all required regulatory approvals and must be completed within the time periods agreed upon with the jurisdictions whose approval of the Acquisition was conditioned on the divestiture, subject to any extensions that are obtained.

Maintenance of Competitive Requirement

In connection with the regulatory approval process of the Acquisition, the Company agreed to certain conditions required by the Ministry of Commerce of the People’s Republic of China (“MOFCOM”), including adopting measures to maintain HGST as an independent competitor until MOFCOM agrees otherwise (with the minimum period being two years). The Company is working closely with MOFCOM to finalize an operations plan that is expected to outline in more detail the conditions of the competitive requirement.

 

 

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Pro Forma Financial Information

The unaudited financial information in the table below summarizes the combined results of operations of the Company, HGST and TSDT as well as the related proposed divestiture of assets to Toshiba, on a pro forma basis, as though the combinations and divestiture had occurred as of the beginning of fiscal 2011. The pro forma financial information presented includes the effects of adjustments related to the fair value of acquired inventory and warranty obligation, acquired or divested fixed assets, amortization charges from acquired intangible assets, depreciation charges from acquired or divested fixed assets and the elimination of certain activities excluded from the transactions. The pro forma financial information as presented below is for informational purposes only and is not necessarily indicative of the results of operations that would have been achieved if the acquisitions, divestiture and any borrowings undertaken to finance the acquisitions had taken place at the beginning of the earliest period presented, nor does it intend to be a projection of future results.

 

 

     Three months ended      Nine months ended  
     Mar. 30,      Apr. 1,      Mar. 30,      Apr. 1,  

(in millions, except per share amounts)

   2012      2011      2012      2011  

Revenue

   $ 4,497       $ 3,654       $ 12,091       $ 11,566   

Net income

   $ 715       $ 160       $ 1,284       $ 718   

Basic income per common share

   $ 2.69       $ 0.62       $ 4.92       $ 2.80   

Diluted income per common share

   $ 2.64       $ 0.61       $ 4.85       $ 2.76   

12. Thailand Flooding

In October 2011, severe flooding in Thailand inundated all of the Company’s Thailand manufacturing facilities and submerged certain equipment located there. These facilities included the Company’s magnetic head slider fabrication facilities, as well as its hard drive, head gimbal assembly and head stack assembly facilities. As a result, the Company recorded $15 million and $214 million of net flood-related charges in the three and nine months ended March 30, 2012, including fixed asset impairments, recovery charges, a write-down of damaged inventory and wage continuation during the shutdown period of the Company’s facilities, offset by $21 million of insurance recoveries and other cost reimbursements. These charges are separately stated as a line item, “Charges related to flooding, net,” within operating expenses on the accompanying condensed consolidated statements of income.

The following table summarizes the flood-related charges for the six months ended March 30, 2012 (in millions):

 

 

     Impairment of
Property, Plant
and Equipment
    Recovery
Charges
    Inventory
Write-
Downs
    Wage
Continuation
    Total  

Accrual for flood-related charges at September 30, 2011

   $ —        $ —        $ —        $ —        $ —     

Flood-related charges

     109       39       28       23       199  

Cash payments

     —          (20 )     —          (23 )     (43 )

Inventory write-off

     —          —          (28 )     —          (28 )

Non-cash charges

     (109 )     —          —          —          (109 )
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Accrual for flood-related charges at December 30, 2011

   $ —        $ 19     $ —        $ —        $ 19  

Flood-related charges

     10       22       —          4       36  

Cash payments

     —          (33 )     —          (4 )     (37 )

Non-cash charges

     (10 )     —          —          —          (10 )
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Accrual for flood-related charges at March 30, 2012

   $ —        $ 8     $ —        $ —        $ 8  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accrued balance of $8 million is expected to be paid in the Company’s fourth quarter of fiscal 2012 and is included within accrued expenses in the accompanying condensed consolidated balance sheets. The Company maintains insurance coverage that provides property and business interruption coverage in the event of losses arising from flooding. The Company has submitted claims to its insurers and is awaiting a determination of how much of its total losses will be covered by insurance. For an additional discussion of the Thailand flooding, see Part I, Item 2 of this Quarterly Report on Form 10-Q.

 

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13. Recent Accounting Pronouncements

In June 2011, the FASB issued Accounting Standards Update (“ASU”) 2011-05 “Presentation of Comprehensive Income” (“ASU 2011-05”). The new standard requires that all non-owner changes in shareholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but continuous statements. If presented in two separate statements, the first statement should present total net income and its components followed immediately by a second statement of total other comprehensive income, its components and the total comprehensive income. In December 2011, the FASB deferred certain changes in ASU 2011-05 that relate to the presentation of reclassification adjustments. The new standard is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2011, which for the Company is the first quarter of fiscal 2013. The Company is currently evaluating how it will report comprehensive income, but the adoption of either method will constitute a change in the Company’s financial statement presentation.

 

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

This information should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in this Quarterly Report on Form 10-Q, and the audited consolidated financial statements and notes thereto and Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, contained in our Annual Report on Form 10-K for the year ended July 1, 2011.

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

Forward-Looking Statements

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

 

   

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

 

   

expectations regarding the shipment of drives in the June quarter with sliders produced in our Penang, Malaysia facility;

 

   

expectations concerning the anticipated benefits of our acquisition of Viviti Technologies Ltd., until recently known as Hitachi Global Storage Technologies Holdings Pte. Ltd.;

 

   

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

 

   

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

 

   

our entry into and position in the traditional enterprise market;

 

   

emergence of new storage markets for hard drives;

 

   

emergence of competing storage technologies;

 

   

our share repurchase plans;

 

   

our stock price volatility;

 

   

expectations regarding the outcome of legal proceedings in which we are involved, including the outcome of our motion to vacate the award entered against us in our arbitration with Seagate Technology LLC and, if necessary, our appeal of the award;

 

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

 

   

contributions to our pension plans in fiscal 2012;

 

   

expectations regarding our capital expenditure plans in fiscal 2012 and calendar 2012, and depreciation and amortization for fiscal 2012;and

 

   

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

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

Our Company

We are a global provider of solutions for the collection, storage, management, protection and use of digital content, including audio and video. Our principal products are hard drives, which are devices that use one or more rotating magnetic disks (“magnetic media”) to store and allow fast access to data. Hard drives are currently the primary storage medium for digital content. Our hard drives are used in desktop and notebook computers, corporate and cloud computing data centers, home entertainment equipment and stand-alone consumer storage devices. In addition to hard drives, we offer solid-state drives and home entertainment and networking products.

Acquisition

Hitachi Global Storage Technologies Holdings Pte. Ltd. (“HGST”) Acquisition

On March 8, 2012 ( the “Closing Date”), we, through Western Digital Ireland (“WDI”), our indirect wholly-owned subsidiary, completed the acquisition (the “Acquisition”) of all the issued and outstanding paid-up share capital of Viviti Technologies Ltd., until recently known as Hitachi Global Storage Technologies Holdings Pte. Ltd. (“HGST”), from Hitachi Ltd. (“Hitachi”), pursuant to a Stock Purchase Agreement, dated March 7, 2011, among us, WDI, Hitachi and HGST (the “SPA”). The Acquisition is intended over time, and subject to compliance with applicable regulatory conditions imposed on the Acquisition, to result in a more efficient and innovative customer-focused storage company, with significant operating scale, strong global talent and a broad product lineup backed by a rich technology portfolio.

The preliminary, aggregate purchase price of the Acquisition amounted to approximately $4.7 billion, which was paid on the Closing Date and funded with existing cash, new debt, and 25 million newly issued shares of our common stock. The cash portion of the purchase price is subject to a post-closing adjustment (an increase or a decrease) that has not been determined for changes in the working capital of HGST and certain other payments and expenses.

Following the issuance of the 25 million shares of our common stock to Hitachi in accordance with the SPA, Hitachi owns approximately ten percent of our outstanding shares of common stock. The shares issued to Hitachi are subject to a restriction that limits their trade or transfer for one year from the Closing Date. Pursuant to the terms of a separate Investor Rights Agreement we entered into with Hitachi in connection with the Acquisition, Hitachi has the right to designate two individuals (the “Hitachi Designees”) to serve as directors on our Board of Directors. This right will terminate (i) with respect to one of the Hitachi Designees, at the end of the second full calendar year following the Closing Date, (ii) in the event Hitachi ceases to beneficially own at least 50% of the shares of our common stock it received in connection with the Acquisition, (iii) if Hitachi has sold at least 10% of the shares of our common stock it received in connection with the Acquisition, in the event that Hitachi ceases to beneficially own at least 5% of our outstanding common stock, (iv) upon Hitachi’s breach of certain standstill or transfer restriction obligations of the Investor Rights Agreement, or (v) upon Hitachi’s material breach of a separate Agreement Not to Compete that we entered into with Hitachi on the Closing Date.

 

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On the Closing Date, WDC, WDI and Western Digital Technologies, Inc. (“WDT”) entered into a five-year credit agreement (the “Credit Facility”) with Bank of America, N.A., as administrative agent, swing line lender and L/C issuer, and the lenders party thereto. The Credit Facility provides for $2.8 billion of unsecured loan facilities consisting of a $2.3 billion term loan facility and a $500 million revolving credit facility. The only borrower under the term loan facility is WDI and the revolving credit facility is available to both WDI and WDT. The $2.3 billion term loans and $500 million revolving loans were used, together with additional cash and the 25 million newly issued shares of our common stock, to fund the Acquisition. See “Liquidity and Capital Resources—Contractual Obligations and Commitments” for a further description of the Credit Facility.

Maintenance of Competitive Requirement

In connection with the regulatory approval process of the Acquisition, we agreed to certain conditions required by the Chinese Ministry of Commerce (“MOFCOM”), including adopting measures to maintain HGST as an independent competitor until MOFCOM agrees otherwise (with the minimum period being two years). We are working closely with MOFCOM to finalize an operations plan that is expected to outline in more detail the conditions of the competitive requirement.

Regulatory Conditions

In connection with the regulatory approval process, we announced on February 28, 2012 that we had reached an agreement with Toshiba Corporation (“Toshiba”) to, subject to regulatory approval, divest certain assets related to the production of 3.5-inch hard drives to address the requirements of regulatory agencies that had conditionally approved the Acquisition. In addition, subject to completion of the divestiture transaction, we agreed to the purchase of Toshiba Storage Device (Thailand) Company Limited (“TSDT”) by WDI. The net assets of TSDT consist primarily of real estate and receivables. The divestiture transaction and the acquisition of TSDT are not expected to have a material impact on our consolidated financial statements. This divestiture transaction has received all required regulatory approvals and must be completed within the time periods agreed upon with the jurisdictions whose approval of the Acquisition was conditioned on the divestiture, subject to any extensions that are obtained.

Thailand Flooding

We suspended production in all of our Thailand manufacturing facilities during the week of October 10, 2011 due to severe flooding in Thailand, where flood waters inundated our facilities and submerged certain equipment located there. The flooded facilities in Thailand included our magnetic head slider fabrication facilities, which supplied a substantial majority of our magnetic head requirements prior to the flooding. The flooded facilities in Thailand also included our hard drive, head gimbal assembly (“HGA”) and head stack assembly (“HSA”) facilities. In addition to the temporary suspension of our Thailand operations and the internal slider shortages, we experienced other shortages of component parts in the December and March quarters from vendors located in several Thailand industrial parks that were flooded or affected by protective plant shutdowns.

Since the flooding, we have restarted and continue to increase hard drive production capacity and have recommenced slider production in Thailand. We are also extending slider production capacity into Malaysia and expect to begin shipping hard drives with sliders produced in Malaysia in the June quarter. We believe we now have the capability to adequately meet anticipated customer demand.

In the three and nine months ended March 30, 2012, we recorded $15 million and $214 million of charges related to the flooding, respectively. Total charges in the three months ended March 30, 2012 included $10 million of fixed asset impairments, $22 million of recovery charges and $4 million in wage continuation during the shutdown period of our facilities, offset by $21 million of insurance recoveries and other cost reimbursements. Total charges in the nine months ended March 30, 2012 included $119 million of fixed asset impairments, $61 million of recovery charges, $28 million of write-downs of damaged inventory and $27 million in wage continuation during the shutdown period of our facilities, offset by $21 million of insurance recoveries and other cost reimbursements. We maintain insurance coverage that provides property and business interruption coverage in the event of losses arising from flooding. We have submitted claims to our insurers and are awaiting a determination of how much of our total losses will be covered by insurance. It is reasonably possible that the final losses that we incur in connection with the flood damage and our business interruption will exceed the limits of our insurance policies.

 

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Third Quarter Overview

In accordance with U.S. generally accepted accounting principles (“U.S. GAAP”), operating results for HGST prior to the date of the Acquisition are not included in our operating results, affecting our discussion of changes in our revenues and expenses for the periods prior to the Acquisition as compared to the periods after the Acquisition.

For the March quarter, we believe that overall hard drive industry shipments totaled approximately 146 million units, down 9% from the prior-year period and up 23% sequentially from the December quarter. We also believe that the industry growth in the March quarter compared to the December quarter was a result of the industry recovering from the Thailand flooding.

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

 

     Three Months Ended     Nine Months Ended  
     Mar. 30,
2012
    Apr. 1,
2011
    Mar. 30,
2012
    Apr. 1,
2011
 

Net revenue

   $ 3,035         100.0   $ 2,252         100.0   $ 7,724         100.0   $ 7,123         100.0

Gross margin

     977         32.2        410         18.2        2,166         28.0        1,322         18.6   

Total operating expenses

     435         14.3        252         11.2        1,203         15.6        713         10.0   

Operating income

     542         17.9        158         7.0        963         12.5        609         8.5   

Net income

     483         15.9        146         6.5        867         11.2        568         8.0   

The following is a summary of our financial performance for the third quarter of 2012:

 

  Consolidated net revenue totaled $3.0 billion.

 

  HGST contributed $614 million to our consolidated net revenue.

 

 

30% of our hard drive revenue was derived from non-compute and enterprise markets, which include CE products, enterprise applications, and branded products, as compared to 36% in the prior-year period.

 

  Hard drive unit shipments decreased by 11% from the prior-year period to 44.2 million units.

 

  Gross margin increased to 32.2%, compared to 18.2% for the prior-year period.

 

  Operating income, including a net $15 million of charges related to the Thailand flooding and $33 million of Acquisition-related expenses, was $542 million, an increase of $384 million from the prior-year period.

 

  We generated $1.2 billion in cash flow from operations in the third quarter of fiscal 2012, and we finished the quarter with $3.4 billion in cash and cash equivalents.

For the June quarter, we expect overall hard drive industry shipments to be approximately 155 to 160 million units. We believe there is sufficient capacity in the industry to support demand. As our recovery from the Thailand flooding is essentially complete, we believe our pricing in the June quarter will be reflective of current market conditions. We believe our revenue in the June quarter, which will include a full-quarter of HGST revenue, will significantly increase from the March quarter.

 

 

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Results of Operations

Net Revenue

 

     Three Months
Ended
          Nine Months
Ended
       

(in millions, except percentages and

average selling price)

   Mar. 30,
2012
    Apr. 1,
2011
    Percentage
Change
    Mar. 30,
2012
    Apr. 1,
2011
    Percentage
Change
 

Net revenue

   $ 3,035      $ 2,252        35   $ 7,724      $ 7,123        8

Average selling price (per unit)*

   $ 68      $ 45        51   $ 59      $ 46        28

Revenues by Geography (%)

            

Americas

     21     22       21     23  

Europe, Middle East and Africa

     18        24          20        24     

Asia

     61        54          59        53     

Revenues by Channel (%)

            

OEM

     64     47       59     47  

Distributors

     28        33          27        33     

Retailers

     8        20          14        20     

Unit Shipments*

            

Compute

     34.0        36.3          96.5        111.7     

Non-compute

     6.6        11.2          26.3        34.2     

Enterprise

     3.6        2.3          7.7        6.9     
  

 

 

   

 

 

     

 

 

   

 

 

   

Total units shipped

     44.2        49.8        (11 )%      130.5        152.8        (15 )% 

 

* Based on sales of hard drive units only.

For the quarter ended March 30, 2012, net revenue was $3.0 billion, an increase of 35% from the prior-year period. Our newly acquired operations from HGST contributed $614 million in net revenue. Total hard drive shipments decreased to 44.2 million units for the quarter ended March 30, 2012 as compared to 49.8 million units in the prior-year period. For the nine months ended March 30, 2012, net revenue was $7.7 billion, an increase of 8% from the prior-year period. Total hard drive shipments decreased to 130.5 million units for the nine months ended March 30, 2012, as compared to 152.8 million units for the prior-year period. These increases in net revenue resulted primarily from an increase in average selling price (“ASP”) and the contribution of the newly acquired operations of HGST, partially offset by a decrease in shipments. For the quarter ended March 30, 2012, ASP increased by $23, from $45 to $68. For the nine months ended March 30, 2012, ASP increased by $13, from $46 to $59. These increases in ASP for the three and nine months ended March 30, 2012 were directly related to the severe supply constraints across the hard drive industry brought about by the Thailand floods.

Changes in revenue by geography and channel generally reflect normal fluctuations in market demand and competitive dynamics. However, during the three and nine months ended March 30, 2012, changes in revenue by geography and channel reflected our efforts to allocate products to our customers by balancing their immediate needs with their prevailing inventory positions in order to maximize the availability of hard drive products to the end customer within the shortest time horizon. For the three and nine months ended March 30, 2012, no customer accounted for 10% or more of our net revenue.

In accordance with standard industry practice, we have sales incentive and marketing programs that provide customers with price protection and other incentives or reimbursements that are recorded as a reduction to gross revenue. For both the three and nine months ended March 30, 2012, these programs represented 5% of gross revenues, compared to 12% and 11% in the comparative prior-year period. These amounts generally vary according to several factors, including industry conditions, seasonal demand, competitor actions, channel mix and overall availability of product. However, for the December and March quarters, sales incentive and marketing programs were significantly reduced due to the severe supply constraints across the hard drive industry brought about by the Thailand floods.

Gross Margin

 

     Three Months
Ended
          Nine Months
Ended
       

(in millions, except percentages)

   Mar. 30,
2012
    Apr. 1,
2011
    Percentage
Change
    Mar. 30,
2012
    Apr. 1,
2011
    Percentage
Change
 

Net revenue

   $ 3,035      $ 2,252        35   $ 7,724      $ 7,123        8

Gross margin

     977        410        138     2,166        1,322        64

Gross margin %

     32.2     18.2       28.0     18.6  

For the three months ended March 30, 2012, gross margin as a percentage of revenue increased to 32.2% as compared to 18.2% for the prior-year period. For the nine months ended March 30, 2012, gross margin as a percentage of revenue increased to 28.0% as compared to 18.6% for the prior-year period. These increases were primarily a result of higher ASPs, partially offset by increased costs per unit due to lower capacity utilization, increased use of air freight as opposed to less expensive sea freight, a higher mix of externally procured heads and higher costs for other components, in each case as a result of the impact of the Thailand flooding on our production and supply chain partners. In addition, the Company had an offset to gross margin of $91 million for costs recognized upon the sale of inventory that was written-up to fair value and $9 million for amortization of intangibles related to the Acquisition. In the fourth quarter of fiscal 2012, we estimate intangible asset amortization of $40 million to be included within cost of revenue.

 

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Table of Contents

Operating Expenses

 

     Three Months
Ended
           Nine Months
Ended
        

(in millions, except percentages)

   Mar. 30,
2012
     Apr. 1,
2011
     Percentage
Change
    Mar. 30,
2012
     Apr. 1,
2011
     Percentage
Change
 

R&D expense

   $ 265       $ 179         48   $ 649       $ 515         26

SG&A expense

     155         73         112     340         198         72

Charges related to flooding, net

     15         —           —          214         —           —     
  

 

 

    

 

 

      

 

 

    

 

 

    

Total operating expenses

   $ 435       $ 252         $ 1,203       $ 713      
  

 

 

    

 

 

      

 

 

    

 

 

    

Research and development (“R&D”) expense was $265 million for the three months ended March 30, 2012, an increase of $86 million from the prior-year period. For the nine months ended March 30, 2012, R&D expense was $649 million, an increase of $134 million from the prior-year period. These increases were primarily due to the continued investment in product development to support new programs and increases in variable incentive compensation, as well as the inclusion of HGST’s R&D activities since the Closing Date. As a percentage of net revenue, R&D expense increased to 8.7% and 8.4% in the three and nine months ended March 30, 2012, respectively, compared to 7.9% and 7.2% in the prior-year periods.

Selling, general and administrative (“SG&A”) expense was $155 million for the three months ended March 30, 2012, an increase of $82 million over the prior-year period. For the nine months ended March 30, 2012, SG&A expense was $340 million, an increase of $142 million over the prior-year period. These increases were primarily due to incremental acquisition-related expenses of $23 million and $44 million in the three and nine months ended March 30, 2012, respectively, and increases in variable incentive compensation, as well as the inclusion of SG&A expense from HGST since the Closing Date. SG&A expense as a percentage of net revenue increased to 5.1% and 4.4% in the three and nine months ended March 30, 2012, respectively, compared to 3.2% and 2.8% in the comparative prior-year periods. In the fourth quarter of fiscal 2012, we estimate intangible asset amortization of $10 million to be included within selling, general and administrative expense.

During the three months ended March 30, 2012, we recorded $15 million of charges related to the flooding, including $10 million of fixed asset impairments, $22 million of recovery charges and $4 million in wage continuation during the shutdown period of our facilities, offset by $21 million of insurance recoveries and other cost reimbursements. During the nine months ended March 30, 2012, we recorded $214 million of charges related to the flooding, including $119 million of fixed asset impairments, $61 million of recovery charges, $28 million of write-downs of damaged inventory and $27 million in wage continuation during the shutdown period of our facilities, offset by $21 million of insurance recoveries and other cost reimbursements.

Other Income (Expense)

Interest income for the three and nine months ended March 30, 2012 increased $1 million and $3 million, respectively, as compared to the prior-year periods primarily due to higher average daily invested cash balances for the periods. Interest and other expense for the three and nine months ended March 30, 2012 increased $6 million and $11 million, respectively, as compared to the prior-year periods. These increases were primarily due to interest on an increased debt balance and $1 million and $7 million of debt commitment fees incurred prior to the closing of the Acquisition in the three and nine months ended March 30, 2012, respectively.

Income Tax Provision

Our income tax provision for the three months ended March 30, 2012 was $55 million as compared to $13 million in the prior-year period. Our income tax provision for the nine months ended March 30, 2012 was $88 million as compared to $41 million in the prior-year period. The differences between the effective tax rate and the U.S. Federal statutory rate are primarily due to tax holidays in Malaysia, the Philippines, Singapore and Thailand that expire at various dates through 2023 and the current year generation of income tax credits.

In the three months ended March 30, 2012, we recorded a net increase of $45 million in our liability for unrecognized tax benefits. This includes $41 million related to the Acquisition. As of March 30, 2012, we had a recorded liability for unrecognized tax benefits of approximately $277 million. Interest and penalties recognized on such amounts were not material.

 

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Table of Contents

The Internal Revenue Service (“IRS”) has completed its field examination of the federal income tax returns for fiscal years 2006 and 2007 for us and calendar years 2005 and 2006 for Komag, Incorporated (“Komag”), which was acquired by us on September 5, 2007. In September 2011, we received a final Revenue Agent Report (“RAR”) and Closing Agreement with respect to the years under examination for Komag. This agreement resulted in an immaterial benefit to our income tax provision. We have also received RARs from the IRS that seek adjustments to income before income taxes of approximately $970 million in connection with unresolved issues related primarily to transfer pricing and certain other intercompany transactions. We disagree with the proposed adjustments. In May 2011, we filed a protest with the IRS Appeals Office regarding the proposed adjustments. Meetings with the Appeals Office began in February 2012. In January 2012, the IRS commenced an examination of our fiscal years 2008 and 2009 and Komag’s fiscal year ended September 5, 2007.

We believe that adequate provision has been made for any adjustments that may result from tax audits. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in our tax audits are resolved in a manner not consistent with management’s expectations, we could be required to adjust our provision for income taxes in the period such resolution occurs. As of March 30, 2012, it is not possible to estimate the amount of change, if any, in the unrecognized tax benefits that is reasonably possible within the next twelve months. Any significant change in the amount of our unrecognized tax benefits would most likely result from additional information or settlements relating to the examination of our tax returns.

Arbitration Award

As disclosed above in Part I, Item 1, Note 5 in the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, on November 18, 2011, a sole arbitrator ruled against us in an arbitration in Minnesota. The arbitration involves claims brought by Seagate Technology LLC against us and a now former employee, alleging misappropriation of confidential information and trade secrets. The arbitrator issued an interim award against us in the amount of $525 million plus pre-award interest. On January 23, 2012, the arbitrator issued a final award adding pre-award interest in the amount of $105.4 million, for a total award of $630.4 million. On January 23, 2012, we filed a petition in the District Court of Hennepin County, Minnesota to have the final arbitration award vacated. A hearing on the petition to vacate was held on March 1, 2012. Interest (as simple interest, not compounding) on the final award ($630.4 million) also accrues at the Minnesota statutory rate of 10% per year while we pursue our motion to vacate the award, and if necessary, an appeal if the motion to vacate the award is unsuccessful. We intend to pursue vigorously our motion to vacate the award and, if necessary, to appeal the award if it is confirmed by the District Court of Hennepin County Minnesota. The Company does not believe it is probable that the arbitrator’s award will be sustained and accordingly has not recorded any cost or liability for the arbitrator’s award in excess of the amount previously accrued by the Company ($25 million). We cannot make any assurances that we will be successful in our efforts to vacate the award or to overturn the award on appeal. If we are unsuccessful in these efforts, payment of the award, including interest, would adversely affect our financial condition, results of operations and cash flows. We will also be required to record a liability for the award if we should determine it is probable we will be required to pay the award.

Liquidity and Capital Resources

We ended the third quarter of fiscal 2012 with total cash and cash equivalents of $3.4 billion. The following table summarizes our statements of cash flows (in millions):

 

     Nine Months Ended  
     Mar. 30,
2012
    Apr. 1,
2011
 

Net cash flow provided by (used in):

    

Operating activities

   $ 1,938      $ 1,208   

Investing activities

     (3,934     (625

Financing activities

     1,889        (87

Effect of exchange rate changes on cash

     (6     —     
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

   $ (113   $ 496   
  

 

 

   

 

 

 

Our investment policy is to manage our investment portfolio to preserve principal and liquidity while maximizing return through the full investment of available funds. We believe our current cash, cash equivalents and cash generated from operations will be sufficient to meet our working capital and capital expenditure needs for the next 12 months. Our ability to sustain our working capital position is subject to a number of risks that we discuss in Part II, Item 1A of this Quarterly Report on Form 10-Q.

 

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Table of Contents

We had cash and cash equivalents of $3.4 billion at March 30, 2012 and $3.5 billion at July 1, 2011, of which $2.1 billion and $3.0 billion was held outside of the United States at March 30, 2012 and July 1, 2011, respectively. Substantially all of the amounts held outside of the United States are intended to be indefinitely reinvested in foreign operations. Our current plans do not anticipate that we will need funds generated from foreign operations to fund our domestic operations. In the event funds from foreign operations are needed in the United States, any repatriation could result in the accrual and payment of additional U.S. income tax.

Operating Activities

Net cash provided by operating activities was $1.9 billion and $1.2 billion during the nine months ended March 30, 2012 and the nine months ended April 1, 2011, respectively. Cash flow from operating activities consists of net income, adjusted for non-cash charges, plus or minus working capital changes. This represents our principal source of cash. Net cash provided by working capital changes was $363 million for the nine months ended March 30, 2012 as compared to $130 million for the prior-year period.

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

 

     Three Months Ended  
     Mar. 30,
2012
    Apr. 1,
2011
 

Days sales outstanding

     71        47   

Days in inventory

     57        28   

Days payables outstanding

     (123     (73
  

 

 

   

 

 

 

Cash conversion cycle

     5        2   
  

 

 

   

 

 

 

For the three months ended March 30, 2012, our days sales outstanding (“DSOs”) increased by 24 days, days in inventory (“DIOs”) increased by 29 days, and days payable outstanding (“DPOs”) increased by 50 days compared to the prior year period. These increases were primarily due to the impact of including HGST’s accounts receivable, inventory and accounts payable balances as of March 30, 2012, but only including HGST’s revenue and cost of sales from the date of Acquisition. From time to time, we modify the timing of payments to our vendors. We make modifications primarily to manage our vendor relationships and to manage our cash flows, including our cash balances. Generally, we make the payment modifications through negotiations with our vendors or by granting to, or receiving from, our vendors payment term accommodations.

Investing Activities

Cash used in investing activities for the nine months ended March 30, 2012 was $3.9 billion as compared to $625 million for the prior-year period and consisted of $3.5 billion, net of cash acquired, used for the Acquisition and capital expenditures of $393 million. Cash used in investing activities for the nine months ended April 1, 2011 consisted of $625 million of capital expenditures.

For fiscal 2012, we expect capital expenditures to be approximately $750 million, which includes capital expenditures we expect to restore our capacity to pre-flood levels and enhance our supply chain infrastructure.

Our cash equivalents at March 30, 2012 were invested in highly liquid money market funds that are invested in U.S. Treasury securities, U.S. Treasury bills and U.S. Government agency securities. During the nine months ended March 30, 2012, we settled $1 million of auction-rate securities, reducing the carrying value of these investments to $14 million.

Financing Activities

Net cash provided by financing activities for the nine months ended March 30, 2012 was $1.9 billion as compared to $87 million used in financing activities in the prior-year period. Net cash provided by financing activities for the nine months ended March 30, 2012 consisted of the $2.8 billion of proceeds borrowed under the Credit Facility in connection with the Acquisition, net of issuance costs, and a net $49 million provided by employee stock plans, offset by $935 million used to repay outstanding debt of the Company as well as debt assumed in the Acquisition. Net cash used in financing activities for the nine months ended April 1, 2011 consisted of $75 million used to repay debt and $50 million used to repurchase shares of our common stock, offset by a net $38 million provided by employee stock plans.

 

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Table of Contents

Off-Balance Sheet Arrangements

Other than facility lease commitments incurred in the normal course of business and certain indemnification provisions (see “Contractual Obligations and Commitments” below), we do not have any off-balance sheet financing arrangements or liabilities, guarantee contracts, retained or contingent interests in transferred assets, or any obligation arising out of a material variable interest in an unconsolidated entity. We do not have any majority-owned subsidiaries that are not included in our unaudited condensed consolidated financial statements. Additionally, we do not have an interest in, or relationships with, any special-purpose entities.

Contractual Obligations and Commitments

Acquisition — As a result of the Acquisition, the Company assumed contractual obligations and commitments from HGST. The following is a summary of the significant contractual cash obligations and commercial commitments assumed as a result of the Acquisition as of March 30, 2012 (in millions):

 

     Total      Less than
1  Year
     1-3 Years      3-5 Years      More than
5  Years
 

Capital leases

   $ 4       $ 1       $ 3       $ —         $ —     

Operating leases

     57         26         23         8         —     

Purchase obligations

     981         970         6         3         2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,042       $ 997       $ 32       $ 11       $ 2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Long-Term Debt — On March 8, 2012, in connection with the Acquisition, WDI and WDT entered into the Credit Facility that provides for $2.8 billion of unsecured loan facilities, consisting of a $2.3 billion term loan facility and a $500 million revolving credit facility. The $2.3 billion term loan facility and $500 million available under the revolving credit facility were borrowed on the Closing Date and used to partially fund the Acquisition and repay our existing debt and debt assumed in the Acquisition. As of March 30, 2012, all $500 million remained outstanding under the revolving credit facility. As of March 30, 2012, the outstanding balance of the term loan facility was $2.2 billion. We are required to make principal payments on the term loan facility totaling $58 million through the remainder of 2012, $230 million a year for 2013 through 2016, and the remaining $1.3 billion balance (subject to adjustment to reflect prepayments or an increase to its term loan facility) in 2017, with the term loan facility balance due and payable in full on March 8, 2017 (the “Maturity Date”). The outstanding amount of revolving credit loans are also required to be repaid on the Maturity Date. We intend to repay the revolving credit facility within one year; therefore, the outstanding balance of $500 million under the revolving credit facility is classified as a current liability on our condensed consolidated balance sheets. See Part I, Item 1, Note 4 in the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

The Credit Facility requires us to comply with a leverage ratio and an interest coverage ratio calculated on a consolidated basis for us and our subsidiaries. In addition, the Credit Facility contains customary covenants, including covenants that limit or restrict, subject to certain exceptions, our ability to incur liens, incur indebtedness, make certain restricted payments, merge, consolidate or dispose of substantially all of our assets, enter into certain speculative hedging arrangements and make any material change in the nature of our business. Upon the occurrence of an event of default under the Credit Facility, the administrative agent at the request, or with the consent, of the Required Lenders (as defined in the Credit Facility) may cease making loans, terminate the Credit Facility and declare all amounts outstanding to be immediately due and payable, require the cash collateralization of letters of credit and/or exercise all other rights and remedies available to it, the lenders and the letter of credit issuer. The Credit Facility specifies a number of events of default (some of which are subject to applicable grace or cure periods), including, among other things, non-payment defaults, covenant defaults, cross-defaults to other material indebtedness, bankruptcy and insolvency defaults, material judgment defaults and a change of control default. As of March 30, 2012, we were in compliance with all covenants under the Credit Facility.

On March 8, 2012, the Company repaid the entire outstanding principal amount of $231 million on its previous term loan facility originally scheduled to mature on February 11, 2013, plus accrued and unpaid interest, as well as $585 million of assumed debt from the acquisition of HGST.

 

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Table of Contents

Purchase Orders — In the normal course of business, we enter into purchase orders with suppliers for the purchase of hard drive components used to manufacture our products. These purchase orders generally cover forecasted component supplies needed for production during the next quarter, are recorded as a liability upon receipt of the components, and generally may be changed or canceled at any time prior to shipment of the components. We also enter into purchase orders with suppliers for capital equipment that are recorded as a liability upon receipt of the equipment. Our ability to change or cancel a capital equipment purchase order without penalty depends on the nature of the equipment being ordered. In some cases, we may be obligated to pay for certain costs related to changes to, or cancellation of, a purchase order, such as costs incurred for raw materials or work in process of components or capital equipment.

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

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

On November 15, 2011, we entered into an agreement with SAE Magnetics (H.K.) Ltd., a subsidiary of TDK (“SAE”), for the supply of heads, which includes quarterly minimum volumes for multiple quarters. The term of the agreement commenced in the third quarter of fiscal 2012. We have had an ongoing supply relationship for heads with SAE over periods spanning several years prior to this agreement.

See Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — “Contractual Obligations and Commitments” in our Annual Report on Form 10-K for the year ended July 1, 2011, for further discussion of our purchase orders and purchase agreements and the associated dollar amounts. See Part II, Item 1A of this Quarterly Report on Form 10-Q for a discussion of the risks associated with these commitments.

Foreign Exchange Contracts — We purchase short-term, foreign exchange contracts to hedge the impact of foreign currency fluctuations on certain underlying assets, revenue, liabilities and commitments for operating expenses and product costs denominated in foreign currencies. See Part I, Item 3, of this Quarterly Report on Form 10-Q under the heading “Disclosure About Foreign Currency Risk,” for a description of our current foreign exchange contract commitments and Part I, Item 1, Note 8 of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

Indemnifications — In the ordinary course of business, we may provide indemnifications of varying scope and terms to customers, vendors, lessors, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of our breach of agreements, products or services to be provided by us, or from intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and certain of our officers that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. We maintain director and officer insurance, which may cover certain liabilities arising from our obligation to indemnify our directors and officers in certain circumstances.

It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Such indemnification agreements may not be subject to maximum loss clauses. Historically, we have not incurred material costs as a result of obligations under these agreements.

Unrecognized Tax Benefits — As of March 30, 2012, the cash portion of our total recorded liability for unrecognized tax benefits was $167 million, which included $12 million related to the HGST acquisition. We estimate the timing of the future payments of these liabilities to be within the next one to five years. See Part I, Item 1, Note 6 of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for information regarding our total tax liability for unrecognized tax benefits.

Stock Repurchase Program — Our Board of Directors previously authorized us to repurchase $750 million of our common stock in open market transactions under a stock repurchase program through March 31, 2013. Since the inception of this program in 2005 through March 30, 2012, we have repurchased 20 million shares of our common stock for a total cost of $334 million. We did not repurchase any shares under this program during the nine months ended March 30, 2012. Subsequent to March 30, 2012 through May 8, 2012, the Company repurchased 7.8 million shares for a total cost of $305 million.

 

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Table of Contents

Critical Accounting Policies and Estimates

We have prepared the accompanying unaudited condensed consolidated financial statements in accordance with U.S. GAAP. The preparation of the financial statements requires the use of judgments and estimates that affect the reported amounts of revenues, expenses, assets, liabilities and shareholders’ equity. We have adopted accounting policies and practices that are generally accepted in the industry in which we operate. We believe the following are our most critical accounting policies that affect significant areas and involve judgment and estimates made by us. If these estimates differ significantly from actual results, the impact to the consolidated financial statements may be material.

Revenue and Accounts Receivable

In accordance with standard industry practice, we provide distributors and retailers (collectively referred to as “resellers”) with limited price protection for inventories held by resellers at the time of published list price reductions, and we provide resellers and OEMs with other sales incentive programs. At the time we recognize revenue to resellers and OEMs, we record a reduction of revenue for estimated price protection until the resellers sell such inventory to their customers and we also record a reduction of revenue for the other programs in effect. We base these adjustments on several factors including anticipated price decreases during the reseller holding period, resellers’ sell-through and inventory levels, estimated amounts to be reimbursed to qualifying customers, historical pricing information and customer claim processing. If customer demand for hard drives or market conditions differs from our expectations, our operating results could be materially affected, as exemplified by the impact of the Thailand flooding on our operating results in the December quarter. We also have programs under which we reimburse qualified distributors and retailers for certain marketing expenditures, which are recorded as a reduction of revenue. These amounts generally vary according to several factors including industry conditions, seasonal demand, competitor actions, channel mix and overall availability of product. Generally, total sales incentive and marketing programs range from 9% to 12% of gross revenues per quarter. However, for the December and March quarters, sales incentive and marketing programs were 5% of gross revenues due to the severe supply constraints across the hard drive industry brought about by the Thailand floods. Changes in future customer demand and market conditions may require us to adjust our incentive programs as a percentage of gross revenue from the current range. Adjustments to revenues due to changes in accruals for these programs related to revenues reported in prior periods have averaged 0.3% of quarterly gross revenue since the first quarter of fiscal 2011. Customer sales incentive and marketing programs are recorded as a reduction of revenue.

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

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

Warranty

We record an accrual for estimated warranty costs when revenue is recognized. We generally warrant our products for a period of one to five years. Our warranty provision considers estimated product failure rates and trends, estimated repair or replacement costs and estimated costs for customer compensatory claims related to product quality issues, if any. We use a statistical warranty tracking model to help prepare our estimates and assist us in exercising judgment in determining the underlying estimates. Our statistical tracking model captures specific detail on hard drive reliability, such as factory test data, historical field return rates, and costs to repair by product type. Our judgment is subject to a greater degree of subjectivity with respect to newly introduced products because of limited field experience with those products upon which to base our warranty estimates. We review our warranty accrual quarterly for products shipped in prior periods and which are still under warranty. Any changes in the estimates underlying the accrual may result in adjustments that impact current period gross margin and income. Such changes are generally a result of differences between forecasted and actual return rate experience and costs to repair. If actual product return trends, costs to repair returned products or costs of customer compensatory claims differ significantly from our estimates, our future results of operations could be materially affected. For a summary of historical changes in estimates related to pre-existing warranty provisions, refer to Part I, Item 1, Note 2 of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

 

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Inventory

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

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

Litigation and Other Contingencies

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

Income Taxes

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

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

Stock-based Compensation

We account for all stock-based compensation at fair value. Stock-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. The fair values of all stock options and stock appreciation rights granted are estimated using a binomial model, and the fair values of all Employee Stock Purchase Plan purchase rights are estimated using the Black-Scholes-Merton option-pricing model. Both the binomial and the Black-Scholes-Merton models require the input of highly subjective assumptions. We are required to use judgment in estimating the amount of stock-based awards that are expected to be forfeited. If actual forfeitures differ significantly from the original estimate, stock-based compensation expense and our results of operations could be materially affected.

 

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Recent Accounting Pronouncements

For a description of recently issued and adopted accounting pronouncements, including the respective dates of adoption and expected effects on our results of operations and financial condition, refer to Part I, Item I, Note 13 of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, which is incorporated by reference in response to this item.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Disclosure About Foreign Currency Risk

Although the majority of our transactions are in U.S. dollars, some transactions are based in various foreign currencies. We purchase short-term, foreign exchange contracts to hedge the impact of foreign currency exchange fluctuations on certain underlying assets, revenue, liabilities and commitments for operating expenses and product costs denominated in foreign currencies. The purpose of entering into these hedge transactions is to minimize the impact of foreign currency fluctuations on our results of operations. The contract maturity dates do not exceed 12 months. We do not purchase foreign exchange contracts for trading or speculative purposes. Currently, we focus on hedging our foreign currency risk related to the Thai Baht, Malaysian Ringgit, Japanese Yen, Singapore Dollar, Philippine Peso, Euro and British Pound Sterling. Thai Baht contracts are designated as either cash flow or fair value hedges. Malaysian Ringgit, Japanese Yen and Singapore Dollar contracts are designated as cash flow hedges. Singapore Dollar, Philippine Peso, Euro and British Pound Sterling contracts are designated as fair value hedges. See Part I, Item 1, Note 8 of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

As of March 30, 2012, we had outstanding the following purchased foreign exchange contracts (in millions, except weighted average contract rate):

 

     Contract
Amount
     Weighted Average
Contract Rate*
     Unrealized
Gain
 

Foreign exchange contracts:

        

Japanese Yen cash flow hedges

   $ 66         80.58         —     

Malaysian Ringgit cash flow hedges

   $ 318         3.09       $ 1   

Singapore Dollar cash flow hedges

   $ 4         1.25         —     

Thai Baht cash flow hedges

   $ 532         31.04       $ 1   

British Pound Sterling fair value hedges

   $ 2         0.63         —     

Euro fair value hedges

   $ 7         0.75         —     

Philippine Peso fair value hedges

   $ 3         42.62         —     

Singapore Dollar fair value hedges

   $ 22         1.27         —     

Thai Baht fair value hedges

   $ 298         31.10         —     

 

* Expressed in units of foreign currency per U.S. dollar.

During the three and nine months ended March 30, 2012, total net realized transaction and foreign exchange contract currency gains and losses were not material to the condensed consolidated financial statements.

Disclosure About Other Market Risks

Variable Interest Rate Risk

Borrowings under the Credit Facility bear interest at a rate equal to, at the option of the applicable Borrower, either (a) a LIBOR rate determined by reference to the British Bankers Association LIBOR Rate for the interest period relevant to such borrowing, subject to certain exceptions (the “Eurodollar Rate”) or (b) a base rate determined by reference to the higher of (i) the federal funds rate plus 0.50%, (ii) the prime rate as announced by Bank of America, N.A. and (iii) the Eurodollar Rate plus 1.00% (the “Base Rate”), in each case plus an applicable margin. The applicable margin for borrowings under the Credit Facility ranges from 1.50% to 2.50% with respect to borrowings at the Eurodollar Rate and 0.50% to 1.50% with respect to borrowings at the Base Rate. The applicable margins for borrowings under the Credit Facility are determined based upon a leverage ratio of the Company and its subsidiaries calculated on a consolidated basis. If the federal funds rate, prime rate or LIBOR rate increase, our interest payments could also increase. A one percent increase in the variable rate of interest on the term loan facility would increase interest expense by approximately $27 million annually.

 

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Item 4. CONTROLS AND PROCEDURES

As required by SEC Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, our disclosure controls and procedures were effective.

As a result of our acquisition of HGST on March 8, 2012, we have adopted certain existing controls of HGST; however, there has been no change in our internal control over financial reporting during the third fiscal quarter ended March 30, 2012, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

For a description of our legal proceedings, refer to Part I, Item 1, Note 5 of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, which is incorporated by reference in response to this item.

Item 1A. RISK FACTORS

We have updated a number of the risk factors affecting our business since those presented in our Annual Report on Form 10-K, Part I, Item 1A, for the fiscal year ended July 1, 2011. Except for the first four risk factors, there have been no material changes in our assessment of our risk factors from those set forth in our Annual Report on Form 10-K for the fiscal year ended July 1, 2011. For convenience, all of our risk factors are included below.

The 2011 severe flooding in Thailand, which inundated our Thailand manufacturing facilities and resulted in the temporary suspension of all production in those facilities, has affected, and will continue to affect, our near-term business, results of operations and financial condition.

As previously disclosed, the 2011 severe flooding in Thailand resulted in the temporary suspension of production in all of our Thailand manufacturing facilities. While production has resumed in our Thailand facilities, material risks and uncertainties as a result of flooding remain, including the following:

 

  Under-Absorption of Assets. Our hard disk drive production capacity has reached a point where we can adequately meet anticipated customer demand; however, industry demand has not returned to pre-flood levels. In addition, we lost market share as a result of the flooding due to the impact on our manufacturing capabilities relative to that of our competitors and due to certain of our competitors entering into long-term purchase agreements with customers. If industry demand does not return to pre-flood levels, or if we are not able to regain market share, our costs will be impacted negatively by significant under-absorption of our assets and infrastructure and our business and results of operations will be adversely affected.

 

  Component Costs. Due to component supply constraints as a result of the flooding, the cost of certain component materials has increased and may continue to increase. In addition, during the flooding we entered into certain volume commitment agreements with certain of our component suppliers, which has resulted and may continue to result in the cost of certain components increasing over pre-flood levels. An increase in the cost of component materials that cannot be recovered through increased pricing could adversely affect our operating results.

 

  Restored Equipment. The equipment we use is highly sophisticated and complex. We have attempted to repair or refurbish certain equipment damaged in the flooding; however, the remaining useful life of, and costs associated with maintaining, such equipment is uncertain. If repaired or refurbished equipment does not last as long as planned, we may be required to increase capital expenditures to replace such equipment, which could adversely affect our financial condition and results of operations.

 

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  Insurance. We maintain insurance coverage that provides property and business interruption coverage in the event of losses arising from flooding. The claim process is in its early stages and we are unable to predict how much of our losses will be covered by insurance. It is reasonably possible that the final losses that we incur in connection with the flood damage and our business interruption will exceed the limits of our insurance policies. We also cannot estimate the timing of the proceeds we will ultimately receive under our insurance policies, and there may be a substantial delay between our incurrence of losses and our recovery under our insurance policies.

 

  New Product Development. The flooding of our Thailand facilities and suspension of operations delayed or adversely impacted our development and introduction of new products and technologies. If our competitors are able to gain an advantage in implementing new technologies and introducing new products, it may reduce our sales and adversely affect our results of operations.

The nature of our business and our reliance on intellectual property and other proprietary information subjects us to the risk of significant litigation.

The data storage industry has been characterized by significant litigation. This includes litigation relating to patent and other intellectual property rights, product liability claims and other types of litigation. Litigation can be expensive, lengthy and disruptive to normal business operations. Moreover, the results of litigation are inherently uncertain and may result in adverse rulings or decisions. We may enter into settlements or be subject to judgments that may, individually or in the aggregate, have a material adverse effect on our business, financial condition or operating results. As disclosed above in Part I, Item 1, Note 5 in the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, on November 18, 2011, a sole arbitrator ruled against us in an arbitration in Minnesota. The arbitration involves claims brought by Seagate Technology LLC against us and a now former employee, alleging misappropriation of confidential information and trade secrets. The arbitrator issued an interim award against us in the amount of $525 million plus pre-award interest. On January 23, 2012, the arbitrator issued a final award adding pre-award interest in the amount of $105.4 million, for a total award of $630.4 million. On January 23, 2012, we filed a petition in the District Court of Hennepin County, Minnesota to have the final arbitration award vacated, and a hearing on the petition was held on March 1, 2012. Interest (as simple interest, not compounding) on the final award ($630.4 million) also accrues at the Minnesota statutory rate of 10% per year while we pursue our motion to vacate the award, and if necessary, an appeal if the motion to vacate the award is unsuccessful. We intend to pursue vigorously our motion to vacate the award and, if necessary, to appeal the award if it is confirmed by the District Court of Hennepin County Minnesota. We do not believe it is probable that the arbitrator’s award will be sustained and accordingly have not recorded any liability for the arbitrator’s award in excess of the amount we have previously accrued ($25 million). We cannot make any assurances that we will be successful in our efforts to vacate the award or to overturn the award on appeal. If we are unsuccessful in these efforts, payment of the award, including interest, would adversely affect our financial condition, results of operations and cash flows. We will also be required to record a liability for the award if we should determine it is probable we will be required to pay the award.

We evaluate notices of alleged patent infringement and notices of patents from patent holders that we receive from time to time. If claims or actions are asserted against us, we may be required to obtain a license or cross-license, modify our existing technology or design a new non-infringing technology. Such licenses or design modifications can be extremely costly. In addition, we may decide to settle a claim or action against us, which settlement could be costly. We may also be liable for any past infringement. If there is an adverse ruling against us in an infringement lawsuit, an injunction could be issued barring production or sale of any infringing product. It could also result in a damage award equal to a reasonable royalty or lost profits or, if there is a finding of willful infringement, treble damages. Any of these results would increase our costs and harm our operating results.

 

 

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In connection with obtaining the regulatory approvals required to complete our acquisition of HGST, we agreed to divest certain assets to Toshiba, and the successful completion of the divestiture is subject to risks and uncertainties, and our business will be adversely affected in the event we fail to successfully complete the divestiture on a timely basis or at all.

In connection with obtaining the regulatory approvals required to complete our acquisition of HGST, we agreed, subject to review by regulatory agencies in certain jurisdictions, to divest certain assets to Toshiba that will expand Toshiba’s capacity to manufacture 3.5-inch hard drives for the desktop, consumer electronics and near-line (business critical) applications. This divestiture transaction has received all required regulatory approvals and must be completed within the time periods agreed upon with the jurisdictions whose approval of the Acquisition was conditioned on the divestiture, subject to any extensions that are obtained. There is no guarantee that we will complete the divestiture to Toshiba on a timely basis or at all. If we are not able to complete the divestiture on a timely basis or at all, the jurisdictions that conditioned their approval of the HGST acquisition on the divestiture could impose certain obligations on us, including a requirement that we divest the assets subject to the Toshiba divestiture (or other assets) to another purchaser, which could adversely affect our business, financial condition and results of operations.

If we fail to realize the anticipated benefits from our acquisition of HGST on a timely basis, or at all, our business and financial condition may be adversely affected.

In connection with obtaining the regulatory approvals required to complete the acquisition of HGST, we agreed to certain conditions required by the Chinese Ministry of Commerce (“MOFCOM”), including adopting measures to keep HGST as an independent competitor until MOFCOM agrees otherwise (with the minimum period being two years). We are working closely with MOFCOM to finalize an operations plan that is expected to outline in more detail the conditions of the competitive requirement. Compliance with these measures will limit or restrict our ability to integrate all or certain portions of HGST’s business with our business, cause delays or uncertainties in making decisions about the combined business, and result in significant costs or require changes in business practices, each of which could negatively impact our business, financial condition and results of operations. In the event we fail to comply with these measures, the time during which we are required to comply with the condition could be extended and we could be subject to other conditions or penalties that could adversely affect the business.

In addition to the requirement to maintain HGST as an independent competitor, we may also fail to realize the anticipated benefits from our acquisition of HGST on a timely basis, or at all, for a variety of other reasons, including the following:

 

  difficulties entering new markets or manufacturing in new geographies where we have no or limited direct prior experience;

 

  failure to identify or assess the magnitude of certain liabilities we are assuming in the acquisition, which could result in unexpected litigation or regulatory exposure, unfavorable accounting treatment, unexpected increases in taxes due, a loss of anticipated tax benefits or other adverse effects on our business, operating results or financial condition;

 

  failure to realize the anticipated increase in our revenues due to the acquisition if customers adjust their purchasing decisions and allocate more market share to our competitors;

 

  failure to successfully manage relationships with our supplier and customer base;

 

  difficulties, when allowed, integrating and harmonizing business systems;

 

  difficulties in modifying HGST’s existing accounting and internal control systems to comply with Section 404 of the Sarbanes-Oxley Act of 2002, which could adversely impact the effectiveness of internal control over financial reporting for the combined company; and

 

  the loss of key employees.

If we are not able to successfully manage these issues, the anticipated benefits and efficiencies of the HGST acquisition may not be realized fully or at all, or may take longer to realize than expected, and our ability to compete, our revenue and gross margins and our results of operations may be adversely affected.

The acquisition of HGST may result in significant restructuring charges that could adversely affect the financial results of the combined company.

The financial results of the combined company may be adversely affected by cash expenses and non-cash accounting charges incurred in connection with the combination. The amount and timing of these possible charges are not yet known. The price of our common stock following the acquisition could decline to the extent the combined company’s financial results are materially affected by these charges.

 

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The financing of the HGST acquisition may have an adverse impact on our liquidity, limit our flexibility in responding to other business opportunities and increase our vulnerability to adverse economic and industry conditions.

Our acquisition of HGST was financed by a combination of the issuance of additional shares of our common stock, the use of a significant amount of our cash on hand and the incurrence of a significant amount of indebtedness. The use of cash on hand and indebtedness to finance the acquisition reduced our liquidity and could cause us to place more reliance on cash flow from operations to pay principal and interest on our debt, thereby reducing the availability of our cash flow for operations and development activities. The credit agreement we entered into with respect to the indebtedness we incurred to finance the acquisition contains restrictive covenants, including financial covenants requiring us to maintain specified financial ratios. Our ability to meet these restrictive covenants can be affected by events beyond our control. The indebtedness and these restrictive covenants will also have the effect, among other things, of impairing our ability to obtain additional financing, if needed, limiting our flexibility in the conduct of our business and making us more vulnerable to economic downturns and adverse competitive and industry conditions. In addition, a breach of the restrictive covenants could result in an event of default under the credit agreement, which, if not cured or waived, could result in the indebtedness becoming immediately due and payable and could have a material adverse effect on our business, financial condition or operating results.

Adverse global economic conditions and credit market uncertainty could harm our business, results of operations and financial condition.

Adverse global economic conditions and uncertain conditions in the credit market have had, and in the future could have, a significant adverse effect on our company and on the storage industry as a whole. Some of the risks and uncertainties we face as a result of these global economic and credit market conditions include the following:

 

  Volatile Demand. Negative or uncertain global economic conditions could cause many of our direct and indirect customers to delay or reduce their purchases of our products and systems containing our products. In addition, many of our customers rely on credit financing to purchase our products. If negative conditions in the global credit markets prevent our customers’ access to credit, product orders may decrease, which could result in lower revenue. Likewise, if our suppliers, sub-suppliers and sub-contractors (collectively referred to as “suppliers”) face challenges in obtaining credit, in selling their products or otherwise in operating their businesses, they may be unable to offer the materials we use to manufacture our products. These actions could result in reductions in our revenue and increased operating costs, which could adversely affect our business, results of operations and financial condition.

 

  Restructuring Activities. If demand slows significantly as a result of a deterioration in economic conditions or otherwise, we may need to execute restructuring activities to realign our cost structure with softening demand. The occurrence of restructuring activities could result in impairment charges and other expenses, which could adversely impact our results of operations or financial condition.

 

  Credit Volatility and Loss of Receivables. We extend credit and payment terms to some of our customers. In addition to ongoing credit evaluations of our customers’ financial condition, we traditionally seek to mitigate our credit risk by purchasing credit insurance on certain of our accounts receivable balances. As a result of the continued uncertainty and volatility in global economic conditions, however, we may find it increasingly difficult to be able to insure these accounts receivable. We could suffer significant losses if a customer whose accounts receivable we have not insured, or have underinsured, fails and is unable to pay us. Additionally, negative or uncertain global economic conditions increase the risk that if a customer whose accounts receivable we have insured fails, the financial condition of the insurance carrier for such customer account may have also deteriorated such that it cannot cover our loss. A significant loss of an accounts receivable that we cannot recover through credit insurance would have a negative impact on our financial results.

 

  Impairment Charges. Negative or uncertain global economic conditions could result in circumstances, such as a sustained decline in our stock price and market capitalization or a decrease in our forecasted cash flows such that they are insufficient, indicating that the carrying value of our long-lived assets or goodwill may be impaired. If we are required to record a significant charge to earnings in our consolidated financial statements because an impairment of our long-lived assets or goodwill is determined, our results of operations will be adversely affected.

 

 

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We participate in a highly competitive industry that is subject to the risk of declining average selling prices (“ASPs”), volatile gross margins and significant shifts in market share, all of which could adversely affect our operating results.

Demand for our hard drives depends in large part on the demand for systems manufactured by our customers and on storage upgrades to existing systems. The demand for systems has been volatile in the past and often has had an exaggerated effect on the demand for hard drives in any given period. As a result, the hard drive market has experienced periods of excess capacity, which can lead to liquidation of excess inventories and more intense price competition. If more intense price competition occurs, we may be forced to lower prices sooner and more than expected, which could result in lower ASPs, revenue and gross margins. Our ASPs and gross margins also tend to decline when there is a shift in the mix of product sales, and sales of lower priced products increase relative to those of higher priced products. In addition, rapid technological changes often reduce the volume and profitability of sales of existing products and increase the risk of inventory obsolescence. These factors, along with others, may result in significant shifts in market share among the industry’s major participants.

Our failure to accurately forecast market and customer demand for our products, or to quickly adjust to forecast changes, could adversely affect our business and financial results or operating efficiencies.

The data storage industry faces difficulties in accurately forecasting market and customer demand for its products. The variety and volume of products we manufacture is based in part on these forecasts. Accurately forecasting demand has become increasingly difficult for us, our customers and our suppliers in light of the volatility in global economic conditions, a recent shift from air to ocean freight in response to increased transportation costs, which requires additional lead times, and industry consolidation, which has resulted in less availability of historical market data for certain product segments. In addition, because hard drives are designed to be largely interchangeable with competitors’ products, our demand forecasts may be impacted significantly by the strategic actions of our competitors. As forecasting demand becomes more difficult, the risk that our forecasts are not in line with demand increases. If our forecasts exceed actual market demand, then we could experience periods of product oversupply and price decreases, which could impact our financial performance. If market demand increases significantly beyond our forecasts or beyond our ability to add manufacturing capacity, then we may not be able to satisfy customer product needs, which could result in a loss of market share if our competitors are able to meet customer demands.

We experience significant sales seasonality and cyclicality, which could cause our operating results to fluctuate.

Sales of computer systems, storage subsystems and consumer electronics tend to be seasonal and cyclical, and therefore we expect to continue to experience seasonality and cyclicality in our business as we respond to variations in our customers’ demand for hard drives. In the desktop, mobile, CE and retail markets, seasonality is partially attributable to the increase in sales of PCs and CE devices during the back-to-school and winter holiday seasons. As such, we anticipate that sales of our products will continue to be lower during the second half of our fiscal year. However, prior to the flooding in Thailand, we began to experience a muting of typical seasonal demand patterns partially driven by the increased adoption of sea freight in the PC supply chain, which requires additional lead times, and the increased importance of emerging markets, which may have different seasonal demand patterns. While this muting of typical season demand patterns has been impacted by the flooding in Thailand, we expect this pattern to continue once the effects of the flooding subside. In the enterprise market our sales are seasonal because of the capital budgeting and purchasing cycles of our end users. However, changes in seasonal and cyclical patterns have made it, and could continue to make it, more difficult for us to forecast demand, especially in the current macroeconomic environment. Changes in the product or channel mix of our business can also impact seasonal and cyclical patterns, adding complexity in forecasting demand. Seasonality and cyclicality also may lead to higher volatility in our stock price. It is difficult for us to evaluate the degree to which seasonality and cyclicality may affect our stock price or business in future periods because of the rate and unpredictability of product transitions and new product introductions and macroeconomic conditions.

Our customers’ demand for storage may not continue to grow at current industry estimates, which may lower the prices our customers are willing to pay for our products or put us at a disadvantage to competing technologies.

Our customers’ demand for storage may not continue to grow at current industry estimates as a result of:

 

  Mobile Devices. There has been a recent rapid growth in CE devices that do not contain a hard drive such as tablet computers and smartphones. While tablet computers and smartphones provide many of the same capabilities as PCs, the extent to which they will displace or materially affect the demand for PCs is uncertain. If device-makers are successful in achieving customer acceptance of these devices as a replacement for traditional computing applications that contain hard drives, or if we are not successful in adapting our product offerings to include alternative storage solutions that address these devices, then demand for our products may decrease.

 

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  Cloud Computing. Consumers traditionally have stored their data on their PC, often supplemented with personal external storage devices. Most businesses also include similar local storage as a primary or secondary storage location. This storage is typically provided by hard disk drives. Recently, cloud computing has emerged whereby applications and data are hosted, accessed and processed through a third-party provider over a broadband Internet connection, potentially reducing or eliminating the need for, among other things, significant storage inside the accessing computer. This trend could cause the market for disk drives in computers to decline over time, which could harm our business to the extent this decline is not offset by the sale of our products to customers who provide cloud computing services.

Demand for our products also could be negatively impacted by developments in the regulation and enforcement of digital rights management, the emergence of processes such as data deduplication and storage virtualization, economic conditions, and the rate of increase in areal density exceeding the increase in our customers’ demand for storage. These factors could lead to our customers’ storage needs being satisfied at lower prices with lower capacity hard drives or solid-state storage products that we do not offer, thereby decreasing our revenue or putting us at a disadvantage to competing storage technologies. As a result, even with increasing aggregate demand for storage, if we fail to anticipate or timely respond to these developments in the demand for storage, our ASPs could decline, which could adversely affect our operating results.

Selling to the retail market is an important part of our business, and if we fail to maintain and grow our market share or gain market acceptance of our branded products, our operating results could suffer.

Selling branded products is an important part of our business, and as our branded products revenue increases as a portion of our overall revenue, our success in the retail market becomes increasingly important to our operating results. Our success in the retail market depends in large part on our ability to maintain our brand image and corporate reputation and to expand into and gain market acceptance of our products in multiple channels, including the e-tail channel. Adverse publicity, whether or not justified, or allegations of product quality issues, even if false or unfounded, could tarnish our reputation and cause our customers to choose products offered by our competitors. In addition, the proliferation of new methods of mass communication facilitated by the Internet makes it easier for false or unfounded allegations to adversely affect our brand image and reputation. If customers no longer maintain a preference for WD®- or HGST™-brand products, our operating results may be adversely affected.

Sales in the distribution channel are important to our business, and if we fail to respond to demand changes in distribution markets or if distribution markets for hard drives weaken, our operating results could suffer.

Our distribution customers typically sell to small computer manufacturers, dealers, systems integrators and other resellers. We face significant competition in this channel as a result of limited product qualification programs and a significant focus on price and availability of product. In addition, the PC market is experiencing a shift to notebook and other mobile devices and, as a result, more computing devices are being delivered to the market as complete systems, which could weaken the distribution market. If we fail to respond to changes in demand in the distribution market, our operating results could suffer. Additionally, if the distribution market weakens as a result of a slowing PC growth rate, technology transitions or a significant change in consumer buying preference, or if we experience significant price declines due to demand changes in the distribution channel, then our operating results would be adversely affected.

Loss of market share with or by a key customer, or consolidation among our customer base, could harm our operating results.

During the quarter ended March 30, 2012, a large percentage of our revenue, 53%, came from sales to our top 10 customers. These customers have a variety of suppliers to choose from and therefore can make substantial demands on us, including demands on product pricing and on contractual terms, which often results in the allocation of risk to us as the supplier. Our ability to maintain strong relationships with our principal customers is essential to our future performance. If we lose a key customer, if any of our key customers reduce their orders of our products or require us to reduce our prices before we are able to reduce costs, if a customer is acquired by one of our competitors or if a key customer suffers financial hardship, our operating results would likely be harmed.

Additionally, if there is consolidation among our customer base, our customers may be able to command increased leverage in negotiating prices and other terms of sale, which could adversely affect our profitability. In addition, if, as a result of increased leverage, customer pressures require us to reduce our pricing such that our gross margins are diminished, we could decide not to sell our products to a particular customer, which could result in a decrease in our revenue. Consolidation among our customer base may also lead to reduced demand for our products, replacement of our products by the combined entity with those of our competitors and cancellations of orders, each of which could harm our operating results.

 

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Our entry into additional markets increases the complexity of our business, and if we are unable to successfully adapt our business processes as required by these new markets, we will be at a competitive disadvantage and our ability to grow will be adversely affected.

As we expand our product line to sell into additional markets, the overall complexity of our business increases at an accelerated rate and we become subject to different market dynamics. The new markets into which we are expanding, or may expand, may have different characteristics from the markets in which we currently exist. These different characteristics may include, among other things, demand volume requirements, demand seasonality, product generation development rates, customer concentrations, warranty and product return policies and performance and compatibility requirements. Our failure to make the necessary adaptations to our business model to address these different characteristics, complexities and new market dynamics could adversely affect our operating results.

Expansion into new hard drive markets may cause our capital expenditures to increase, and if we do not successfully expand into new markets, our business may suffer.

To remain a significant supplier of hard drives, we will need to offer a broad range of hard drive products to our customers. We currently offer a variety of 3.5-inch or 2.5-inch hard drives for the desktop, mobile, enterprise, CE and external storage markets. However, demand for hard drives may shift to products in form factors or with interfaces that our competitors offer but which we do not. Expansion into other hard drive markets and resulting increases in manufacturing capacity requirements may require us to make substantial additional investments in part because our operations are largely vertically integrated now that we manufacture heads and magnetic media for use in many of the hard drives we manufacture. If we fail to successfully expand into new hard drive markets with products that we do not currently offer, we may lose business to our competitors who offer these products.

Our vertical integration of head and magnetic media manufacturing makes us dependent on our ability to timely and cost-effectively develop heads and magnetic media with leading technology and overall quality, and creates additional capital expenditure costs and asset utilization risks to our business.

Under our business plan, we are developing and manufacturing a substantial portion of the heads and magnetic media used in the hard drive products we manufacture. Consequently, we are more dependent upon our own development and execution efforts and less able to take advantage of head and magnetic media technologies developed by other manufacturers. Technology transition for head and magnetic media designs is critical to increasing our volume production of heads and magnetic media. There can be no assurance, however, that we will be successful in timely and cost-effectively developing and manufacturing heads or magnetic media for products using future technologies. We also may not effectively transition our head or magnetic media design and technology to achieve acceptable manufacturing yields using the technologies necessary to satisfy our customers’ product needs, or we may encounter quality problems with the heads or magnetic media we manufacture. If we are unable to timely and cost-effectively develop heads and magnetic media with leading technology and overall quality, our ability to sell our products may be significantly diminished, which could materially and adversely affect our business and financial results.

In addition, as a result of our vertical integration of head and magnetic media manufacturing, we make more capital investments and carry a higher percentage of fixed costs than we would if we were not vertically integrated. If our overall level of production decreases for any reason, and we are unable to reduce our fixed costs to match sales, our head or magnetic media manufacturing assets may face under-utilization that may impact our operating results. We are therefore subject to additional risks related to overall asset utilization, including the need to operate at high levels of utilization to drive competitive costs and the need for assured supply of components that we do not manufacture ourselves. If we do not adequately address the challenges related to our head or magnetic media manufacturing operations, our ongoing operations could be disrupted, resulting in a decrease in our revenue or profit margins and negatively impacting our operating results.

 

 

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We make significant investments in research and development to improve our technology and develop new technologies, and unsuccessful investments could materially adversely affect our business, financial condition and results of operations.

Over the past several years, our business strategy has been to derive a competitive advantage by moving from being a follower of new technologies to being a leader in the innovation and development of new technologies. This strategy requires us to make significant investments in research and development and, in attempting to remain competitive, we may increase our capital expenditures and expenses above our historical run-rate model. There can be no assurance that these investments will result in viable technologies or products, or if these investments do result in viable technologies or products, that they will be profitable or accepted by the market. Significant investments in unsuccessful research and development efforts could materially adversely affect our business, financial condition and results of operations. In addition, increased investments in technology could cause our cost structure to fall out of alignment with demand for our products, which would have a negative impact on our financial results.

Current or future competitors may gain a technology advantage or develop an advantageous cost structure that we cannot match.

It may be possible for our current or future competitors to gain an advantage in product technology, manufacturing technology, or process technology, which may allow them to offer products or services that have a significant advantage over the products and services that we offer. Advantages could be in capacity, performance, reliability, serviceability, or other attributes. A competitive cost structure for our products, including critical components, labor and overhead, is also critical to the success of our business. We may be at a competitive disadvantage to any companies that are able to gain a technological or cost structure advantage.

Further industry consolidation could provide competitive advantages to our competitors.

The hard drive industry has experienced consolidation over the past several years, including the acquisition of the hard disk drive business of Samsung Electronics Co., Ltd. by Seagate Technology plc in December 2011. Consolidation by our competitors may enhance their capacity, abilities and resources and lower their cost structure, causing us to be at a competitive disadvantage.

Some of our competitors with diversified business units outside the hard drive industry may over extended periods of time sell hard drives at prices that we cannot profitably match.

Some of our competitors earn a significant portion of their revenue from business units outside the hard drive industry. Because they do not depend solely on sales of hard drives to achieve profitability, they may sell hard drives at lower prices and operate their hard drive business unit at a loss over an extended period of time while still remaining profitable overall. In addition, if these competitors can increase sales of non-hard drive products to the same customers, they may benefit from selling their hard drives at lower prices. Our operating results may be adversely affected if we cannot successfully compete with the pricing by these companies.

If we fail to qualify our products with our customers or if product life cycles lengthen, it may have a significant adverse impact on our sales and margins.

We regularly engage in new product qualification with our customers. Once a product is accepted for qualification testing, failures or delays in the qualification process can result in delayed or reduced product sales, reduced product margins caused by having to continue to offer a more costly current generation product, or lost sales to that customer until the next generation of products is introduced. The effect of missing a product qualification opportunity is magnified by the limited number of high volume OEMs, which continue to consolidate their share of the storage markets. Likewise, if product life cycles lengthen, we may have a significantly longer period to wait before we have an opportunity to qualify a new product with a customer, which could reduce our profits because we expect declining gross margins on our current generation products as a result of competitive pressures.

We are subject to risks related to product defects, which could result in product recalls or epidemic failures and could subject us to warranty claims in excess of our warranty provisions or which are greater than anticipated.

We warrant the majority of our products for periods of one to five years. We test our hard drives in our manufacturing facilities through a variety of means. However, there can be no assurance that our testing will reveal defects in our products, which may not become apparent until after the products have been sold into the market. Accordingly, there is a risk that product defects will occur, which could require a product recall. Product recalls can be expensive to implement and, if a product recall occurs during the product’s warranty period, we may be required to replace the defective product. Moreover, there is a risk that product defects may trigger an epidemic failure clause in a customer agreement. If an epidemic failure occurs, we may be required to replace or refund the value of the defective product and to cover certain other costs associated with the consequences of the epidemic failure. In addition, a product recall or epidemic failure may damage our reputation or customer relationships, and may cause us to lose market share with our customers, including our OEM and ODM customers.

 

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Our standard warranties contain limits on damages and exclusions of liability for consequential damages and for misuse, improper installation, alteration, accident or mishandling while in the possession of someone other than us. We record an accrual for estimated warranty costs at the time revenue is recognized. We may incur additional operating expenses if our warranty provision does not reflect the actual cost of resolving issues related to defects in our products, whether as a result of a product recall, epidemic failure or otherwise. If these additional expenses are significant, it could adversely affect our business, financial condition and operating results.

Dependence on a limited number of qualified suppliers of components and manufacturing equipment could lead to delays, lost revenue or increased costs.

Our future operating results may depend substantially on our suppliers’ ability to timely qualify their components in our programs, and their ability to supply us with these components in sufficient volumes to meet our production requirements. A number of the components that we use are available from only a single or limited number of qualified suppliers, and may be used across multiple product lines. As such, the success of our products depends on our ability to gain access to and integrate parts from reliable component suppliers. To do so, we must maintain effective relationships with our supply base to source our component needs, develop compatible technology, and maintain continuity of supply at reasonable costs. If we fail to maintain effective relationships with our supply base, or if we fail to integrate components from our suppliers effectively, this may adversely affect our ability to develop and deliver the best products to our customers and our profitability could suffer.

Certain equipment and consumables we use in our manufacturing or testing processes are available only from a limited number of suppliers. Some of this equipment and consumables use materials that at times could be in short supply. If these materials are not available, or are not available in the quantities we require for our manufacturing and testing processes, our ability to manufacture our products could be impacted, and we could suffer significant loss of revenue.

Each of the following could also significantly harm our operating results:

 

  an unwillingness of a supplier to supply such components or equipment to us;

 

  consolidation of key suppliers;

 

  failure of a key supplier’s business process;

 

  a key supplier’s or sub-supplier’s inability to access credit necessary to operate its business; or

 

  failure of a key supplier to remain in business, to remain an independent merchant supplier, or to adjust to market conditions.

Shortages of commodity materials or commodity components, price volatility, or use by other industries of materials and components used in the hard drive industry, may negatively impact our operating results.

Increases in the cost for certain commodity materials or commodity components may increase our costs of manufacturing and transporting hard drives and key components. Shortages of commodity components such as DRAM and NAND flash, or commodity materials such as glass substrates, stainless steel, aluminum, nickel, neodymium, ruthenium, platinum or cerium, may increase our costs and may result in lower operating margins if we are unable to find ways to mitigate these increased costs. We or our suppliers acquire certain precious metals and rare earth metals like ruthenium, platinum, neodymium and cerium, critical to the manufacture of components in our products from a number of countries, including the People’s Republic of China. The government of China or any other nation may impose regulations, quotas or embargoes upon these metals that would restrict the worldwide supply of such metals and/or increase their cost, both of which could negatively impact our operating results until alternative suppliers are sourced. Furthermore, if other high volume industries increase their demand for materials or components used in our products, our costs may further increase, which could have an adverse effect on our operating margins. In addition, shortages in other commodity components and materials used in our customers’ products could result in a decrease in demand for our products, which would negatively impact our operating results. The volatility in the cost of oil also affects our costs and may result in lower operating margins if we are unable to pass these increased costs on to our customers.

Contractual commitments with component suppliers may result in us paying increased charges and cash advances for such components or may cause us to have inadequate or excess component inventory.

 

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To reduce the risk of component shortages, we attempt to provide significant lead times when buying components, which may subject us to cancellation charges if we cancel orders as a result of technology transitions or changes in our component needs. In addition, we may from time to time enter into contractual commitments with component suppliers in an effort to increase and stabilize the supply of those components and enable us to purchase such components at favorable prices. Some of these commitments may require us to buy a substantial number of components from the supplier or make significant cash advances to the supplier; however, these commitments may not result in a satisfactory increase or stabilization of the supply of such components. Furthermore, as a result of uncertain global economic conditions, our ability to forecast our requirements for these components has become increasingly difficult, therefore increasing the risk that our contractual commitments may not meet our actual supply requirements, which could cause us to have inadequate or excess component inventory and adversely affect our operating results and increase our operating costs.

Failure by certain suppliers to effectively and efficiently develop and manufacture components, technology or production equipment for our products may adversely affect our operations.

We rely on suppliers for various component parts that we integrate into our hard drives but do not manufacture ourselves, such as semiconductors, motors, flex circuits and suspensions. Likewise, we rely on suppliers for certain technology and equipment necessary for advanced development technology for future products. Some of these components, and most of this technology and production equipment, must be specifically designed to be compatible for use in our products or for developing and manufacturing our future products, and are only available from a limited number of suppliers, some of with whom we are sole sourced. We are therefore dependent on these suppliers to be able and willing to dedicate adequate engineering resources to develop components that can be successfully integrated with our products, and technology and production equipment that can be used to develop and manufacture our next-generation products efficiently. The failure of these suppliers to effectively and efficiently develop and manufacture components that can be integrated into our products or technology and production equipment that can be used to develop or manufacture next generation products may cause us to experience inability or delay in our manufacturing and shipment of hard drive products, our expansion into new technology and markets, or our ability to remain competitive with alternative storage technologies, therefore adversely affecting our business and financial results.

Changes in product life cycles could adversely affect our financial results.

If product life cycles lengthen, we may need to develop new technologies or programs to reduce our costs on any particular product to maintain competitive pricing for that product. If product life cycles shorten, it may result in an increase in our overall expenses and a decrease in our gross margins, both of which could adversely affect our operating results. In addition, shortening of product life cycles also makes it more difficult to recover the cost of product development before the product becomes obsolete. Our failure to recover the cost of product development in the future could adversely affect our operating results.

A fundamental change in recording technology could result in significant increases in our operating expenses and could put us at a competitive disadvantage.

Historically, when the industry experiences a fundamental change in technology, any manufacturer that fails to successfully and timely adjust its designs and processes to accommodate the new technology fails to remain competitive. There are some revolutionary technologies, such as current-perpendicular-to-plane giant magnetoresistance, shingle magnetic recording, energy assisted magnetic recording, patterned magnetic media and advanced signal processing, that if implemented by a competitor on a commercially viable basis ahead of the industry, could put us at a competitive disadvantage. As a result of these technology shifts, we could incur substantial costs in developing new technologies, such as heads, magnetic media, and tools to remain competitive. If we fail to successfully implement these new technologies, or if we are significantly slower than our competitors at implementing new technologies, we may not be able to offer products with capacities that our customers desire.

The difficulty of introducing hard drives with higher levels of areal density and the challenges of reducing other costs may impact our ability to achieve historical levels of cost reduction.

Storage capacity of the hard drive, as manufactured by us, is determined by the number of disks and each disk’s areal density. Areal density is a measure of the amount of magnetic bits that can be stored on the recording surface of the disk. Generally, the higher the areal density, the more information can be stored on a single platter. Higher areal densities require existing head and magnetic media technology to be improved or new technologies developed to accommodate more data on a single disk. Historically, we have been able to achieve a large percentage of cost reduction through increases in areal density. Increases in areal density mean that the average drive we sell has fewer heads and disks for the same capacity and, therefore, may result in a lower component cost. However, increasing areal density has become more difficult in the hard drive industry. If we are not able to increase areal density at the same rate as our competitors or at a rate that is expected by our customers, we may be required to include more components in our drives to meet demand without corresponding incremental revenue, which could negatively impact our operating margins and make achieving historical levels of cost reduction difficult or unlikely. Additionally, increases in areal density may require us to make further capital expenditures on items such as new testing equipment needed as a result of an increased number of gigabytes per platter. Our inability to achieve cost reductions could adversely affect our operating results.

 

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If we do not properly manage technology transitions and new product development, our competitiveness and operating results may be negatively affected.

The storage markets in which we offer our products continuously undergo technology transitions which we must anticipate and adapt our products to address in a timely manner. If we fail to implement these new technologies successfully, or if we are slower than our competitors at implementing new technologies, we may not be able to competitively offer products that our customers desire, which could harm our operating results.

In addition, the success of our new product introductions depends on a number of other factors, including

 

  difficulties faced in manufacturing ramp;

 

  implementing at an acceptable cost product features expected by our customers;

 

  market acceptance/qualification;

 

  effective management of inventory levels in line with anticipated product demand; and

 

  quality problems or other defects in the early stages of new product introduction that were not anticipated in the design of those products.

Our business may suffer if we fail to successfully anticipate and manage these issues associated with our product development.

If we fail to develop and introduce new hard drives that are competitive against alternative storage technologies, our business may suffer.

Our success depends in part on our ability to develop and introduce new products in a timely manner in order to keep pace with competing technologies. Alternative storage technologies like solid-state storage technology have successfully served digital entertainment markets for products such as digital cameras, MP3 players, USB flash drives, mobile phones and tablet devices that cannot be economically serviced using hard drive technology. Advances in semiconductor technology have resulted in solid-state storage emerging as a technology that is competitive with hard drives for high performance needs in advanced digital computing markets such as enterprise servers and storage. Solid-state storage is produced by large semiconductor companies who can then sell their storage products at lower prices while still remaining profitable overall. This can help them improve their market share at the expense of the competition. In addition, these semiconductor companies may choose to supply companies like us with semiconductor media at prices that make it difficult, if not impossible, for us to compete with them on a profitable basis. As a result, there can be no assurance that we will be successful in anticipating and developing new products for the desktop, mobile, enterprise, CE and external storage markets in response to solid-state storage, as well as other competing technologies. If our hard drive technology fails to offer higher capacity, performance and reliability with lower cost-per-gigabyte than solid-state storage for the desktop, mobile, enterprise, CE and external storage markets, we will be at a competitive disadvantage to companies using semiconductor technology to serve these markets and our business will suffer.

Our manufacturing operations, and those of certain of our suppliers and customers, are concentrated in large, purpose-built facilities, which subjects us to substantial risk of damage or loss if operations at any of these facilities are disrupted.

 

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As a result of our cost structure and strategy of vertical integration, we conduct our manufacturing operations at large, high volume, purpose-built facilities in California and in Asia. The manufacturing facilities of many of our customers, our suppliers and our customers’ suppliers are also concentrated in certain geographic locations in Asia and elsewhere. A localized health risk affecting our employees at these facilities or the staff of our or our customers’ other suppliers, such as the spread of the Influenza A (H1N1) or a new pandemic influenza, could impair the total volume of hard drives that we are able to manufacture and/or sell, which would result in substantial harm to our operating results. Similarly, a fire, flood, earthquake, tsunami or other disaster, condition or event such as political instability, civil unrest or a power outage that adversely affects any of these facilities, including access to or from these facilities by employees or logistics operations, would significantly affect our ability to manufacture and/or sell hard drives, which would result in a substantial loss of sales and revenue and a substantial harm to our operating results. For example, prior to the 2011 flooding in Thailand, all of our internal slider capacity and 60% of our hard drive manufacturing capacity was in Thailand. As a result of the flooding in Thailand, our facilities were inundated and temporarily shut down. During that period, our ability to manufacture hard drives was significantly constrained, which adversely affected our business, financial condition and results of operations. While we have taken certain steps to diversify our manufacturing footprint, a significant event that impacts any of our manufacturing sites, or the sites of our customers or suppliers, could adversely affect our ability to manufacture hard drives, and our business, financial condition and results of operations could suffer.

Manufacturing and marketing our products globally subjects us to numerous risks.

We are subject to risks associated with our global manufacturing operations and global marketing efforts, including:

 

  obtaining requisite governmental permits and approvals;

 

  currency exchange rate fluctuations or restrictions;

 

  political instability and civil unrest;

 

  limited transportation availability, delays, and extended time required for shipping, which risks may be compounded in periods of price declines;

 

  higher freight rates;

 

  labor challenges, including difficulties finding and retaining talent or responding to labor disputes or disruptions;

 

  trade restrictions or higher tariffs;

 

  copyright levies or similar fees or taxes imposed in European and other countries;

 

  exchange, currency and tax controls and reallocations;

 

  increasing labor and overhead costs; and

 

  loss or non-renewal of favorable tax treatment under agreements or treaties with foreign tax authorities.

Terrorist attacks may adversely affect our business and operating results.

The continued threat of terrorist activity and other acts of war or hostility have created uncertainty in the financial and insurance markets and have significantly increased the political, economic and social instability in some of the geographic areas in which we operate. Additionally, it is uncertain what impact the reactions to such acts by various governmental agencies and security regulators worldwide will have on shipping costs. Acts of terrorism, either domestically or abroad, could create further uncertainties and instability. To the extent this results in disruption or delays of our manufacturing capabilities or shipments of our products, our business, operating results and financial condition could be adversely affected.

Sudden disruptions to the availability of freight lanes could have an impact on our operations.

We generally ship our products to our customers, and receive shipments from our suppliers, via air, ocean or land freight. The sudden unavailability or disruption of cargo operations or freight lanes, such as due to labor difficulties or disputes, severe weather patterns or other natural disasters, or political instability or civil unrest, could impact our operating results by impairing our ability to timely and efficiently deliver our products.

We are vulnerable to system failures or attacks, which could harm our business.

We are heavily dependent on our technology infrastructure, among other functions, to operate our factories, sell our products, fulfill orders, manage inventory and bill, collect and make payments. Our systems are vulnerable to damage or interruption from natural disasters, power loss, telecommunication failures, cyber-attacks such as computer viruses, computer denial-of-service attacks and other events. Our business is also subject to break-ins, sabotage and intentional acts of vandalism by third parties as well as employees. Despite any precautions we may take, such problems could result in, among other consequences, loss or theft of our, our customers’ or our business partners’ intellectual property, proprietary business information or personally identifiable information; damage to our reputation; interruptions in our business; and remediation costs, each of which could harm our business, operating results and financial condition.

 

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If we fail to identify, manage, complete and integrate acquisitions, investment opportunities or other significant transactions, it may adversely affect our future results.

As part of our growth strategy, we may pursue acquisitions of, investment opportunities in or other significant transactions with companies that are complementary to our business. In order to pursue this strategy successfully, we must identify attractive acquisition or investment opportunities, successfully complete the transaction, some of which may be large and complex, and manage post-closing issues such as integration of the acquired company or employees. We may not be able to identify or complete appealing acquisition or investment opportunities given the intense competition for these transactions. Even if we identify and complete suitable corporate transactions, we may not be able to successfully address any integration challenges in a timely manner, or at all. If we fail to successfully integrate an acquisition, we may not realize all or any of the anticipated benefits of the acquisition, and our future results of operations could be adversely affected. Please see the risk factors above for specific risks and uncertainties regarding our acquisition of HGST.

If we are unable to retain or hire key staff and skilled employees our business results may suffer.

Our success depends upon the continued contributions of our key staff and skilled employees, many of whom would be extremely difficult to replace. Global competition for skilled employees in the data storage industry is intense and, as we attempt to move to a position of technology leadership in the storage industry, our business success becomes increasingly dependent on our ability to retain our key staff and skilled employees as well as attract, integrate and retain new skilled employees. Volatility or lack of positive performance in our stock price and the overall markets may adversely affect our ability to retain key staff or skilled employees who have received equity compensation. Additionally, because a substantial portion of our key employees’ compensation is placed “at risk” and linked to the performance of our business, when our operating results are negatively impacted by global economic conditions, we are at a competitive disadvantage for retaining and hiring key staff and skilled employees versus other companies that pay a relatively higher fixed salary. If we are unable to retain our existing key staff or skilled employees, or hire and integrate new key staff or skilled employees, or if we fail to implement succession plans for our key staff, our operating results would likely be harmed.

Our reliance on intellectual property and other proprietary information subjects us to the risk that these key ingredients of our business could be copied by competitors.

Our success depends, in significant part, on the proprietary nature of our technology, including non-patentable intellectual property such as our process technology. If a competitor is able to reproduce or otherwise capitalize on our technology despite the safeguards we have in place, it may be difficult, expensive or impossible for us to obtain necessary legal protection. Also, the laws of some foreign countries may not protect our intellectual property to the same extent as do U.S. laws. In addition to patent protection of intellectual property rights, we consider elements of our product designs and processes to be proprietary and confidential. We rely upon employee, consultant and vendor non-disclosure agreements and contractual provisions and a system of internal safeguards to protect our proprietary information. However, any of our registered or unregistered intellectual property rights may be challenged or exploited by others in the industry, which might harm our operating results.

The costs of compliance with state, federal and international legal and regulatory requirements, such as environmental, labor, trade and tax regulations, and customers’ standards of corporate citizenship could cause an increase in our operating costs.

We may be or become subject to various state, federal and international laws and regulations governing our environmental, labor, trade and tax practices. These laws and regulations, particularly those applicable to our international operations, are or may be complex, extensive and subject to change. We will need to ensure that we and our component suppliers timely comply with such laws and regulations, which may result in an increase in our operating costs. For example, the European Union (“EU”) has enacted the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (“RoHS”) directive, which prohibits the use of certain substances in electronic equipment, and the Waste Electrical and Electronic Equipment (“WEEE”) directive, which obligates parties that place electrical and electronic equipment onto the market in the EU to put a clearly identifiable mark on the equipment, register with and report to EU member countries regarding distribution of the equipment, and provide a mechanism to take back and properly dispose of the equipment. Similar legislation may be enacted in other locations where we manufacture or sell our products. In addition, climate change and financial reform legislation in the United States is a significant topic of discussion and has generated and may continue to generate federal or other regulatory responses in the near future. If we or our component suppliers fail to timely comply with applicable legislation, our customers may refuse to purchase our products or we may face increased operating costs as a result of taxes, fines or penalties, which would have a materially adverse effect on our business, financial condition and operating results.

 

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In connection with our compliance with such environmental laws and regulations, as well as our compliance with industry environmental initiatives, the standards of business conduct required by some of our customers, and our commitment to sound corporate citizenship in all aspects of our business, we could incur substantial compliance and operating costs and be subject to disruptions to our operations and logistics. In addition, if we were found to be in violation of these laws or noncompliant with these initiatives or standards of conduct, we could be subject to governmental fines, liability to our customers and damage to our reputation and corporate brand which could cause our financial condition or operating results to suffer.

Violation of applicable laws, including labor or environmental laws, and certain other practices by our suppliers could harm our business.

We expect our suppliers to operate in compliance with applicable laws and regulations, including labor and environmental laws, and to otherwise meet our required supplier standards of conduct. While our internal operating guidelines promote ethical business practices, we do not control our suppliers or their labor or environmental practices. The violation of labor, environmental or other laws by any of our suppliers, or divergence of a supplier’s business practices from those generally accepted as ethical in the United States, could harm our business by:

 

  interrupting or otherwise disrupting the shipment of our product components;

 

  damaging our reputation;

 

  forcing us to find alternate component sources;

 

  reducing demand for our products (for example, through a consumer boycott); or

 

  exposing us to potential liability for our supplier’s wrongdoings.

Fluctuations in currency exchange rates as a result of our international operations may negatively affect our operating results.

Because we manufacture and sell our products abroad, our revenue, margins, operating costs and cash flows are impacted by fluctuations in foreign currency exchange rates. If the U.S. dollar exhibits sustained weakness against most foreign currencies, the U.S. dollar equivalents of unhedged manufacturing costs could increase because a significant portion of our production costs are foreign-currency denominated. Conversely, there would not be an offsetting impact to revenues since revenues are substantially U.S. dollar denominated. Additionally, we negotiate and procure some of our component requirements in U.S. dollars from non-U.S. based vendors. If the U.S. dollar continues to weaken against other foreign currencies, some of our component suppliers may increase the price they charge for their components in order to maintain an equivalent profit margin. If this occurs, it would have a negative impact on our operating results.

Prices for our products are substantially U.S. dollar denominated, even when sold to customers that are located outside the United States. Therefore, as a substantial portion of our sales are from countries outside the United States, fluctuations in currency exchanges rates, most notably the strengthening of the U.S. dollar against other foreign currencies, contribute to variations in sales of products in impacted jurisdictions and could adversely impact demand and revenue growth. In addition, currency variations can adversely affect margins on sales of our products in countries outside the United States.

We have attempted to manage the impact of foreign currency exchange rate changes by, among other things, entering into short-term, foreign exchange contracts. However, these contracts do not cover our full exposure and can be canceled by the counterparty if currency controls are put in place.

Increases in our customers’ credit risk could result in credit losses and an increase in our operating costs.

Some of our OEM customers have adopted a subcontractor model that requires us to contract directly with companies, such as ODMs, that provide manufacturing and fulfillment services to our OEM customers. Because these subcontractors are generally not as well capitalized as our direct OEM customers, this subcontractor model exposes us to increased credit risks. Our agreements with our OEM customers may not permit us to increase our product prices to alleviate this increased credit risk. Additionally, as we attempt to expand our OEM and distribution channel sales into emerging economies such as Brazil, Russia, India and China, the customers with the most success in these regions may have relatively short operating histories, making it more difficult for us to accurately assess the associated credit risks. Our acquisition of HGST has also resulted in an increase to our customer credit risk given that we service many of the same customers. Any credit losses we may suffer as a result of these increased risks, or as a result of credit losses from any significant customer, would increase our operating costs, which may negatively impact our operating results.

 

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Our operating results fluctuate, sometimes significantly, from period to period due to many factors, which may result in a significant decline in our stock price.

Our quarterly operating results may be subject to significant fluctuations as a result of a number of other factors including:

 

  the timing of orders from and shipment of products to major customers;

 

  our product mix;

 

  changes in the prices of our products;

 

  manufacturing delays or interruptions;

 

  acceptance by customers of competing products in lieu of our products;

 

  variations in the cost of and lead times for components for our products;

 

  limited availability of components that we obtain from a single or a limited number of suppliers;

 

  seasonal and other fluctuations in demand for PCs often due to technological advances; and

 

  availability and rates of transportation.

We often ship a high percentage of our total quarterly sales in the third month of the quarter, which makes it difficult for us to forecast our financial results before the end of the quarter. As a result of the above or other factors, our forecast of operating results for the quarter may differ materially from our actual financial results. If our results of operations fail to meet the expectations of analysts or investors, it could cause an immediate and significant decline in our stock price.

We have made and continue to make a number of estimates and assumptions relating to our consolidated financial reporting, and actual results may differ significantly from our estimates and assumptions.

We have made and continue to make a number of estimates and assumptions relating to our consolidated financial reporting. The highly technical nature of our products and the rapidly changing market conditions with which we deal means that actual results may differ significantly from our estimates and assumptions. These changes have impacted our financial results in the past and may continue to do so in the future. Key estimates and assumptions for us include:

 

  price protection adjustments and other sales promotions and allowances on products sold to retailers, resellers and distributors;

 

  inventory adjustments for write-down of inventories to lower of cost or market value (net realizable value);

 

  reserves for doubtful accounts;

 

  accruals for product returns;

 

  accruals for warranty costs related to product defects;

 

  accruals for litigation and other contingencies;

 

  liabilities for unrecognized tax benefits; and

 

  expensing of stock-based compensation.

The market price of our common stock is volatile.

The market price of our common stock has been, and may continue to be, extremely volatile. Factors that may significantly affect the market price of our common stock include the following:

 

  actual or anticipated fluctuations in our operating results, including those resulting from the seasonality of our business;

 

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  announcements of technological innovations by us or our competitors, which may decrease the volume and profitability of sales of our existing products and increase the risk of inventory obsolescence;

 

  new products introduced by us or our competitors;

 

  periods of severe pricing pressures due to oversupply or price erosion resulting from competitive pressures or industry consolidation;

 

  developments with respect to patents or proprietary rights;

 

  conditions and trends in the hard drive, computer, data and content management, storage and communication industries;

 

  contraction in our operating results or growth rates that are lower than our previous high growth-rate periods;

 

  changes in financial estimates by securities analysts relating specifically to us or the hard drive industry in general; and

 

  macroeconomic conditions that affect the market generally.

In addition, general economic conditions may cause the stock market to experience extreme price and volume fluctuations from time to time that particularly affect the stock prices of many high technology companies. These fluctuations often appear to be unrelated to the operating performance of the companies.

Securities class action lawsuits are often brought against companies after periods of volatility in the market price of their securities. A number of such suits have been filed against us in the past, and should any new lawsuits be filed, such matters could result in substantial costs and a diversion of resources and management’s attention.

Current economic conditions have caused us difficulty in adequately protecting our increased cash and cash equivalents from financial institution failures.

The uncertain global economic conditions and volatile investment markets have caused us to hold more cash and cash equivalents than we would hold under normal circumstances. Since there has been an overall increase in demand for low-risk, U.S. government-backed securities with a limited supply in the financial marketplace, we face increased difficulty in adequately protecting our increased cash and cash equivalents from possible sudden and unforeseeable failures by banks and other financial institutions. A failure of any of these financial institutions in which deposits exceed FDIC limits could have an adverse impact on our financial position.

If our internal controls are found to be ineffective, our financial results or our stock price may be adversely affected.

Our most recent evaluation resulted in our conclusion that as of July 1, 2011, in compliance with Section 404 of the Sarbanes-Oxley Act of 2002, our internal control over financial reporting was effective. As a result of our acquisition of HGST on March 8, 2012, our internal control over financial reporting, subsequent to the date of acquisition, includes certain existing controls adopted from HGST. If our internal control over financial reporting is found to be ineffective or if we identify a material weakness in our financial reporting in future periods, investors may lose confidence in the reliability of our financial statements, which may adversely affect our financial results or our stock price.

From time to time we may become subject to income tax audits or similar proceedings, and as a result we may incur additional costs and expenses or owe additional taxes, interest and penalties that may negatively impact our operating results.

We are subject to income taxes in the United States and certain foreign jurisdictions, and our determination of our tax liability is subject to review by applicable domestic and foreign tax authorities. For example, as we have previously disclosed, we are under examination by the Internal Revenue Service for certain fiscal years and in connection with that examination, we received Revenue Agent Reports seeking certain adjustments to income as disclosed in Part I, Item 1, Note 6 in the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. Although we believe our tax positions are properly supported, the final timing and resolution of the notice of proposed adjustment and the audits are subject to significant uncertainty and could result in our having to pay amounts to the applicable tax authority in order to resolve examination of our tax positions, which could result in an increase or decrease of our current estimate of unrecognized tax benefits and may negatively impact our financial position, results of operations, net income or cash flows.

 

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Item 6. EXHIBITS

Pursuant to the rules and regulations of the SEC, we have filed or incorporated by reference certain agreements as exhibits to this Quarterly Report on Form 10-Q. These agreements may contain representations and warranties by us or our subsidiaries. These representations and warranties have been made solely for the benefit of the other party or parties to such agreements and (i) may have been qualified by disclosures made to such other party or parties, (ii) were made only as of the date of such agreements or such other date(s) as may be specified in such agreements and are subject to more recent developments, which may not be fully reflected in our public disclosures, (iii) may reflect the allocation of risk among the parties to such agreements and (iv) may apply materiality standards different from what may be viewed as material to investors. Accordingly, these representations and warranties may not describe the actual state of affairs at the date hereof and should not be relied upon.

 

Exhibit No.

  

Description

2.1    Stock Purchase Agreement, dated March 7, 2011, among Western Digital Corporation, Western Digital Ireland, Ltd., Hitachi, Ltd., and Viviti Technologies Ltd. (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q (File No. 1-08703), as filed with the Securities and Exchange Commission on May 2, 2011)
2.2    First Amendment to Stock Purchase Agreement, dated May 21, 2011, among Western Digital Corporation, Western Digital Ireland, Ltd., Hitachi, Ltd. and Viviti Technologies Ltd. (Incorporated by reference to the Company’s Annual Report on Form 10-K (File No. 1-08703), as filed with the Securities and Exchange Commission on August 12, 2011)
2.3    Second Amendment to Stock Purchase Agreement, dated November 23, 2011, among Western Digital Corporation, Western Digital Ireland, Ltd., Hitachi, Ltd. and Viviti Technologies Ltd. (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q (File No. 1-08703), as filed with the Securities and Exchange Commission on January 27, 2012)
2.4    Third Amendment to Stock Purchase Agreement, dated January 30, 2012, among Western Digital Corporation, Western Digital Ireland, Ltd., Hitachi, Ltd. and Viviti Technologies Ltd. †
2.5    Fourth Amendment to Stock Purchase Agreement, dated February 15, 2012, among Western Digital Corporation, Western Digital Ireland, Ltd., Hitachi, Ltd. and Viviti Technologies Ltd. †
2.6    Fifth Amendment to Stock Purchase Agreement, dated March 6, 2012, among Western Digital Corporation, Western Digital Ireland, Ltd., Hitachi, Ltd. and Viviti Technologies Ltd. †
2.7    Sixth Amendment to Stock Purchase Agreement, dated March 6, 2012, among Western Digital Corporation, Western Digital Ireland, Ltd., Hitachi, Ltd. and Viviti Technologies Ltd. †
3.1    Amended and Restated Certificate of Incorporation of Western Digital Corporation, as amended to date (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q (File No. 1-08703), as filed with the Securities and Exchange Commission on February 8, 2006)
3.2    Amended and Restated Bylaws of Western Digital Corporation, as amended effective as of November 5, 2007 (Incorporated by reference to the Company’s Current Report on Form 8-K (File No. 1-08703), as filed with the Securities and Exchange Commission on November 8, 2007)
10.1    Western Digital Corporation Summary of Compensation Arrangements for Named Executive Officers and Directors†*
10.2    Employment Agreement, dated as of March 7, 2011, between Western Digital Corporation and Stephen D. Milligan†*
10.3    Western Digital Corporation Executive Severance Plan, amended and restated as of February 16, 2012†*

 

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Exhibit No.

  

Description

10.4    Investor Rights Agreement, dated as of March 8, 2012, between Western Digital Corporation and Hitachi, Ltd.†
10.5    First Amendment to Commitment Letter, dated March 2, 2012, among Bank of America, N.A., Merrill Lynch, Pierce, Fenner & Smith Incorporation, Western Digital Corporation, Western Digital Technologies, Inc. and Western Digital Ireland, Ltd.†
10.6    Credit Agreement, dated as of March 8, 2012, among Western Digital Technologies, Inc. and Western Digital Ireland, Ltd., as Borrowers; Western Digital Corporation, as Holdings; Bank of America, N.A., as Administrative Agent, Swing Line Lender and L/C Issuer; lenders party thereto; Merrill Lynch, Pierce, Fenner & Smith Incorporated, as Sole Lead Arranger and Sole Bookrunner; and The Bank of Nova Scotia, Union Bank, N.A., HSBC Bank USA, National Association, and JPMorgan Chase Bank, N.A., as Co-Syndication Agents†
31.1    Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002†
31.2    Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002†
32.1    Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002†
32.2    Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002†

 

Exhibit No.

  

Description

101.INS    XBRL Instance Document**
101.SCH    XBRL Taxonomy Extension Schema Document**
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document**
101.LAB    XBRL Taxonomy Extension Label Linkbase Document**
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document**
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document**

 

Filed with this report.
* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to applicable rules of the Securities and Exchange Commission.
** Furnished herewith. In accordance with Rule 406T of Regulation S-T, the information in these exhibits shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to liability under that section, and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, except as expressly set forth by specific reference in such filing.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized.

 

WESTERN DIGITAL CORPORATION

Registrant

/s/ WOLFGANG U. NICKL
Wolfgang U. Nickl
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)

 

/s/ JOSEPH R. CARRILLO
Joseph R. Carrillo
Vice President and Chief Accounting Officer
(Principal Accounting Officer)

Date: May 9, 2012

 

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Item 6. EXHIBITS

Pursuant to the rules and regulations of the SEC, we have filed or incorporated by reference certain agreements as exhibits to this Quarterly Report on Form 10-Q. These agreements may contain representations and warranties by us or our subsidiaries. These representations and warranties have been made solely for the benefit of the other party or parties to such agreements and (i) may have been qualified by disclosures made to such other party or parties, (ii) were made only as of the date of such agreements or such other date(s) as may be specified in such agreements and are subject to more recent developments, which may not be fully reflected in our public disclosures, (iii) may reflect the allocation of risk among the parties to such agreements and (iv) may apply materiality standards different from what may be viewed as material to investors. Accordingly, these representations and warranties may not describe the actual state of affairs at the date hereof and should not be relied upon.

 

Exhibit No.

  

Description

2.1    Stock Purchase Agreement, dated March 7, 2011, among Western Digital Corporation, Western Digital Ireland, Ltd., Hitachi, Ltd., and Viviti Technologies Ltd. (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q (File No. 1-08703), as filed with the Securities and Exchange Commission on May 2, 2011)
2.2    First Amendment to Stock Purchase Agreement, dated May 21, 2011, among Western Digital Corporation, Western Digital Ireland, Ltd., Hitachi, Ltd. and Viviti Technologies Ltd. (Incorporated by reference to the Company’s Annual Report on Form 10-K (File No. 1-08703), as filed with the Securities and Exchange Commission on August 12, 2011)
2.3    Second Amendment to Stock Purchase Agreement, dated November 23, 2011, among Western Digital Corporation, Western Digital Ireland, Ltd., Hitachi, Ltd. and Viviti Technologies Ltd. (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q (File No. 1-08703), as filed with the Securities and Exchange Commission on January 27, 2012)
2.4    Third Amendment to Stock Purchase Agreement, dated January 30, 2012, among Western Digital Corporation, Western Digital Ireland, Ltd., Hitachi, Ltd. and Viviti Technologies Ltd. †
2.5    Fourth Amendment to Stock Purchase Agreement, dated February 15, 2012, among Western Digital Corporation, Western Digital Ireland, Ltd., Hitachi, Ltd. and Viviti Technologies Ltd. †
2.6    Fifth Amendment to Stock Purchase Agreement, dated March 6, 2012, among Western Digital Corporation, Western Digital Ireland, Ltd., Hitachi, Ltd. and Viviti Technologies Ltd. †
2.7    Sixth Amendment to Stock Purchase Agreement, dated March 6, 2012, among Western Digital Corporation, Western Digital Ireland, Ltd., Hitachi, Ltd. and Viviti Technologies Ltd. †
3.1    Amended and Restated Certificate of Incorporation of Western Digital Corporation, as amended to date (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q (File No. 1-08703), as filed with the Securities and Exchange Commission on February 8, 2006)
3.2    Amended and Restated Bylaws of Western Digital Corporation, as amended effective as of November 5, 2007 (Incorporated by reference to the Company’s Current Report on Form 8-K (File No. 1-08703), as filed with the Securities and Exchange Commission on November 8, 2007)
10.1    Western Digital Corporation Summary of Compensation Arrangements for Named Executive Officers and Directors†*
10.2    Employment Agreement, dated as of March 7, 2011, between Western Digital Corporation and Stephen D. Milligan†*
10.3    Western Digital Corporation Executive Severance Plan, amended and restated as of February 16, 2012†*
10.4    Investor Rights Agreement, dated as of March 8, 2012, between Western Digital Corporation and Hitachi, Ltd.†

 

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Exhibit No.

  

Description

10.5    First Amendment to Commitment Letter, dated March 2, 2012, among Bank of America, N.A., Merrill Lynch, Pierce, Fenner & Smith Incorporation, Western Digital Corporation, Western Digital Technologies, Inc. and Western Digital Ireland, Ltd.†
10.6    Credit Agreement, dated as of March 8, 2012, among Western Digital Technologies, Inc. and Western Digital Ireland, Ltd., as Borrowers; Western Digital Corporation, as Holdings; Bank of America, N.A., as Administrative Agent, Swing Line Lender and L/C Issuer; lenders party thereto; Merrill Lynch, Pierce, Fenner & Smith Incorporated, as Sole Lead Arranger and Sole Bookrunner; and The Bank of Nova Scotia, Union Bank, N.A., HSBC Bank USA, National Association, and JPMorgan Chase Bank, N.A., as Co-Syndication Agents†
31.1    Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002†
31.2    Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002†
32.1    Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002†
32.2    Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002†

Exhibit No.

  

Description

101.INS    XBRL Instance Document**
101.SCH    XBRL Taxonomy Extension Schema Document**
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document**
101.LAB    XBRL Taxonomy Extension Label Linkbase Document**
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document**
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document**

 

Filed with this report.
* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to applicable rules of the Securities and Exchange Commission.
** Furnished herewith. In accordance with Rule 406T of Regulation S-T, the information in these exhibits shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to liability under that section, and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, except as expressly set forth by specific reference in such filing.

 

55

EX-2.4

EXHIBIT 2.4

THIRD AMENDMENT TO STOCK PURCHASE AGREEMENT

This Third Amendment to the Stock Purchase Agreement (this “Amendment”) is made this 30th day of January, 2012, by and among Western Digital Corporation, a Delaware corporation (the “Buyer Parent”), Western Digital Ireland, Ltd., a corporation organized under the laws of the Cayman Islands and an indirect wholly owned subsidiary of the Buyer Parent (the “Buyer”), Hitachi, Ltd., a company incorporated under the laws of Japan (the “Seller”), and Viviti Technologies Ltd., a company incorporated under the laws of the Republic of Singapore and a wholly owned subsidiary of the Seller (the “Company”, and collectively with the Seller, Buyer and Buyer Parent, the “Parties”, and each, a “Party”). Capitalized terms used herein and not otherwise defined shall have the meanings set forth in the Stock Purchase Agreement (as defined below).

WHEREAS, the Parties entered into a Stock Purchase Agreement on March 7, 2011, as amended by a First Amendment to Stock Purchase Agreement, dated May 27, 2011, and as further amended by a Second Amendment to Stock Purchase Agreement, dated November 23, 2011 (together, the “Stock Purchase Agreement”); and

WHEREAS, the Parties desire to amend the Stock Purchase Agreement as reflected herein.

NOW, therefore, in exchange for good and valuable consideration, the receipt of which is hereby acknowledged, the Parties hereby agree as follows:

1. Exhibit B of the Stock Purchase Agreement. Exhibit B of the Stock Purchase Agreement, Form of IP License Agreement, is hereby deleted in its entirety and replaced by the Form of IP License Agreement attached hereto as Exhibit A.

2. Effect on the Stock Purchase Agreement. This Amendment shall not constitute a waiver, amendment or modification of any provision of the Stock Purchase Agreement not expressly referred to herein. Except as expressly amended or modified herein, the provisions of the Stock Purchase Agreement are and shall remain in full force and effect and are hereby ratified and confirmed. On and after the date hereof, each reference in the Stock Purchase Agreement to “this Agreement”, “herein”, “hereof”, “hereunder” or words of similar import shall mean and be a reference to the Stock Purchase Agreement as amended hereby, although it shall not alter the dates as of which any provision of the Stock Purchase Agreement speaks. For example, phrases such as “as of the date hereof” and “as of the date of this Agreement” shall continue to refer to March 7, 2011, the date that the Stock Purchase Agreement was originally executed. To the extent that a provision of this Amendment conflicts with or differs from a provision of the Stock Purchase Agreement, such provision of this Amendment shall prevail and govern for all purposes and in all respects.

3. Miscellaneous. Sections 12.4, 12.5, 12.7 and 12.13 of the Stock Purchase Agreement are incorporated herein by reference.

[Signature page follows]


IN WITNESS WHEREOF, the Parties hereto have executed this Third Amendment to Stock Purchase Agreement as of the date first written above.

 

“BUYER PARENT”
WESTERN DIGITAL CORPORATION
By:   /s/ John F. Coyne
 

 

  Name: John F. Coyne
  Title: President & CEO
“BUYER”
WESTERN DIGITAL IRELAND, LTD.
By:   /s/ Michael Ray
 

 

  Name: Michael Ray
  Title: Vice President
“SELLER”
HITACHI, LTD
By:   /s/ Toyoki Furuta
 

 

  Name: Toyoki Furuta
  Title: General Manager,
            Business Development Office
“COMPANY”
VIVITI TECHNOLOGIES LTD.
By:   /s/ Christopher Dewees
 

 

  Name: Christopher Dewees
  Title: SVP & General Counsel

Signature Page to Third Amendment to Stock Purchase Agreement


EXHIBIT A

Amended and Restated Form of IP License Agreement

[See Attached]


EXHIBIT B

FORM OF

LICENSE AGREEMENT

This License Agreement (“Agreement”), effective as of the Closing Date (as defined below), is entered into by and between Western Digital Corporation (“Buyer Parent”), a Delaware company with its principal place of business at 3355 Michelson Drive, Suite 100 Irvine, California 92612, USA, and Hitachi, Ltd. (“HITACHI”), a Japanese company with its principal place of business at 6-6, Marunouchi 1-chome, Chiyoda-ku, Tokyo 100-8280, Japan. Each of the signatories to this Agreement is referred to as a “Party,” and jointly as the “Parties.”

RECITALS

WHEREAS, Buyer Parent, Western Digital Ireland, Ltd., a corporation organized under the laws of the Cayman Islands and an indirect wholly-owned subsidiary of the Buyer Parent (the “Buyer”), HITACHI, and Hitachi Global Storage Technologies Holdings Pte. Ltd., a company incorporated under the laws of the Republic of Singapore (“HGST”) and a wholly owned subsidiary of HITACHI, have entered into that certain Stock Purchase Agreement dated as of March 7, 2011 (the “Purchase Agreement”);

WHEREAS, pursuant to the Purchase Agreement, Buyer Parent desires to enter into a patent cross-license with HITACHI for certain technologies and enter into a mutual release of claims pursuant to the terms and conditions of this Agreement; and

WHEREAS, pursuant to the Purchase Agreement, HITACHI desires to enter into a patent cross-license with Buyer Parent for certain technologies and enter into a mutual release of claims pursuant to the terms and conditions of this Agreement.

NOW, THEREFORE, in consideration of the mutual promises and covenants set out below, the Parties agree as follows:

TERMS OF AGREEMENT

1. DEFINITIONS

 

  1.1 “External Drive” means an enclosure that encases one or more HDDs or SSDs and related peripheral hardware, or Software or Firmware components (other than RAID).

 

  1.2 “Existing Terms” means terms and conditions in written agreements existing as of the Closing Date between HGST or any of its Subsidiaries, on the one hand, and HITACHI or any HITACHI Sublicensed Subsidiary, on the other hand, with respect to license limitations, restrictions on use (with respect to any intellectual property rights, Works or materials not owned by HITACHI or a HITACHI Sublicensed Subsidiary), restrictions on disclosure, royalties or other consideration, and/or license duration.

 

  1.3 “Have Made” means to have any products or other items subject to the licenses granted herein made by a third-party manufacturer for the use, lease, sale or other transfer by a Party or its Subsidiaries; provided, however, that (i) the specifications for such products or other items were solely or jointly created by or at the direction of such Party or its Subsidiaries, and (ii) such product or other item is not an off-the-shelf product of a third-party manufacturer.

 

  1.4 “HDD” means any device designed to magnetically record and/or read digital information on or from a rotating disk (“Rotating Magnetic Storage”) that contains one or more spindle motors, one or more magnetic heads, and one or more actuators, all of which are incorporated in a single enclosure, and related peripheral hardware, or Software or Firmware components. For the avoidance of doubt “HDD” (a) includes any device that incorporates both Rotating Magnetic Storage and other digital storage media, such as semiconductor-based memory, but only in the case that the memory capacity of Rotating Magnetic Storage supersedes that of other digital storage media, and (b) excludes External Drive, RAID (as defined below), Information Versatile Disk for Removable Usage (iVDR), and optical disk products.

 

1


  1.5 “Buyer Parent SSD Patents” means all Patents related to SSD (i) issued or issuing on patent applications entitled to a first effective filing date on or before the end of the Term, (ii) under which Buyer Parent or any of its Subsidiaries has now or during the Term obtains the right to grant licenses within the scope granted herein without the payment of royalties or other consideration to any third party, and (iii) that would be, but for this Agreement, directly or indirectly infringed by HITACHI or HITACHI Sublicensed Subsidiaries making, using, importing, exporting, leasing, selling, offering to sell, or otherwise disposing of SSD.

 

  1.6 “Storage Software Products” means the Hitachi BackupTM software product and the LifestudioTM software product.

 

  1.7 “Storage Software Patents” means all Patents related to the Storage Software Products (i) issued or issuing on patent applications entitled to a first effective filing date on or before the end of the Term, (ii) under which Hitachi or any HITACHI Sublicensed Subsidiary has now or during the Term obtains the right to grant licenses within the scope granted herein without the payment of royalties or other consideration to any third party, and (iii) that would be, but for this Agreement, directly or indirectly infringed by Buyer Parent or its Subsidiaries making, using, importing, exporting, selling, leasing, offering to sell, or otherwise disposing of the version of either Storage Software Product that is generally commercially available as of the Closing Date.

 

  1.8 “HGST RAID Patents” means all Patents related to RAID (i) issued or issuing on patent applications entitled to a first effective filing date on or before the first anniversary of the Closing Date (ii) under which Buyer Parent or any of its Subsidiaries has now or hereafter obtains the right to grant licenses within the scope granted herein without the payment of royalties or other consideration to any third party, (iii) whose named inventors are or were employees or contractors of HGST or any of its Subsidiaries on or prior to the Closing Date or that were assigned or exclusively licensed to HGST or any of its Subsidiaries on or prior to the Closing Date, and (iv) that would be, but for this Agreement, directly or indirectly infringed by HITACHI or HITACHI Sublicensed Subsidiaries making, using, importing, exporting, leasing, selling, offering to sell, or otherwise disposing of RAID.

 

  1.9 “Buyer Parent RAID Patents” means all Patents related to RAID (i) issued or issuing on patent applications entitled to a first effective filing date on or before the end of the Term (ii) under which Buyer Parent or any of its Subsidiaries has now or hereafter obtains the right to grant licenses within the scope granted herein without the payment of royalties or other consideration to any third party, and (iii) that would be, but for this Agreement, directly or indirectly infringed by HITACHI or HITACHI Sublicensed Subsidiaries making, using, importing, exporting, leasing, selling, offering to sell, or otherwise disposing of RAID. For clarity, the Buyer Patent RAID Patents include, but are not limited to, the HGST RAID Patents.

 

  1.10 “Closing Date” has the meaning set forth in the Purchase Agreement.

 

  1.11 “HITACHI External Drive Patents” means all Patents related to External Drive (i) issued or issuing on patent applications entitled to a first effective filing date on or before the end of the Term, (ii) under which HITACHI or any HITACHI Sublicensed Subsidiary has now or during the Term obtains the right to grant licenses within the scope granted herein without the payment of royalties or other consideration to any third party, and (iii) that would be, but for this Agreement, directly or indirectly infringed by Buyer Parent or its Subsidiaries making, using, importing, exporting, selling, leasing, offering to sell, or otherwise disposing of External Drive.

 

2


  1.12 “HITACHI HDD Patents” means all Patents related to HDD (i) issued or issuing on patent applications entitled to a first effective filing date on or before the end of the Term, (ii) under which HITACHI or any HITACHI Sublicensed Subsidiary has now or hereafter obtains the right to grant licenses within the scope granted herein without the payment of royalties or other consideration to any third party, and (iii) that would be, but for this Agreement, directly or indirectly infringed by Buyer Parent or its Subsidiaries making, using, importing, exporting, leasing, selling, offering to sell, or otherwise disposing of HDD.

 

  1.13 “HITACHI Exclusions” means (i) any Works (e.g., Software) that as of the Closing Date are made generally commercially available by HITACHI or any of the HITACHI Sublicensed Subsidiaries, and (ii) any proprietary information of HITACHI or any of the HITACHI Sublicensed Subsidiaries that has been disclosed to HGST or any of its Subsidiaries in its role as a supplier or potential supplier of products to HITACHI or a HITACHI Sublicensed Subsidiary.

 

  1.14 “HITACHI Licensed Copyrights” means copyrights owned by HITACHI or any of the HITACHI Sublicensed Subsidiaries as of the Closing Date in any Works that were provided to HGST by HITACHI or any HITACHI Sublicensed Subsidiary prior to, and are used by HGST or any of its Subsidiaries as of, the Closing Date; provided, however, that “HITACHI Licensed Copyrights” do not include any copyrights embodied or used in any HITACHI Exclusions.

 

  1.15 “HITACHI Licensed Trade Secrets” means trade secrets owned by HITACHI or any of the HITACHI Licensed Subsidiaries as of the Closing Date that were provided to HGST by HITACHI or any HITACHI Sublicensed Subsidiary prior to, and are used by HGST or any of its Subsidiaries as of, the Closing Date; provided, however, that “HITACHI Licensed Trade Secrets” do not include any trade secrets embodied or used in HITACHI Exclusions.

 

  1.16 “HITACHI RAID Patents” means all Patents related to RAID (i) issued or issuing on patent applications entitled to a first effective filing date on or before the end of the Term, (ii) under which HITACHI or any HITACHI Sublicensed Subsidiary has now or during the Term obtains the right to grant licenses within the scope granted herein without the payment of royalties or other consideration to any third party, and (iii) that would be, but for this Agreement, directly or indirectly infringed by Buyer Parent or its Subsidiaries making, using, importing, exporting, selling, leasing, offering to sell, or otherwise disposing of RAID.

 

  1.17 “HITACHI SSD Patents” means all Patents related to SSD (i) issued or issuing on patent applications entitled to a first effective filing date on or before the end of the Term, and (ii) under which HITACHI or any HITACHI Sublicensed Subsidiary has now or during the Term obtains the right to grant licenses within the scope granted herein without the payment of royalties or other consideration to any third party, and (iii) that would be, but for this Agreement, directly or indirectly infringed by Buyer Parent or its Subsidiaries making, using, importing, exporting, selling, leasing, offering to sell, or otherwise disposing of SSD.

 

  1.18 “HITACHI Sublicensed Subsidiary” means any HITACHI Subsidiary to which the rights, licenses, releases, covenants and privileges are extended in accordance with Section 2.4.

 

  1.19 “Non-HDD Business” means any entity (or internal business division or organization of an entity) that is principally engaged in a business other than the design, sale, or manufacture of HDDs.

 

  1.20 “Patents” means all classes and types of patents, including utility patents, utility models, design patents, invention certificates, including divisionals, continuations, continuations-in-part, reexaminations, reissues, extensions and renewals, in all jurisdictions of the world.

 

  1.21 “RAID” means a device comprised of an assembly of storage media components and related peripheral hardware, or Software or Firmware components contained within one or more enclosures, combined with associated Software or Firmware, for the purpose of data storage and retrieval, designed to protect digital information from a single component failure or to enhance performance by dividing data among multiple storage media components. For the avoidance of doubt, “RAID” excludes storage media components incorporated therein.

 

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  1.22 “Software or Firmware” means a set of instructions, that either (i) directly provides instructions to the computer hardware, or, (ii) indirectly serves as an input to another piece of software.

 

  1.23 “SSD” means a product, component, subcomponent or subassembly thereof, and related peripheral hardware, or Software or Firmware components, designed, in whole or in part, to electrically write, read and/or erase digital information from storage media or memory (including, without limitation, NOR-flash, NAND-flash, or MRAM semiconductor microchips), which utilizes an HDD-type interface (or an interface also employed for HDDs), including without limitation, PATA, SATA, SAS, PCI Express, SCI, Fibre Channel, USB 3.0 and InfiniBand. For the avoidance of doubt, “SSD” excludes HDD and RAID.

 

  1.24 “Subsidiary” of either party shall mean a corporation, partnership, joint venture, limited liability company or other business entity of which a majority of the shares of securities or other interests having ordinary voting power for the election of directors or other governing body are at the time beneficially owned, directly, or indirectly, by such party. For the purposes of this Agreement, HGST and its Subsidiaries will be Subsidiaries of Buyer Parent (subject to meeting the requirements of the preceding sentence) and are not Subsidiaries of HITACHI.

 

  1.25 “Term” means the period from the Closing Date through the fifth anniversary of the Closing Date.

 

  1.26 “HDD Component” means any component, subcomponent, subassembly, Software or Firmware which is specifically designed for HDD, whether or not sold as a stand-alone unit or integrated within an HDD.

 

  1.27 “Works” means works of authorship and other copyrightable materials and subject matter, including Software to the extent within the subject matter of copyright.

 

  1.28 “3.5” HDD” means an HDD in the 3.5” form factor having an enclosure with a width of 101.6mm and a depth of 146mm that is designed and sold for use in, and used in, consumer electronics and desktop personal computer products only. For clarity, the term “3.5” HDD” does not include (a) HDDs in any form factor designed for use in, sold for use in or used in servers or other applications other than consumer electronics or desktop personal computers or (b) HDD Components.

2. LICENSES, RELEASES, AND COVENANTS GRANTED TO HITACHI

 

  2.1 SSD License to HITACHI. Buyer Parent, on behalf of itself and its Subsidiaries, hereby grants to HITACHI a non-exclusive, irrevocable, fully paid-up, world-wide term license, without the right to grant a sublicense (other than pursuant to Section 2.4), under the Buyer Parent SSD Patents, to make, Have Made, use, import, export, sell, lease, offer to sell, or otherwise dispose of SSD.

 

  2.2 RAID License to HITACHI. Buyer Parent, on behalf of itself and its Subsidiaries, hereby grants to HITACHI a non-exclusive, irrevocable, fully paid-up, world-wide, license, without the right to grant a sublicense (other than pursuant to Section 2.4), under the Buyer Parent RAID Patents, to make, Have Made, use, import, export, sell, lease, offer to sell, or otherwise dispose of RAID.

 

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  2.3 Past Release to HITACHI. Buyer Parent, on behalf of itself and its Subsidiaries, hereby irrevocably releases and forever discharges HITACHI and the HITACHI Sublicensed Subsidiaries from any and all claims, losses, demands, causes of action, liabilities, and rights of action of any kind, at law or in equity, whether known or unknown, suspected and unsuspected, disclosed and undisclosed, liquidated or unliquidated, for any act of direct or indirect infringement, before the Closing Date, of any Buyer Parent SSD Patent or Buyer Parent RAID Patent by HITACHI or any HITACHI Sublicensed Subsidiary making, using, importing, exporting, selling, leasing, offering to sell, or otherwise disposing of SSD (in the case of Buyer Parent SSD Patents) or RAID (in the case of Buyer Parent RAID Patents). For the avoidance of doubt, the foregoing release is intended to and does apply to all activities of HITACHI and the HITACHI Sublicensed Subsidiaries that fall within the scope of the licenses granted by Buyer Parent set forth in this Agreement that were carried out before the Closing Date.

 

  2.4 Extension to HITACHI’s Subsidiaries. HITACHI shall have a right to extend to its Subsidiaries the rights, releases, licenses, covenants and any other privileges granted to HITACHI hereunder, if such Subsidiary agrees to abide by the terms and conditions of this Agreement and include its Patents in HITACHI HDD Patents, HITACHI External Drive Patents, HITACHI RAID Patents, and HITACHI SSD Patents as if it were named in the place of HITACHI hereunder, subject to the termination provision in Section 4.2.

 

  2.5 Covenant Not To Sue HITACHI Regarding RAID. Buyer Parent and its Subsidiaries shall reserve the right to sue the sellers and/or manufacturers of HDD incorporated into RAID sold to HITACHI or HITACHI Sublicensed Subsidiaries for infringement of Buyer Parent Patents related to HDD by making, using, selling, offering to sell, leasing, importing or otherwise disposing of such HDD incorporated into RAID; provided however, that Buyer Parent, on behalf of itself and its Subsidiaries, covenants not to sue HITACHI, HITACHI Sublicensed Subsidiaries, or their customers (to the extent the RAID was purchased from HITACHI or HITACHI Sublicensed Subsidiaries) for infringement of Buyer Parent Patents related to HDD by using, leasing, importing, exporting, selling, offering to sell such HDD incorporated into RAID.

3. LICENSES, RELEASE AND COVENANTS GRANTED TO BUYER PARENT

 

  3.1 HDD/HDD Component License to Buyer Parent. HITACHI, on behalf of itself and HITACHI Sublicensed Subsidiaries, hereby grants to Buyer Parent and its Subsidiaries a non-exclusive, irrevocable, fully paid-up, world-wide, license, without the right to grant a sublicense (other than pursuant to Section 3.11), under the HITACHI HDD Patents, to make, Have Made, use, import, export, sell, lease, offer to sell, or otherwise dispose of HDD and HDD Components.

 

  3.2 SSD License to Buyer Parent. HITACHI, on behalf of itself and HITACHI Sublicensed Subsidiaries, hereby grants to Buyer Parent and its Subsidiaries a non-exclusive, irrevocable, fully paid-up, world-wide term license, without the right to grant a sublicense under HITACHI SSD Patents, to make, Have Made, use, import, export, sell, lease, offer to sell, or otherwise dispose of SSD.

 

  3.3 RAID License to Buyer Parent. HITACHI, on behalf of itself and HITACHI Sublicensed Subsidiaries, hereby grants to Buyer Parent and its Subsidiaries a non-exclusive, irrevocable, fully paid-up, world-wide term license, without the right to grant a sublicense , under HITACHI RAID Patents, to make, Have Made, use, import, export, sell, lease, offer to sell, or otherwise dispose of RAID.

 

  3.4 External Drive License to Buyer Parent. HITACHI, on behalf of itself and HITACHI Sublicensed Subsidiaries, hereby grants to Buyer Parent and its Subsidiaries a non-exclusive, irrevocable, fully paid-up, world-wide term license, without the right to grant a sublicense , under HITACHI External Drive Patents, to make, Have Made, use, import, export, sell, lease, offer to sell, or otherwise dispose of External Drive.

 

  3.5 Storage Software License. HITACHI, on behalf of itself and HITACHI Sublicensed Subsidiaries, hereby grants to Buyer Parent and its Subsidiaries a non-exclusive, irrevocable, fully paid-up, world-wide, term license, without the right to grant a sublicense , under the Storage Software Patents, to make, Have Made, use, import, export, sell, lease, offer to sell, or otherwise dispose of the Storage Software Products, including future versions thereof.

 

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  3.6 HITACHI Licensed Copyrights License. Subject, in the case of any particular HITACHI Licensed Work, to any applicable Existing Terms, HITACHI, on behalf of itself and the HITACHI Sublicensed Subsidiaries, hereby grants to Buyer Parent and its Subsidiaries a nonexclusive, irrevocable, fully paid-up, world-wide, perpetual license under the HITACHI Licensed Copyrights to reproduce, distribute, display, perform, and make derivative works of any Works covered by the HITACHI Licensed Copyrights (“HITACHI Licensed Works”), in each case, in the ordinary course of the business of Buyer Parent and its Subsidiaries (such license, the “HITACHI Licensed Copyrights License”). Buyer Parent and its Subsidiaries may grant sublicenses under the HITACHI Licensed Copyrights License to third parties (a) as provided in Section 3.11 and (b) in connection with the development, manufacture, distribution, provision, sale and use of any products or services of Buyer Parent and its Subsidiaries, in each case, solely in such fields, provided that any disclosure to such third parties of HITACHI Licensed Trade Secrets embodied in HITACHI Licensed Works (and any use of such HITACHI Licensed Trade Secrets by such third parties) shall be only as permitted by Section 3.8.

 

  3.7 HITACHI Licensed Trade Secrets License. Subject to the terms and conditions of this Agreement and, in the case of any particular HITACHI Licensed Trade Secret, to any applicable Existing Terms, HITACHI, on behalf of itself and the HITACHI Sublicensed Subsidiaries, hereby grants to Buyer Parent and its Subsidiaries, a nonexclusive, irrevocable, fully paid-up, worldwide, perpetual license under the HITACHI Licensed Trade Secrets to use the HITACHI Licensed Trade Secrets, in each case, in the ordinary course of the business of Buyer Parent and its Subsidiaries (the “HITACHI Licensed Trade Secrets License”). The HITACHI Licensed Trade Secrets shall be deemed Confidential Information of HITACHI and the HITACHI Trade Secret License shall be subject to the terms and conditions of Section 3.8. Notwithstanding the preceding sentence, Buyer Parent and its Subsidiaries may disclose the HITACHI Licensed Trade Secrets to and allow use of the HITACHI Licensed Trade Secrets by third parties as (a) provided in Section 3.11 and (b) reasonably necessary in connection with the development, manufacture, distribution, provision, sale, and use of the products and services of Buyer Parent and its Subsidiaries, in each case, solely in such fields, provided that such third parties are bound in writing by confidentiality terms at least as protective as those set forth in Section 3.8. Except as expressly set forth in the preceding sentence or as expressly permitted by Section 3.8, Buyer Parent and its Subsidiaries shall not (and shall have no right to) disclose or allow the use of any HITACHI Licensed Trade Secret.

 

  3.8 Confidentiality. Buyer Parent and its Subsidiaries shall maintain the HITACHI Licensed Trade Secrets with at least the same degree of care it uses to protect its own proprietary information of a similar nature or sensitivity, but no less than reasonable care under the circumstances. Buyer Parent and its Subsidiaries shall not disclose any HITACHI Licensed Trade Secrets to third parties except where (i) such disclosure is required by law or order of a court of competent jurisdiction, provided that, in such event, Buyer Parent shall provide HITACHI prompt, advance notice of such requirement to allow intervention (and shall cooperate with HITACHI) to contest or minimize the scope of the disclosure (including through application for a protective order), (ii) the HITACHI Licensed Trade Secret disclosed was in the public domain prior to the disclosure to Buyer Parent or its Subsidiaries, (iii) the HITACHI Licensed Trade Secret disclosed becomes part of the public domain by publication or otherwise except by breach of this Agreement, or (iv) Buyer Parent can establish by competent proof the HITACHI Licensed Trade Secret disclosed was received from a third party without restrictions on confidentiality. Buyer Parent shall be responsible to HITACHI for the acts and omissions of any Subsidiary, employee or agent with respect to such confidentiality obligations. To the extent a particular HITACHI Licensed Trade Secret is subject to confidentiality obligations under a written agreement existing as of the Closing Date between HGST or any of its Subsidiaries, on the one hand, and HITACHI or any HITACHI Sublicensed Subsidiary, on the other hand, the obligations set forth in this Section 3.8 will not extend in duration beyond the expiration of the confidentiality obligations set forth in such written agreement.

 

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  3.9 Past Release to Buyer Parent. HITACHI, on behalf of itself and HITACHI Sublicensed Subsidiaries, hereby irrevocably releases and forever discharges Buyer Parent and its Subsidiaries from any and all claims, losses, demands, causes of action, liabilities, and rights of action of any kind, at law or in equity, whether known or unknown, suspected and unsuspected, disclosed and undisclosed, liquidated or unliquidated, for any act of direct or indirect infringement, before the Closing Date, of any HITACHI HDD Patent, HITACHI SSD Patent, HITACHI External Drive Patent, HITACHI RAID Patent or Storage Software Patent by Buyer Parent or its Subsidiaries making, using, importing, exporting, selling, leasing, offering to sell, or otherwise disposing of HDD (in the case of HITACHI HDD Patents), External Drive (in the case of HITACHI External Drive Patents), SSD (in the case of HITACHI SSD Patents), RAID (in the case of HITACHI RAID patents) or Storage Software Products (in the case of Storage Software Patents). For the avoidance of doubt, the foregoing release is intended to and does apply to all activities of Buyer Parent and its Subsidiaries that fall within the scope of the licenses granted by HITACHI set forth in this Agreement that were carried out before the Closing Date.

 

  3.10 No Licenses to Third Parties. Nothing in this Agreement shall be deemed to grant any license, immunity, release, or other right to any person or entity, other than the Parties and their respective Subsidiaries, as provided herein.

 

  3.11 Divestment Sublicense. Buyer Parent shall have a right to grant to Toshiba Corporation (“Toshiba”) a sublicense under the rights granted to Buyer Parent pursuant to Sections 3.1, 3.6 and 3.7, effective upon the closing of Toshiba’s purchase from Buyer Parent of assets relating to the 3.5” HDD business owned by Viviti Technologies Limited pursuant to the Purchase Agreement in connection with any commitment to, order by, regulation of, or other obligation to a regulatory body, competition authority or similar entity including the commitments under the Case No. Comp M.6203 Western Digital / Viviti Technologies Commitments to the European Commission (collectively, such assets purchased by Toshiba constituting the “Divested Business”), subject to the following conditions:

 

  (a) the sublicense granted to Toshiba under the rights granted to Buyer Parent pursuant to Sections 3.1, 3.6 and 3.7 will apply only with respect to developing, making, Having Made, using, importing, exporting, selling, leasing, offering to sell, distributing and otherwise disposing of 3.5” HDDs in the ordinary course of Toshiba’s 3.5” HDD business;

 

  (b) the sublicense granted to Toshiba under the rights granted to Buyer Parent pursuant to Sections 3.1, 3.6 and 3.7 will apply only to the operation of the Divested Business, and not to the operation of any businesses or assets (whether or not related to 3.5” HDDs) possessed by Toshiba prior to Toshiba’s acquisition of the Divested Business, or acquired or developed by Toshiba independently of Toshiba’s acquisition of the Divested Business; and

 

  (c) the sublicense granted to Toshiba will be pursuant to a written agreement, satisfactory in form to Hitachi, obligating Toshiba to observe all applicable terms and conditions of this Agreement with respect to rights granted to Toshiba, and containing confidentiality terms at least as protective of the HITACHI Licensed Trade Secrets, and HITACHI’s rights therein, as the terms of Section 3.8 of this Agreement, and further containing terms expressly designating Hitachi as an intended third party beneficiary and providing that Hitachi shall have the right to exercise the same rights and remedies against Toshiba with respect to the sublicense as HITACHI may exercise against Buyer Parent with respect to the applicable provisions of this Agreement. For the avoidance of doubt, the form set forth as Exhibit A is satisfactory to Hitachi as relates to the sublicense pursuant to this Section 3.11.

 

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Notwithstanding anything to the contrary, HITACHI may enforce any rights or seek any remedies arising from any act or omission by Toshiba directly against Toshiba or Buyer Parent; provided, however, that HITACHI will not seek injunctive relief against Buyer Parent, or terminate any rights of Buyer Parent pursuant to this Agreement, due to a breach of the sublicense by Toshiba. If HITACHI is unable to enforce any rights or remedies against Toshiba because of Toshiba’s status as a sublicensee under the sublicense agreement (as opposed to a direct licensee of HITACHI), then, Buyer Parent and its Subsidiaries shall reasonably cooperate with HITACHI to enforce such rights or obtain remedies (including, to the extent necessary, Buyer Parent’s or its Subsidiaries’ joining as a party to any enforcement action or terminating rights granted to Toshiba pursuant to the sublicense agreement). Buyer Parent shall provide a copy of the executed sublicense agreement to HITACHI, and, with respect to those terms relating to the sublicense from HITACHI, shall (i) not amend the sublicense agreement without HITACHI’s prior consent, (ii) provide HITACHI with prompt notice of any breach of the sublicense agreement by Toshiba of which Buyer Parent becomes aware, and (iii) not waive any such breach of the sublicense agreement by Toshiba without HITACHI’s prior consent.

4. TERMS AND TERMINATIONS

 

  4.1 Termination and Survival. The licenses granted in Sections 2.1, 3.2, 3.3, 3.4 and shall terminate at the end of Term. Further, the license grant in Sections 2.2 and 3.1 shall terminate in part: with respect to Section 2.2, only the license under Buyer Parent RAID Patents that are not HGST RAID Patents shall terminate at the end of the Term; with respect to Section 3.1, only the license under Patents issued or issuing on patent applications entitled to a first effective filing date after the first anniversary of the Closing Date shall terminate at the end of the Term. The remainder of the licenses set forth in Sections 2.2 and 3.1, including their transferability, shall continue and remain in full force and effect until the expiration of the life of the last Patent, as defined herein. In addition, the covenant set forth in Section 2.5 shall terminate (a) at the end of the Term, with respect to Patents issued or issuing on patent applications entitled to a first effective filing date after the first anniversary of the Closing Date and (b) upon the expiration of the life of the last Patent subject to the covenant, as to all other Patents subject to the covenant. The remainder of this Agreement, including the licenses set forth in Sections 3.6 and 3.7 and the provisions of Section 3.8, shall continue and remain in full force for so long as any HITACHI License Copyright or HITACHI Licensed Trade Secret continues to exist and be enforceable.

 

  4.2 Termination of the Rights Granted to Subsidiaries. All rights, licenses and covenants granted to any Subsidiaries of either Party shall automatically terminate in the event that such Subsidiaries no longer fall under the definition of “Subsidiary,” as defined herein.

 

  4.3 Termination For Material Breach. If Buyer Parent or any of its Subsidiaries breaches Section 2.5 of this Agreement, and if such material breach is not corrected within sixty (60) days after written notice by HITACHI, the continuing covenants, rights, licenses, and any other privileges granted to Buyer Parent and its Subsidiaries in this Agreement may be terminated by HITACHI forthwith by written notice to Buyer Parent; provided that no such termination shall terminate, modify or limit, in any manner, any of the continuing covenants, rights, licenses, and any other privileges granted to HITACHI and the HITACHI Sublicensed Subsidiaries in this Agreement, all of which shall continue unaffected.

 

  4.4 Termination For Bankruptcy. A Party may terminate this Agreement by giving written notice of termination to the other Party at any time upon or after:

 

  (a) the filing by the other Party of an petition in bankruptcy or insolvency which petition or proceeding is not dismissed within sixty (60) days;

 

  (b) any adjudication that the other Party is bankrupt or insolvent;

 

  (c) the filing by the other Party of any petition or answer seeking reorganization, readjustment or arrangement of its business under any law relating to bankruptcy or insolvency which petition or proceeding is not dismissed within sixty (60) days;

 

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  (d) the appointment of a receiver for all or substantially all of the property of the other Party;

 

  (e) the institution of any proceeding for the liquidation winding up of the other Party’s business which petition or proceeding is not dismissed within sixty (60) days.

Notwithstanding the foregoing, the occurrence of any of the events provided above shall not be deemed to terminate, modify or limit, in any manner (or permit a Party to terminate, modify or limit, in any manner), any of the continuing covenants, rights, licenses and any other privileges granted to the terminating Party and its Subsidiaries in this Agreement, all of which shall continue unaffected by such event.

 

  4.5 No Release on Termination. No termination in this Agreement pursuant to Section 4.2, 4.3, or 4.4 above shall relieve either Party of any obligation or liability accrued hereunder prior to such termination.

5. REPRESENTATIONS AND WARRANTIES

 

  5.1 Authority. Each Party represents and warrants that it has the corporate power and authority to enter this Agreement, and to carry out the terms and obligations set forth in this Agreement, and that the persons executing this Agreement on its behalf have the authority to act for and bind the Party and/or, in case of Buyer Parent, its Subsidiaries, and in case of HITACHI, HITACHI Sublicensed Subsidiaries.

 

  5.2 Buyer Parent’s Right To Grant. Buyer Parent, on behalf of itself and its Subsidiaries, represents and warrants that Buyer Parent (or a Subsidiary of Buyer Parent) owns, and that Buyer Parent has the right to license, the Patents licensed by Buyer Parent; and that it is not a party to any agreements or obligations inconsistent with this Agreement.

 

  5.3 HITACHI’s Right To Grant. HITACHI, on behalf of itself and HITACHI Sublicensed Subsidiaries, represents and warrants that HITACHI (or a HITACHI Sublicensed Subsidiary) owns, and that HITACHI has the right to license, the Patents licensed by HITACHI; and that it is not a party to any agreements or obligations inconsistent with this Agreement.

 

  5.4 No Warranty by Buyer Parent. This Agreement does not and shall not be interpreted or construed to include: (a) any warranty or representation on the part of Buyer Parent as to the validity, enforceability, or scope of any Patent licensed by Buyer Parent; (b) any warranty or representation that any specific apparatus or method used by HITACHI in connection with any Patents licensed by Buyer Parent is or will be free from infringement of patents of others or other intangible rights of third parties; (c) any requirement to file any patent application, or secure or maintain any patent; (d) any obligation to bring or prosecute any action for infringement of any Patent licensed by Buyer Parent; (e) any obligation to furnish any technical or support information; (f) any license or right by implication or estoppel; or (g) any warranty of MERCHANTABILITY, NON-INFRINGEMENT OR FITNESS FOR ANY PARTICULAR PURPOSE OR USE for implementations of Patents licensed by Buyer Parent.

 

  5.5 No Warranty by HITACHI. This Agreement does not and shall not be interpreted or construed to include: (a) any warranty or representation on the part of HITACHI as to the validity, enforceability, or scope of any Patent licensed by HITACHI; (b) any warranty or representation that any specific apparatus or method used by Buyer Parent or its Subsidiaries in connection with any Patent licensed by HITACHI is or will be free from infringement of patents of others or other intangible rights of third parties; (c) any requirement to file any patent application, or secure or maintain any patent; (d) any obligation to bring or prosecute any action for infringement of any Patent licensed by HITACHI; (e) any obligation to furnish any technical or support information; (f) any license or right by implication or estoppel; or (g) any warranty of MERCHANTABILITY, NON-INFRINGEMENT OR FITNESS FOR ANY PARTICULAR PURPOSE OR USE for implementations of the Patents licensed by HITACHI.

 

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6. NOTICES

All notices and other communications required or permitted hereunder shall be in writing and shall be mailed by Federal Express or other internationally recognized express carrier, registered or certified mail, postage prepaid, or otherwise delivered by hand or by messenger, addressed to a Party at the addresses set forth below, or at such other address as a Party may substitute by written notice provided to the other Party in such manner. Such notices shall be deemed to have been served when delivered.

If to HITACHI:

IP Business Division

Intellectual Property Group

Hitachi, Ltd.

Atten: General Manager

6-1 Marunouchi 1-chome, Chiyoda-ku

Tokyo 100-8220 Japan

If to Buyer Parent:

7. BUSINESS ACQUISITION, TRANSFER, CHANGE OF CONTROL, ETC.

 

  7.1 Assignment and Change of Control of Buyer Parent HDD Business. Buyer Parent may assign or transfer the rights, licenses, and covenants under Section 3.1 of this Agreement in connection with any sale or other transfer of (i) all or substantially all of Buyer Parent’s HDD business, (ii) all or substantially all of Buyer Parent’s HDD-related assets in a single transaction or a series of transactions, or (iii) any transaction under which Buyer Parent undergoes a change in control.

 

  7.2 Assignment of Buyer Parent Non-HDD Business. In connection with any sale or other transfer of (a) all or substantially all of Buyer Parent’s RAID, External Drive, and/or SSD business, or (b) all or substantially all of Buyer Parent’s RAID-, External Drive-and/or SSD-related assets in a single transaction or a series of transactions, Buyer Parent may assign or transfer the rights, licenses and covenants under Sections 3.2, 3.3, 3.4, 3.5 and/or 3.6 corresponding to the sold or transferred business, subject to the following limitations:

 

  (a) The rights, licenses, and covenants under Sections 3.2, 3.3, 3.4, 3.5 and/or 3.6 shall be assignable provided that: the acquiring third party (“Acquiring 3rd Party”) agrees to grant a royalty-free license to HITACHI and the HITACHI Sublicensed Subsidiaries under the Patents which would fall within the scope of Buyer Parent SSD Patents or Buyer Parent RAID Patents if the Acquiring 3rd Party were named in the place of Buyer Parent in Sections 1.4 and 1.5 hereunder, in each case for the applicable term set forth in Section 4.1;

 

  (b) The rights, licenses, and covenants under Sections 3.2, 3.3, 3.4, 3.5 and/or 3.6 shall not be extended to the business originally run by the Acquiring 3rd Party or any of its Subsidiaries. To the extent that such rights, licenses and covenants continue to extend to the acquired portion of the business, the extension shall be limited to a revenue of such business equal to no more than the revenue of the acquired business in the twelve (12) months preceding such sale or transfer plus twenty percent (20%); and shall also be limited, in each of the successive twelve-month periods following such transfer or sale, to a revenue equal to no more than the immediately preceding twelve-month period plus twenty percent (20%). To the extent that the business exceeds this cap, and the Acquiring 3rd Party desires to obtain further rights and licenses, the Acquiring 3rd Party and HITACHI shall discuss a mutually acceptable resolution; and,

 

  (c) In no event shall the rights, licenses, and covenants under Sections 3.2, 3.3, 3.4, 3.5 and/or 3.6 supersede or relieve any obligation by any party to pay on-going royalties under any existing patent license agreement with respect to business operations of the Acquiring 3rd Party.

 

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  (d) The rights, licenses, and covenants under Sections 3.2, 3.3, 3.4, 3.5 and/or 3.6 may not be assigned or transferred by Buyer Parent to any Acquiring 3rd Party if such Acquiring 3rd Party or any of its Subsidiaries has made, in court or otherwise, a written allegation of patent infringement against HITACHI that existed prior to the completion of the assignment or transfer and has not been resolved prior to the completion of the assignment or transfer.

 

  7.3 Impact of Change of Control of Buyer Parent or HGST on Sections 3.2, 3.3, 3.4, 3.5 and 3.6 Licenses. In the event that in a single transaction or in a series of transactions Buyer Parent is acquired by a third party, through a merger, stock sale, asset purchase, or otherwise, HITACHI may, at its option, terminate the rights, licenses, and covenants under Section 3.2, 3.3, 3.4, 3.5 or 3.6 of this Agreement (but not the license under Section 3.1), if and only if the Acquiring 3rd Party or any of its Subsidiaries is a competitor in the RAID business. Buyer Parent shall timely notify HITACHI in writing of the acquisition with the information reasonably required for HITACHI to determine whether or not to terminate those rights, including the framework and schedule of the acquisition. HITACHI shall notify, in turn, Buyer Parent in writing of its election whether or not to terminate the license within ninety (90) days after receipt of the notice. In the event that HITACHI chooses to terminate the license pursuant to the terms of this provision, HITACHI and Buyer Parent shall have a good faith basis upon which to renegotiate the license. Notwithstanding the foregoing, the rights, licenses and covenants in Sections 3.1 and 3.8 shall not be terminated in any event.

 

  7.4 Acquisition of Non-HDD Business by Buyer Parent. In the event that Buyer Parent directly or indirectly acquires a Non-HDD Business pursuant to a merger, asset or stock purchase, or otherwise in a single transaction or a series of transactions during the Term, HITACHI shall have an option not to extend the rights, licenses, releases, and covenants under Section 3 to such Non-HDD Business; provided, however, if HITACHI exercises the option, the Patents owned or controlled by the acquired Non-HDD Business shall not be included in the definitions of Buyer Parent SSD Patents or Buyer Parent RAID Patents. Buyer Parent shall notify HITACHI in writing of the acquisition with information of the acquired Non-HDD Business reasonably required for HITACHI to determine the exercise of the option. HITACHI shall notify, in turn, Buyer Parent in writing of its exercise of the option or not within ninety (90) days after HITACHI received such notice without delay.

 

  7.5 Assignment of RAID Business By HITACHI. HITACHI may assign or transfer the rights, licenses and covenants under Section 2.2 in connection with any sale or other transfer of (i) all or substantially all of HITACHI’s RAID business or (ii) substantially all of HITACHI’s related RAID assets in a single transaction or a series of transactions.

 

  7.6 Assignment of SSD Business By HITACHI. HITACHI may assign or transfer the rights, licenses and covenants under Section 2.1 in connection with any sale or other transfer of (i) all or substantially all of HITACHI’s SSD business or (ii) substantially all of HITACHI’s related SSD assets in a single transaction or a series of transactions during the Term.

 

  7.7 Change of Control of HITACHI. In the event that in a single transaction or in a series of transactions HITACHI is acquired by a third party, through a merger, stock sale, asset purchase, or otherwise, this Agreement shall remain effective and shall not be terminated.

 

  7.8 Notice of Assignment/Transfer. In the event of a valid assignment or transfer (i.e., one made pursuant to the terms of Section 7.1, 7.2, 7.5 or 7.6 above) by either Party of this Agreement, the transferring or assigning Party shall, within ninety (90) calendar days, provide the other Party notice, in writing, of such assignment or transfer and shall identify the person to whom it has made such assignment or transfer.

 

11


  7.9 Effect of Assignment. Any license, covenants and/or any other rights assigned by either Party pursuant to any provision of this Section 7 shall be effective with respect to the assignee (and its business and operations) on a prospective basis only. Accordingly, no such assignment shall relieve, release or discharge any assignee from any liability for damages accruing prior to the effective date of the applicable assignment due to the infringement of any Patent licensed under this Agreement. Should either Party assign or otherwise transfer this Agreement or any of its respective Patents, such transfer shall not operate to terminate, impair or in any way modify the licenses and releases provided by the Parties herein, except as expressly provided for under the terms of this Agreement.

 

  7.10 Assignment of Patents. From and after any assignment or transfer of a Patent by either Party or its Subsidiaries, the assignee shall be bound by the terms and conditions of this Agreement with respect to such Patents.

 

  7.11 Sublicense. Neither party, nor their Subsidiaries, may sublicense any rights under this Agreement unless otherwise provided hereunder.

8. MISCELLANEOUS

 

  8.1 Entire Agreement. This Agreement contains the complete agreement between, and contains all of the promises and undertakings made to each other by, the Parties regarding the subject matter of this Agreement. Any and all prior agreements, representations, negotiations, and undertakings between the Parties, oral or written, express or implied, with respect to the subject matter hereof are hereby superseded and merged by and into this Agreement. This Agreement may not be revised or modified without the mutual written consent of the Parties.

 

  8.2 Severability. If any paragraph, provision or clause of this Agreement shall be found or held to be invalid or unenforceable by a court or other decision-making body of competent jurisdiction, in a judgment from which no further appeal can be taken, the remainder of this Agreement shall remain valid and enforceable, and to the extent required in the pursuit of this Agreement, the Parties shall negotiate in good faith a substitute, valid and enforceable provision that reflects the Parties’ intent in entering this Agreement.

 

  8.3 No Other Rights. Nothing contained in this Agreement shall be construed as conferring any rights by implication, estoppel or otherwise, under any non-patent intellectual property right, or any patent, other than the Patents licensed to Buyer Parent and HITACHI. Neither Party is required hereunder to furnish or disclose to the other any technical or other information (including copies of Patents licensed to Buyer Parent and HITACHI.)

 

  8.4 ADR Provision. The Parties agree that, in the event of a dispute arising under this Agreement, the Parties shall agree to attend a non-binding mediation prior to bringing any action in a court of law. The mediation shall be facilitated by a neutral third-party, selected by the parties. A representative from each Party with authority to settle on behalf of that party shall attend the mediation in person. The purpose of the mediation is to resolve the disputed issue(s) without the need for formal legal proceedings.

 

  —  

 

  8.6 Jurisdiction. The Parties agree that the Delaware Court of Chancery (and if jurisdiction in the Delaware Court of Chancery shall be unavailable, any Delaware State court and the Federal court of the United States of America sitting in the State of Delaware) shall have exclusive jurisdiction of interpreting or enforcing this Agreement. The parties expressly waive their right to a trial by jury.

 

12


  8.7 Counterparts. This Agreement may be executed in identical counterparts, each of which shall constitute an original and all of which shall constitute one and the same agreement.

 

  8.8 Bankruptcy Code. The Parties acknowledge and agree that the rights and licenses granted in this Agreement, including but not limited to Section 2.0, are “intellectual property” as defined in Section 101 (35) of the United States Bankruptcy Code, as the same may be amended from time to time (the “Code”), for purposes of Section 365(n) of the Code, and have been licensed in this Agreement in a contemporaneous exchange for value.

 

  8.9 Further Assurances. Each Party hereto shall execute and cause to be delivered to each other Party hereto such instruments and other documents, and shall take such other actions, as such other Party may reasonably request, to effect, evidence, record or perfect any of the licenses and other rights set forth in this Agreement. The requesting Party shall reimburse the other Party for its reasonable out-of-pocket costs in responding to a request under this Section.

 

  8.10 Disclosure. The terms of this Agreement shall remain confidential and neither Party shall disclose this Agreement or its terms to any individual or entity, except (a) with the prior written consent of the other Party, (b) to the extent disclosure by a Party is required by law or order of a court of competent jurisdiction, provided that, in such event, such Party shall provide the other Party prompt, advance notice of such requirement to allow intervention (and shall cooperate with the other Party) to contest or minimize the scope of the disclosure (including through application for a protective order) or (c) in confidence by a Party to its auditors or legal counsel in connection with the provision of audit or legal services (respectively) to such Party, to the extent required for the provision of such services.

[Remainder of this page is intentionally left blank]

 

13


IN WITNESS WHEREOF, the Parties have caused their duly authorized officers to execute this Agreement on the dates indicated below.

 

For and on behalf of

Hitachi Ltd., and HITACHI Sublicensed Subsidiaries,

By:       Date:                                  

Name: Naoya Takahashi

Title: Executive Vice President and Executive Officer

For and on behalf of

Western Digital Corporation, a Delaware corporation, and its Subsidiaries,

 

By:       Date:                                
Name:      
Title:      

 

14

EX-2.5

EXHIBIT 2.5

FOURTH AMENDMENT TO STOCK PURCHASE AGREEMENT

This Fourth Amendment to the Stock Purchase Agreement (this “Amendment”) is made this 15th day of February, 2012, by and among Western Digital Corporation, a Delaware corporation (the “Buyer Parent”), Western Digital Ireland, Ltd., a corporation organized under the laws of the Cayman Islands and an indirect wholly owned subsidiary of the Buyer Parent (the “Buyer”), Hitachi, Ltd., a company incorporated under the laws of Japan (the “Seller”), and Viviti Technologies Ltd., a company incorporated under the laws of the Republic of Singapore and a wholly owned subsidiary of the Seller (the “Company”, and collectively with the Seller, Buyer and Buyer Parent, the “Parties”, and each, a “Party”). Capitalized terms used herein and not otherwise defined shall have the meanings set forth in the Stock Purchase Agreement (as defined below).

WHEREAS, the Parties entered into a Stock Purchase Agreement on March 7, 2011, as amended by a First Amendment to Stock Purchase Agreement, dated May 27, 2011, as further amended by a Second Amendment to Stock Purchase Agreement, dated November 23, 2011, and as further amended by a Third Amendment to Stock Purchase Agreement, dated January 30, 2012 (together, the “Stock Purchase Agreement”); and

WHEREAS, the Parties desire to amend the Stock Purchase Agreement as reflected herein.

NOW, therefore, in exchange for good and valuable consideration, the receipt of which is hereby acknowledged, the Parties hereby agree as follows:

1. Schedule 7.8 of the Stock Purchase Agreement. Schedule 7.8 of the Stock Purchase Agreement, Retained Land, is hereby deleted in its entirety and replaced by the Schedule 7.8 attached hereto as Exhibit A.

2. Effect on the Stock Purchase Agreement. This Amendment shall not constitute a waiver, amendment or modification of any provision of the Stock Purchase Agreement not expressly referred to herein. Except as expressly amended or modified herein, the provisions of the Stock Purchase Agreement are and shall remain in full force and effect and are hereby ratified and confirmed. On and after the date hereof, each reference in the Stock Purchase Agreement to “this Agreement”, “herein”, “hereof”, “hereunder” or words of similar import shall mean and be a reference to the Stock Purchase Agreement as amended hereby, although it shall not alter the dates as of which any provision of the Stock Purchase Agreement speaks. For example, phrases such as “as of the date hereof” and “as of the date of this Agreement” shall continue to refer to March 7, 2011, the date that the Stock Purchase Agreement was originally executed. To the extent that a provision of this Amendment conflicts with or differs from a provision of the Stock Purchase Agreement, such provision of this Amendment shall prevail and govern for all purposes and in all respects.

3. Miscellaneous. Sections 12.4, 12.5, 12.7 and 12.13 of the Stock Purchase Agreement are incorporated herein by reference.


IN WITNESS WHEREOF, the Parties hereto have executed this Fourth Amendment to Stock Purchase Agreement as of the date first written above.

 

“BUYER PARENT”
WESTERN DIGITAL CORPORATION
By:  

/s/ Michael C. Ray

  Name:   Michael C. Ray
  Title:   SVP, GC & Secretary
“BUYER”
WESTERN DIGITAL IRELAND, LTD.
By:  

/s/ Michael C. Ray

  Name:   Michael C. Ray
  Title:   VP
“SELLER”
HITACHI, LTD.
By:  

/s/ Toyoki Furuta

  Name:   Toyoki Furuta
  Title:   General Manager,
    Business Development Office
“COMPANY”
VIVITI TECHNOLOGIES LTD.
By:  

/s/ Christopher Dewees

  Name:   Christopher Dewees
  Title:   SVP & General Counsel

Signature Page to Fourth Amendment to Stock Purchase Agreement

EX-2.6

EXHIBIT 2.6

FIFTH AMENDMENT TO STOCK PURCHASE AGREEMENT

This Fifth Amendment to the Stock Purchase Agreement (this “Amendment”) is made this 6th day of March, 2012, by and among Western Digital Corporation, a Delaware corporation (the “Buyer Parent”), Western Digital Ireland, Ltd., a corporation organized under the laws of the Cayman Islands and an indirect wholly owned subsidiary of the Buyer Parent (the “Buyer”), Hitachi, Ltd., a company incorporated under the laws of Japan (the “Seller”), and Viviti Technologies Ltd., a company incorporated under the laws of the Republic of Singapore and a wholly owned subsidiary of the Seller (the “Company”, and collectively with the Seller, the Buyer and the Buyer Parent, the “Parties”, and each, a “Party”). Capitalized terms used herein and not otherwise defined shall have the meanings set forth in the Stock Purchase Agreement (as defined below).

WHEREAS, the Parties entered into a Stock Purchase Agreement on March 7, 2011, as amended by a First Amendment to Stock Purchase Agreement, dated May 27, 2011, as further amended by a Second Amendment to Stock Purchase Agreement, dated November 23, 2011, as further amended by a Third Amendment to Stock Purchase Agreement, dated January 30, 2012, and as further amended by a Fourth Amendment to Stock Purchase Agreement, dated February 15, 2012 (together, the “Stock Purchase Agreement”);

WHEREAS, concurrent with the execution of this Amendment, the Buyer Parent, the Seller and the Company have executed and delivered Amendment No. 2 to the Transition Services Agreement; and WHEREAS, the Parties desire to amend the Stock Purchase Agreement and certain other Transaction Documents as reflected herein.

NOW, therefore, in exchange for good and valuable consideration, the receipt of which is hereby acknowledged, the Parties hereby agree as follows:

1. Section 1.1 of the Stock Purchase Agreement. The definition of “Outstanding Company Debt” set forth in Section 1.1 of the Stock Purchase Agreement is hereby amended and restated in its entirety to read as follows:

Outstanding Company Debt” means all short and long-term debt, accounts receivable related borrowings and lines of credit of the Company or any of its Subsidiaries outstanding as of the Closing Date, other than intercompany indebtedness between the Company and any of its Subsidiaries or between any of its Subsidiaries, and other than any debt outstanding under (i) that certain Credit Line Agreement between Hitachi Global Storage Technologies (Shenzhen) Co., Ltd. and Agricultural Bank of China, dated December 22, 2011, and/or (ii) that certain Credit Line Agreement between Hitachi Global Storage Products (Shenzhen) Co., Ltd. and Agricultural Bank of China, dated December 22, 2011.”

 


2. Section 2.3(a) of the Stock Purchase Agreement. Section 2.3(a) of the Stock Purchase Agreement is hereby amended and restated in its entirety to read as follows:

“At the Closing, the Buyer shall make the following payments by wire transfer of immediately available funds for the benefit of the Persons and to the accounts and in the amounts specified on a spreadsheet containing the items listed below in this Section 2.3(a)(the “Consideration Spreadsheet”), to be prepared by the Company not less than three (3) Business Days prior to the Closing:

(i) Unpaid Transaction Expenses. The Buyer shall pay, from the Cash Portion of the Purchase Price, the Transaction Expenses not paid by the Company or any of the Subsidiaries prior to the Closing;

(ii) Unpaid Change of Control Payments. The Buyer shall pay, from the Cash Portion of the Purchase Price, an aggregate amount equal to the Change of Control Payments not paid by the Company or any of the Subsidiaries prior to the Closing to Hitachi Global Storage Technologies Netherlands B.V. (“HGST BV”) for further distribution to the applicable Subsidiaries, who will then make subsequent distributions to the applicable employees in accordance with such Subsidiary’s normal payroll processes;

(iii) Unpaid Employee Payments. The Buyer shall pay, from the Cash Portion of the Purchase Price, an aggregate amount equal to the Employee Payments not paid by the Company or any of the Subsidiaries prior to the Closing to (A) HGST BV for further distribution to the applicable Subsidiaries, who will then make subsequent distributions to the applicable employees in accordance with such Subsidiary’s normal payroll processes and/or (B) the Company in accordance with the Company’s normal payroll processes;

(iv) Unpaid Outstanding Company Debt. The Buyer shall pay, from the Cash Portion of the Purchase Price, all Outstanding Company Debt, to the extent not paid by the Company or any of the Subsidiaries prior to the Closing;

(v) Equity Award Payments. The Buyer shall pay, from the Cash Portion of the Purchase Price, an aggregate amount equal to the Equity Award Payments not paid by the Company or any of the Subsidiaries prior to the Closing to (A) HGST BV for further distribution to the applicable Subsidiaries, who will then subsequently make such Equity Award Payments, less applicable withholding Taxes, to the respective Vested Equity Holders in accordance with such Subsidiary’s normal payroll process and/or (B) the Company, who will then subsequently make such Equity Award Payments, less applicable withholding Taxes, to the respective Vested Equity Holders in accordance with the Company’s normal payroll process;

 

2


(vi) Seller. The Buyer shall pay to the Seller from the Cash Portion of the Purchase Price, an amount equal to the sum of (A) the product of (x) the total number of issued and paid-up shares of the Stock owned by the Seller at the Closing and (y) the Per Share Closing Payment less (B) the Stock Portion of the Purchase Price; provided, however, that neither the Company nor any of the Subsidiaries will distribute any unpaid Change of Control Payments, unpaid Employee Payments or Equity Award Payments to the individuals listed on Schedule 1.1(a) prior to the eighth (8th) day following such individual’s execution of a waiver and release of claims against the Company, substantially in the form prescribed by the Company attached hereto as Exhibit H (together with the related clarification included in Exhibit H).”

 

3. Amendments to the Stock Purchase Agreement Related to Secondment.

 

  (a) Section 6.12(e)(i) of the Stock Purchase Agreement.

(1) The number of R&D Secondees defined as “up to 113 employees of the Seller” in Section 6.12(e)(i) of the Stock Purchase Agreement is hereby amended to state “up to 102 employees of the Seller”.

(2) Schedule 6.12(e)(i) of the Stock Purchase Agreement (Seller Seconded R&D Employees) is hereby deleted in its entirety and replaced by the Schedule 6.12(e)(i) attached hereto as Exhibit A.

 

  (b) Section 6.12(e)(ii) of the Stock Purchase Agreement.

(1) The Non-R&D/R&D Related Secondees defined as “up to 26 employees of the Seller” in Section 6.12(e)(ii) of the Stock Purchase Agreement is hereby amended to state “up to 31 employees of the Seller and its Related Subsidiaries”.

(2) Schedule 6.12(e)(ii) of the Stock Purchase Agreement (Seller Seconded Non-R&D Employees) is hereby deleted in its entirety and replaced by the Schedule 6.12(e)(ii) attached hereto as Exhibit B.

(3) The reference to “either the Seller or HGST Japan” in the proviso of Section 6.12(e)(ii) of the Stock Purchase Agreement is hereby amended to state “either the Seller or its Related Subsidiary, as applicable, or HGST Japan”.

(c) Section 6.12(e)(iii) of the Stock Purchase Agreement. Each of the two references to “the Seller” in the second sentence of Section 6.12(e)(iii) is hereby amended to state “the Seller or its Related Subsidiary, as applicable,”.

 

  (d) Section 6.12(f) of the Stock Purchase Agreement.

 

3


(1) The HGST Japan Secondees defined as “up to 82 employees of HGST Japan to Seller” in Section 6.12(f) of the Stock Purchase Agreement is hereby amended to state “up to 60 employees of HGST Japan to Seller and its Related Subsidiaries, as applicable”.

(2) Schedule 6.12(f) of the Stock Purchase Agreement (HGST Japan Secondees) is hereby deleted in its entirety and replaced by the Schedule 6.12(f) attached hereto as Exhibit C.

(3) Each of the two references to “the Seller” in the third sentence of Section 6.12(f) is hereby amended to state “the Seller or its Related Subsidiary, as applicable,”.

4. Amendment to Secondment Periods in the Stock Purchase Agreement. Each of the R&D Secondment Period, the Non-R&D/R&D Related Secondment Period and the HGST Japan Secondment Period as defined in Sections 6.12(e)(i), 6.12(e)(ii) and 6.12(f), respectively, of the Stock Purchase Agreement is hereby amended such that the initial period of secondment shall commence on the Closing Date (unless otherwise indicated on Schedule 6.12(e)(i), Schedule 6.12(e)(ii) or Schedule 6.12(f)) and terminate as of the close of business on March 31, 2014.

5. Section 6.12(h)(ii) of the Stock Purchase Agreement. Section 6.12(h)(ii) of the Stock Purchase Agreement is hereby amended to delete the last sentence of such section, which reads: “The Buyer shall use commercially reasonable efforts to provide for remittance of continued payroll deductions to service any participant loan balance maintained by a Continuing Employee under the Seller 401(k) Plan through the end of the calendar quarter following the calendar quarter in which the Closing occurs (or through the date of distribution of such Continuing Employee’s account under the Seller 401(k) Plan, if earlier).”

 

6. Schedule 1.1(a) to the Stock Purchase Agreement.

(a) Item 3 of Schedule 1.1(a) is hereby amended and restated in its entirety to read as follows:

“3. Severance and Change in Control Agreement, dated September 27, 2010, by and between the Company and Steven G. Campbell, as contemplated to be amended pursuant to Schedule 6.1.***”

(b) Item 4 of Schedule 1.1(a) is hereby amended and restated in its entirety to read as follows:

“4. Severance and Change in Control Agreement, dated September 27, 2010, by and between the Company and Michael D. Cordano, as contemplated to be amended pursuant to Schedule 6.1.***”

 

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7. Exhibit A to the Stock Purchase Agreement. Exhibit B (Key HGST Employees) to Exhibit A to the Stock Purchase Agreement, Form of Agreement Not to Compete, is hereby amended and restated in its entirety to read as set forth on Exhibit D hereto.

8. Exhibit B to the Stock Purchase Agreement. Section 1.1 of Exhibit B to the Stock Purchase Agreement, Form of License Agreement, is hereby amended and restated in its entirety to read as follows:

External Drive” means an enclosure that encases one or more HDDs or SSDs and related peripheral hardware, or Software or Firmware components (other than RAID). For the avoidance of doubt, “External Drive” includes Information Versatile Disk for Removable Usage (iVDR) enclosures that encase one or more HDDs or SSDs and related peripheral hardware, or Software or Firmware components (other than RAID).”

 

9. Exhibit C to the Stock Purchase Agreement.

(a) Section 2.01 of Exhibit C to the Stock Purchase Agreement, Form of Investor Rights Agreement, is hereby amended and restated in its entirety to read as follows:

Investor Designee Appointment and Nomination Right. The Investor shall have the right, but not the obligation, to designate two nominees to serve as directors of the Company (each, an “Investor Designee” and, together, the “Investor Designees”). In the event the Investor determines to designate the initial Investor Designees, the Investor shall notify the Company in writing of the names of the initial Investor Designees. Promptly following receipt by the Company of all documentation reasonably requested by the Company in connection with the appointment of the initial Investor Designees, the Company shall increase the size of the Board by two, and fill the resulting vacancies with the initial Investor Designees in accordance with the Company’s Bylaws. Thereafter, the Company shall (a) include the Investor Designees in its slate of nominees for election to the Board of Directors at each annual or special meeting of stockholders of the Company following the Closing at which directors are to be elected and at which the seats held by the Investor Designees are subject to election (such annual or special meetings, the “Election Meetings”) and (b) recommend that the Company’s stockholders vote in favor of the election of the Investor Designees, support the Investor Designees for election in a manner no less favorable than the manner in which the Company supports its other nominees, and otherwise use commercially reasonable efforts to cause the election of the Investor Designees to the Board of Directors at each of the Election Meetings. The foregoing appointment and nomination rights will be subject to the Investor Designees satisfying the Company’s Board Qualifications (as defined in Section 2.03); provided that, if an Investor Designee does not meet the Board Qualifications, (i) the Company will not nominate a replacement candidate in place of the rejected Investor Designee (unless the Investor does not nominate a replacement candidate pursuant to its rights in the following clause (ii) within the time period stated in such clause), and (ii) the Investor shall have the right (if exercised as promptly as reasonably practicable and in any event within 30 days) to nominate a replacement candidate in place of the rejected Investor Designee until such time as an Investor Designee that meets the Board Qualifications is put forward by the Investor.”

 

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(b) The list attached as Exhibit E hereto is the “Competitor List Letter” as such term is defined in the Form of Investor Rights Agreement attached as Exhibit C to the Stock Purchase Agreement.

10. Exhibit E to the Stock Purchase Agreement. Exhibit E to the Stock Purchase Agreement, Form of R&D Services Agreement, is hereby amended and restated in its entirety to read as set forth on Exhibit F hereto.

11. Exhibit F to the Stock Purchase Agreement. Exhibit F to the Stock Purchase Agreement, Form of Branding Agreement, is hereby amended and restated in its entirety to read as set forth on Exhibit G hereto.

12. Exhibit G to the Stock Purchase Agreement. Exhibit G to the Stock Purchase Agreement, Form of Secondment Agreement, is hereby amended and restated in its entirety to read as set forth on Exhibit H hereto.

13. Exhibit H to the Stock Purchase Agreement. The Stock Purchase Agreement is hereby amended by adding Exhibit H as set forth on Exhibit I hereto.

 

14. Exhibit I to the Stock Purchase Agreement.

(a) The Stock Purchase Agreement is hereby amended by adding Exhibit I, Form of Reverse Services Agreement, as set forth on Exhibit J hereto.

(b) Section 8.8 of the Stock Purchase Agreement. A new Section 8.8 is hereby added to the Stock Purchase Agreement as follows:

Section 8.8 Reverse Services Agreement. The Seller shall have received the reverse services agreement, in the form attached as Exhibit I, executed by the Company.”

 

6


15. Effect on the Stock Purchase Agreement. This Amendment shall not constitute a waiver, amendment or modification of any provision of the Stock Purchase Agreement not expressly referred to herein. Except as expressly amended or modified herein, the provisions of the Stock Purchase Agreement are and shall remain in full force and effect and are hereby ratified and confirmed. On and after the date hereof, each reference in the Stock Purchase Agreement to “this Agreement”, “herein”, “hereof”, “hereunder” or words of similar import shall mean and be a reference to the Stock Purchase Agreement as amended hereby, although it shall not alter the dates as of which any provision of the Stock Purchase Agreement speaks. For example, phrases such as “as of the date hereof” and “as of the date of this Agreement” shall continue to refer to March 7, 2011, the date that the Stock Purchase Agreement was originally executed. To the extent that a provision of this Amendment conflicts with or differs from a provision of the Stock Purchase Agreement, such provision of this Amendment shall prevail and govern for all purposes and in all respects.

16. Miscellaneous. Sections 12.4, 12.5, 12.7 and 12.13 of the Stock Purchase Agreement are incorporated herein by reference.

[Signature page follows]

 

7


IN WITNESS WHEREOF, the Parties hereto have executed this Fifth Amendment to Stock Purchase Agreement as of the date first written above.

 

“BUYER PARENT”
WESTERN DIGITAL CORPORATION
By:  

/s/ Michael Ray

  Michael Ray
 

Senior Vice President, General Counsel

and Secretary

“BUYER”
WESTERN DIGITAL IRELAND, LTD.
By:  

/s/ Michael Ray

  Michael Ray
  Vice President
“SELLER”
HITACHI, LTD.
By:  

/s/ Toyoki Furuta

  Name: Toyoki Furuta
  Title:   General Manager
              Business Development Office
“COMPANY”
VIVITI TECHNOLOGIES LTD.
By:  

/s/ Christopher S. Dewees

  Name: Christopher S. Dewees
  Title:   SVP

Signature Page to Fifth Amendment to Stock Purchase Agreement


EXHIBIT F

EXHIBIT E TO THE STOCK PURCHASE AGREEMENT

Form of R&D Services Agreement

[see attached]

Form of R&D Services Agreement


Exhibit E

FORM OF

R&D SERVICES AGREEMENT

This R&D Services Agreement (“Agreement”) effective as of the Closing Date (as defined below), is entered into by and between Western Digital Corporation, a Delaware company with its principal place of business at 3355 Michelson Drive, Suite 100 Irvine, California 92612 (“Company”) and Hitachi, Ltd. (“Hitachi”), a Japanese company with its principal place of business at 6-6, Marunouchi 1- chome, Chiyoda-ku, Tokyo 100-8280, Japan. Each of the signatories to this Agreement is referred to as a “Party,” and jointly as the “Parties.”

RECITALS

WHEREAS, Company, Western Digital Ireland, Ltd., a corporation organized under the laws of the Cayman Islands and an indirect wholly-owned subsidiary of the Company (“Buyer “), Hitachi and Viviti Technology Ltd., a company incorporated under the laws of the Republic of Singapore (“Viviti”) have entered into that certain Stock Purchase Agreement dated as of March 7, 2011 (the “Purchase Agreement”);

WHEREAS, prior to the Closing Date, Hitachi has performed, from time to time, certain research and development services for the Viviti; and WHEREAS, Company and Hitachi desire that following the Closing Date Hitachi will continue to provide certain research and development services to Company and its Subsidiaries relating to HDD (as defined below), of a nature similar to those provided to Viviti prior to the Closing Date, pursuant to the terms and conditions set forth herein;

NOW, THEREFORE, in consideration of the mutual promises and covenants set out herein, the Parties agree as follows:

TERMS OF AGREEMENT

 

1. DEFINITIONS

 

  1.1 Background Intellectual Property Rights” means Intellectual Property Rights, if any, owned by Hitachi that are (a) embodied in Background Technology, and (b) not Developed Intellectual Property Rights; provided, however, that a Patent will be a Background Intellectual Property Right only if Hitachi has the right to grant to Company a license of the scope set forth in Section 4.2 under such Patent without incurring any obligation to pay any royalty or other consideration to any third party.

 

  1.2 Background Technology” means Technology, if any, owned by Hitachi or its Subsidiaries that is (a) embodied in any Deliverable, and (b) not Developed Technology.

 

  1.3 Closing Date” has the meaning set forth in the Purchase Agreement.

 

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  1.4 Deliverables” means the deliverables, if any, to be provided by Hitachi as part of the Services performed hereunder, as specifically described in an applicable Project Agreement.

 

  1.5 Developed Intellectual Property Rights” means Intellectual Property Rights to the extent such Intellectual Property Rights (i) are first created by Hitachi in the course of its performance of the Services pursuant to the applicable Project Agreement and within the scope and during the term of such applicable Project Agreement, and (ii) are embodied in Developed Technology. For the avoidance of doubt, “Developed Intellectual Property Rights” includes the right to seek Patent protection for inventions that constitute Developed Intellectual Property, if any, but does not include any Patents or Patent applications of Hitachi or its Subsidiaries.

 

  1.6 Developed IP” means, collectively, Developed Technology and Developed Intellectual Property Rights.

 

  1.7 Developed Technology” means Technology embodied in any Deliverable to the extent such Technology is first developed or created by Hitachi in the course of its performance of the Services pursuant to the applicable Project Agreement and within the scope and during the term of such applicable Project Agreement.

 

  1.8 Fully Burdened Cost” means all of Hitachi’s costs and expenses incurred in connection with the performance of the Services, including labor and material costs, expenses, and general and administrative expenses and overhead, all as determined in accordance with generally accepted accounting principles as consistently applied by Hitachi.

 

  1.9 HDD” has the meaning set forth in the License Agreement.

 

  1.10 Intellectual Property Rights” means Patents, copyrights, and rights with respect to trade secrets, whether arising under the laws of the United States, Japan or any other jurisdiction, including, in each case, any rights apply for, register, and enforce any of the foregoing. Notwithstanding the foregoing, “Intellectual Property Rights” does not include any trademark rights or similar rights with respect to indicia of source or origin.

 

  1.11 License Agreement” means that certain License Agreement entered into by and between Company and Hitachi as of the Closing Date.

 

  1.12 Patents” means all classes and types of patents, including utility patents, utility models, design patents, invention certificates, including divisionals, continuations, continuations-in-part, reexaminations, reissues, extensions and renewals, in all jurisdictions of the world.

 

  1.13 Project Coordinator(s)” means the Hitachi representative(s) and Company representative(s) identified as project coordinator(s) in the applicable Project Agreement.

 

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  1.14 Services” means the research and development services to be performed by Hitachi hereunder, as specifically described in an applicable Project Agreement.

 

  1.15 Software or Firmware” means a set of instructions, that either (i) directly provides instructions to the computer hardware, or, (ii) indirectly serves as an input to another piece of software.

 

  1.16 Subsidiary” of either Party shall mean a corporation, partnership, joint venture, limited liability company or other business entity of which a majority of the shares of securities or other interests having ordinary voting power for the election of directors or other governing body are at the time beneficially owned, directly, or indirectly, by such Party. For the purposes of this Agreement, Viviti and its Subsidiaries will be Subsidiaries of Company (subject to meeting the requirements of the preceding sentence) and are not Subsidiaries of Hitachi.

 

  1.17 Technology” means inventions, know-how, designs, specifications, Software or Firmware and other copyrightable material, technical information, devices, and other developments and technology.

 

  1.18 Term” means the period beginning on the Closing Date and ending eighteen (18) months from the Closing Date.

 

2. SCOPE OF SERVICES

 

  2.1 Project Agreements. Any services and deliverables to be performed or provided by Hitachi hereunder with respect to any Project (as defined below) shall be mutually agreed and described in a written Project Agreement entered into by the Parties hereunder and specifically referencing this Agreement (“Project Agreements”). As soon as practicable following the Closing Date, the Parties shall use commercially reasonable efforts to enter into a Project Agreement for each research and development project listed in Schedule 1 (“Project”), which such Project Agreements shall describe the applicable Project in reasonable detail, contain terms and conditions applicable to such Project that are materially consistent with the terms and conditions for each such Project as set forth in Schedule 2 hereto, and set forth in sufficient detail (i) the type, scope, and nature of the Services and Deliverables to be performed or provided by Hitachi with respect to such Project, (ii) specific staffing requirements and schedule, if applicable, for such Project, (iii) the Project Coordinators for such Project, and (iv) such other matters as the Parties may mutually agree. In addition, Hitachi will use commercially reasonable efforts to identify in the applicable Project Agreement any Patents owned by Hitachi and claiming Background Technology Hitachi expects to be embodied in Deliverables to be delivered to Company in the course of a Project under which Hitachi does not have the right to grant to company a license of the scope set forth in Section 4.2 without incurring an obligation to pay a royalty or other consideration to a third party. All Project Agreements shall be an integral part of this Agreement and be subject to the terms and conditions set forth herein.

 

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  2.2 Projects. The Projects currently contemplated by the Parties are described in Schedule 1 hereto. The Parties may mutually agree to add additional Projects directly related to the business of Company during the Term. Unless otherwise expressly agreed in writing by the Parties, all Projects will be directed to HDDs. If the Parties agree in writing to undertake a Project directed in whole or in part to any product or technology other than HDDs, the Parties will discuss and agree in the Project Agreement for such Project any additional or revised terms that will apply to such Project, including without limitation with respect to ownership and licenses of associated Developed IP and/or Background IP.

 

  2.3 Services. Hitachi shall use commercially reasonable efforts to perform or cause to be performed for Company the Services, and to deliver to Company the Deliverables, as set forth in the applicable Project Agreements. Hitachi shall perform such Services in a manner that is consistent with its past practice in regards to its performance of similar services for Viviti prior to the Closing Date (“Past Practice”).

 

  2.4 Personnel and Project Coordinators. Hitachi will assign employees and subcontractors with suitable qualifications to perform the Services consistent with Past Practice. Hitachi may replace or change employees and subcontractors as required. The Parties’ Project Coordinators will be responsible for exchanging information, coordinating meetings, and arranging all other matters pertinent to the applicable Project. Each Party may change its Project Coordinator by giving written notice to the other Party. The Project Coordinators are not authorized to modify or change any term or condition of this Agreement, including any Project Agreement.

 

  2.5 Company’s Cooperation. Company acknowledges that its timely provision of reasonable assistance, cooperation, and complete and accurate information and data (“Cooperation”) is essential to the performance of the Services, and that Hitachi shall not be responsible for any deficiency in performing the Services if such deficiency results from Company’s failure to provide such Cooperation as required hereunder.

 

  2.6 Quarterly Project Review. Company shall have the right to review and assess the continuing need for all Projects on a quarterly basis and may terminate one or more active Projects, and the Project Agreements associated therewith, effective upon the beginning of any calendar quarter (i.e., January 1, April 1, July 1, or October 1), provided that Company has provided Hitachi at least forty-five (45) days’ advance notice of such termination.

 

3. PAYMENTS

 

  3.1 Fees. Unless otherwise specified in the applicable Project Agreement, all Services shall be provided on a time-and-materials basis at Hitachi’s Fully Burdened Cost (such Fully Burdened Costs and any other fees and payments specified in an applicable Project Agreement, the “Fees”).

 

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  3.2 Expenses. Company shall reimburse Hitachi for all reasonable travel, lodging, communications, shipping, and other out-of-pocket expenses incurred by Hitachi in connection with providing the Services and Deliverables (“Expenses”).
 
  3.3 Payment Terms. Hitachi will invoice Company on a monthly basis for all Fees and Expenses and other payments due under this Agreement and any Project Agreement and, unless otherwise specified in the applicable Project Agreement, Company shall pay such invoiced amounts within thirty (30) days of the date of the invoice. Customer agrees to pay interest at the rate of one and one-half percent (1.5%) per month (or the maximum rate permitted by applicable law, whichever is less) for all amounts not paid within thirty (30) days from the date of the invoice therefor. All payments shall be made in Japanese Yen by wire transfer in immediately available funds to an account designated by Hitachi.
 
  3.4 Taxes. In addition to all Fees, Expenses and other amounts payable under this Agreement and the Project Agreements, Company shall pay or reimburse Hitachi for all federal, state, local or other taxes, including, without limitation, sales, use, excise, withholding, and property taxes, or amounts levied in lieu thereof, based on the Services provided or amounts payable under this Agreement or any Project Agreement. Company shall have no responsibility for taxes imposed on Hitachi’s net income.

 

4. INTELLECTUAL PROPERTY

 

  4.1 Developed IP. Subject to Company’s compliance with the terms and conditions of this Agreement, including payment of all Fees, Expenses, and other amounts payable hereunder, Hitachi hereby assigns and agrees to assign all of its right, title and interest in and to the Developed IP to Company. Company shall have the sole right to apply for, file, register, or otherwise seek Intellectual Property Rights with respect to Developed IP, including the right to seek Patent protection for inventions that constitute Developed IP, if any. Hitachi will provide (and will use commercially reasonable efforts to cause any inventors of Developed IP in Hitachi’s or its Subsidiaries’ employ to provide) reasonable information and assistance, at Company’s cost and expense, to effect the assignment of rights pursuant to this Section 4.1. With respect to any Developed Technology, Hitachi reserves and Company hereby grants and agrees to grant to Hitachi and its Subsidiaries, under the Developed Intellectual Property Rights, a worldwide, non-exclusive, perpetual and irrevocable license to use such Developed Technology in the ordinary course of its business. With respect to any Patents within the Developed Intellectual Property Rights, Hitachi reserves and Company hereby grants and agrees to grant to Hitachi and its Subsidiaries a worldwide, non-exclusive, perpetual and irrevocable license to make, have made, use, sell, offer for sale, and import any article of manufacture or composition of matter and practice any method or process.

 

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  4.2 Background IP. To the extent, if any, that any Background Technology is embodied in any Deliverables provided to Company under this Agreement, subject to Company’s compliance with the terms and conditions of this Agreement, including payment of all Fees, Expenses, and other amounts payable hereunder, Hitachi hereby grants and agrees to grant to Company and its Subsidiaries, under Hitachi’s Background Intellectual Property Rights, a worldwide, non-exclusive, perpetual, and irrevocable license to use such Background Technology, solely as embodied in such Deliverables, in the ordinary course of its business.

 

  4.3 No Other Rights. Except as expressly set forth in this Agreement, neither Party grants any rights in or to its Technology or Intellectual Property Rights pursuant to this Agreement. As between the Parties, each Party shall be solely responsible to prepare, file, prosecute, maintain, and enforce its Intellectual Property Rights in its discretion and at its own cost. Except as expressly set forth in this Agreement, there shall be no right, license, authority, covenant not to sue, immunity from suit, or other defense, whether by implication, by reason of exhaustion, estoppel, or otherwise pursuant to or as a result of this Agreement or the activities of the Parties under this Agreement.

 

5. CONFIDENTIALITY

 

  5.1 Confidential Information” of a Party shall mean Technology of such Party that is (a) identified as Confidential Information in an applicable Project Agreement, and (b) marked as “proprietary” or “confidential” at the time of disclosure, or, if disclosed in a form not susceptible to marking, described and designated as “proprietary” or “confidential” in a writing provided to the Recipient within thirty (30) days of such disclosure.

 

  5.2 Non-Disclosure. For the term of each Project Agreement, and for a period of five (5) years from the end of such Project Agreement, the receiving Party agrees to limit disclosure of the disclosing Party’s Confidential Information disclosed in connection with such Project Agreement to those of the receiving Party’s employees who have a need to know it, and the receiving Party agrees to use the same care and discretion to avoid disclosure, publication or dissemination outside of those employees as the receiving Party does with similar information of its own which it does not desire to publish, disclose or disseminate. In addition, the receiving Party shall not use, and shall not permit its employees to use, any Confidential Information of the disclosing Party except in connection with the performance of its obligations pursuant to this Agreement and the applicable Project Agreement, except as otherwise permitted hereunder (including pursuant to any license grant set forth herein) or in such Project Agreement. Notwithstanding the foregoing, the receiving Party’s use of Residuals of the disclosing Party’s confidential information for any purpose shall not constitute a breach of this Section 5.2. As used herein, “Residuals” shall mean that portion of any trade secret or other Technology subject to any obligation of confidentiality between the Parties, which is in intangible form and which is retained in the unaided memory of any of a Party’s employees who have had authorized access to such trade secrets or other Technology pursuant to this Agreement.

 

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  5.3 Exceptions. The receiving Party may disclose Confidential Information if the disclosure is required by law, but the receiving Party must give the disclosing Party reasonable prior notice to allow the disclosing Party an opportunity to obtain a protective order. The obligations of Section 5.2 above will not apply to information to the extent it is: (a) already rightfully in the possession of the receiving Party or its Subsidiaries without an obligation of confidence; (b) independently developed by the receiving Party or its Subsidiaries; (c) publicly available when received by the receiving Party, or becomes publicly available through no fault of the receiving Party or its Subsidiaries; or (d) disclosed by the disclosing Party without obligation of confidence.

 

6. TERM AND TERMINATION

 

  6.1 Term. This Agreement, including any Project Agreement, shall be effective during the Term, unless terminated earlier in accordance with the provisions hereof and except to the extent any Project Agreement expressly sets forth a different term.

 

  6.2 Termination for Breach.

 

  (a) If any material breach of this Agreement occurs, and such breach is not cured within thirty (30) days after written notice from the non-breaching Party, the non-breaching Party shall have the right to terminate this Agreement by giving the breaching Party five (5) days’ written notice.

 

  (b) If any material breach of any Project Agreement occurs, and such breach is not cured within thirty (30) days after written notice from the non-breaching Party, the non-breaching Party shall have the right to terminate that Project Agreement by giving five (5) days’ written notice.

 

  6.3 Termination for Bankruptcy. A Party may terminate this Agreement by giving written notice of termination to the other Party at any time upon or after:

 

  (a) the filing by the other Party of an petition in bankruptcy or insolvency which petition or proceeding is not dismissed within sixty (60) days;

 

  (b) any adjudication that the other Party is bankrupt or insolvent;

 

  (c) the filing by the other Party of any petition or answer seeking reorganization, readjustment or arrangement of its business under any law relating to bankruptcy or insolvency which petition or proceeding is not dismissed within sixty (60) days;

 

  (d) the appointment of a receiver for all or substantially all of the property of the other Party;

 

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  (e) the institution of any proceeding for the liquidation winding up of the other Party’s business which petition or proceeding is not dismissed within sixty (60) days.

 

  6.4 Effect of Termination of Agreement. Upon any termination of this Agreement all Project Agreements shall simultaneously terminate. No termination in this Agreement shall relieve either Party of any obligation or liability accrued hereunder prior to such termination. Upon the expiration or earlier termination of this Agreement, the Parties will immediately cease performing work under all Project Agreements. Upon the expiration or earlier termination of any Project Agreement, the Parties will immediately cease performing work under the expired or terminated Project Agreement.

 

  6.5 Survival. Notwithstanding anything to the contrary in this Agreement, Sections 1, 3, 4, 5 (as provided therein), 6.4, 6.5, 7.2, 7.3, and 10 shall, to the extent applicable, survive any expiration or termination of this Agreement.

 

7. REPRESENTATIONS AND WARRANTIES; LIABILITY LIMITATION