<PAGE> 1
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 September 29, 2000.
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
WESTERN DIGITAL CORPORATION
------------------------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 95-2647125
------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8105 Irvine Center Drive
Irvine, California 92618
------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE: (949) 932-5000
REGISTRANT'S WEB SITE: HTTP://WWW.WESTERNDIGITAL.COM
N/A
--------------------------------------------------------------------------------
Former name, former address and former fiscal year if changed since last report.
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
--- ---
Number of shares outstanding of Common Stock, as of October 27, 2000,
is 171,341,988.
<PAGE> 2
WESTERN DIGITAL CORPORATION
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Operations - Three-Month Periods
Ended October 2, 1999 and September 29, 2000..................................... 3
Condensed Consolidated Balance Sheets - June 30, 2000 and
September 29, 2000............................................................... 4
Condensed Consolidated Statements of Cash Flows - Three-Month Periods
Ended October 2, 1999 and September 29, 2000..................................... 5
Notes to Condensed Consolidated Financial Statements............................. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................................. 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................... 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................ 23
Item 2. Changes in Securities and Use of Proceeds........................................ 24
Item 6. Exhibits and Reports on Form 8-K................................................. 24
Signatures................................................................................... 25
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
WESTERN DIGITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE-MONTH PERIOD ENDED
---------------------------
OCT. 2, SEP. 29,
1999 2000
--------- ---------
<S> <C> <C>
Revenues, net .................................... $ 406,957 $ 440,222
Costs and expenses:
Cost of revenues ........................... 472,300 414,493
Research and development ................... 50,143 34,961
Selling, general and administrative ........ 43,822 33,899
Restructuring charges ...................... 32,300 --
--------- ---------
Total costs and expenses .............. 598,565 483,353
--------- ---------
Operating loss ................................... (191,608) (43,131)
Net interest and other expense ................... (5,329) (1,632)
--------- ---------
Loss before extraordinary item ................... (196,937) (44,763)
Extraordinary gain from redemption of debentures . 90,622 11,243
--------- ---------
Net loss ......................................... $(106,315) $ (33,520)
========= =========
Loss per common share:
Before extraordinary item .................. $ (2.05) $ (.30)
Extraordinary item ......................... .94 .07
--------- ---------
Basic and diluted .......................... $ (1.11) $ (.23)
========= =========
Common shares used in computing per share amounts:
Basic and diluted ..................... 95,918 148,044
========= =========
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
<PAGE> 4
WESTERN DIGITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
JUN. 30, SEP. 29,
2000 2000
--------- ---------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ............................ $ 184,021 $ 166,949
Accounts receivable, less allowance for doubtful
accounts of $13,316 at June 30, 2000 and
$13,368 at September 29, 2000 ................... 149,135 146,318
Inventories .......................................... 84,546 60,027
Prepaid expenses and other current assets ............ 33,693 25,567
--------- ---------
Total current assets ............................ 451,395 398,861
Property and equipment at cost, net ........................ 98,952 100,102
Other assets, net .......................................... 65,227 63,764
--------- ---------
Total assets .................................... $ 615,574 $ 562,727
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
Current liabilities:
Accounts payable ..................................... $ 266,841 $ 236,471
Accrued expenses ..................................... 137,866 113,459
Accrued warranty ..................................... 40,359 30,989
--------- ---------
Total current liabilities ....................... 445,066 380,919
Other liabilities .......................................... 44,846 46,844
Convertible debentures ..................................... 225,496 178,512
Minority interest .......................................... 10,000 9,644
Shareholders' deficiency:
Preferred stock, $.01 par value;
Authorized: 5,000 shares
Outstanding: None .............................. -- --
Common stock, $.01 par value;
Authorized: 225,000 shares
Outstanding: 153,335 shares at June 30, 2000
and 168,455 at September 29, 2000 ............... 1,534 1,685
Additional paid-in capital ........................... 549,932 624,086
Accumulated deficit .................................. (482,857) (516,377)
Accumulated other comprehensive income ............... 1,367 8,915
Treasury stock-common stock at cost;
9,773 shares at June 30, 2000 and 8,906
shares at September 29, 2000 .................... (179,810) (171,501)
--------- ---------
Total shareholders' deficiency .................. (109,834) (53,192)
--------- ---------
Total liabilities and shareholders' deficiency .. $ 615,574 $ 562,727
========= =========
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
<PAGE> 5
WESTERN DIGITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE-MONTH PERIOD ENDED
---------------------------
OCT. 2, SEP. 29,
1999 2000
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ................................................... $(106,315) $ (33,520)
Adjustments to reconcile net loss to net cash
used for operating activities:
Non-Cash Items:
Depreciation and amortization ...................... 24,690 13,760
Interest on convertible debentures ................. 6,079 2,856
Non-cash portion of restructuring charges .......... 14,029 --
Extraordinary gain on debenture redemptions ........ (90,622) (11,243)
Other .............................................. -- 382
Changes in assets and liabilities:
Accounts receivable ................................ 186,180 2,817
Inventories ........................................ (63,648) 24,519
Prepaid expenses and other assets .................. (6,364) (998)
Accrued warranty ................................... (11,851) (6,156)
Accounts payable and accrued expenses .............. (41,999) (54,777)
Other .............................................. 46 (4,155)
--------- ---------
Net cash used for operating activities ......... (89,775) (66,515)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of property and equipment .............. 26,019 --
Capital expenditures, net .................................. (7,526) (10,587)
Proceeds from sales of marketable equity securities ........ -- 14,979
Other ...................................................... (1,100) --
--------- ---------
Net cash provided by investing activities ...... 17,393 4,392
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from ESPP shares issued and stock options
exercised ................................................. 1,624 2,970
Repayment of bank debt ...................................... (2,500) --
Common stock issued for cash ................................ 32,165 42,081
--------- ---------
Net cash provided by financing activities ...... 31,289 45,051
--------- ---------
Net decrease in cash and cash equivalents ................... (41,093) (17,072)
Cash and cash equivalents, beginning of period .............. 226,147 184,021
--------- ---------
Cash and cash equivalents, end of period .................... $ 185,054 $ 166,949
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for income taxes ..................... $ 294 $ 162
Cash paid during the period for interest ......................... 991 32
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
<PAGE> 6
WESTERN DIGITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Basis of Presentation
The accounting policies followed by the Company are set forth in Note 1 of
Notes to Consolidated Financial Statements included in the Company's Annual
Report on Form 10-K as of and for the year ended June 30, 2000.
In the opinion of management, all adjustments necessary to fairly state the
condensed consolidated financial statements have been made. All such
adjustments are of a normal recurring nature. Certain information and
footnote disclosures normally included in the consolidated financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission. These condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements and the notes thereto included in the
Company's Annual Report on Form 10-K as of and for the year ended June 30,
2000.
The Company has a 52 or 53-week fiscal year. In order to align its
manufacturing and financial calendars, effective during the three months
ended December 31, 1999, the Company changed its fiscal calendar so that
each fiscal month ends on the Friday nearest to the last day of the
calendar month. Prior to this change, the Company's fiscal month ended on
the Saturday nearest to the last day of the calendar month. The change did
not have a material impact on the Company's results of operations or
financial position. All general references to years relate to fiscal years
unless otherwise noted.
2. Supplemental Financial Statement Data (in thousands)
<TABLE>
<CAPTION>
JUN. 30, SEP. 29,
2000 2000
-------- --------
<S> <C> <C>
Inventories:
Finished goods .................. $69,033 $41,127
Work in process ................. 11,253 10,618
Raw materials and component
parts ......................... 4,260 8,282
------- -------
$84,546 $60,027
======= =======
</TABLE>
<TABLE>
<CAPTION>
THREE-MONTH PERIOD ENDED
------------------------
OCT. 2, SEP. 29,
1999 2000
------- --------
<S> <C> <C>
Net Interest and Other Income (Expense):
Interest income ...................................... $ 2,480 $ 1,841
Realized investment losses ........................... -- (738)
Interest expense ..................................... (7,809) (3,091)
Minority interest in losses of consolidated
subsidiary ......................................... -- 356
------- -------
$(5,329) $(1,632)
======= =======
</TABLE>
6
<PAGE> 7
<TABLE>
<CAPTION>
THREE-MONTH PERIOD ENDED
------------------------
OCT. 2, SEP. 29,
1999 2000
-------- --------
<S> <C> <C>
Supplemental disclosure of non-cash investing and
financing activities:
Common stock issued for redemption of convertible
debentures ......................................... $ 71,572 $37,565
======== =======
Redemption of convertible debentures for Company common
stock, net of capitalized issuance costs ............ $162,194 $48,808
======== =======
</TABLE>
3. Loss per Share
As of October 2, 1999 and September 29, 2000, 17.9 and 19.9 million shares,
respectively, relating to the possible exercise of outstanding stock
options were not included in the computation of diluted loss per share. As
of October 2, 1999 and September 29, 2000, an additional 12.9 and 6.6
million shares, respectively, issuable upon conversion of the convertible
debentures were excluded from the computation of diluted loss per share.
The effects of these items were not included in the computation of diluted
loss per share as their effect would have been anti-dilutive.
4. Common Stock Transactions
During the three months ended September 29, 2000, the Company issued
approximately 686,000 shares of its common stock in connection with
Employee Stock Purchase Plan ("ESPP") purchases and 181,000 shares of its
common stock in connection with common stock option exercises, for
aggregate cash proceeds of $3.0 million. During the corresponding period of
the prior year, the Company issued approximately 362,000 shares of its
common stock in connection with ESPP purchases and 51,000 shares of its
common stock in connection with common stock option exercises, for
aggregate cash proceeds of $1.6 million.
Under an existing shelf registration statement (the "equity facility"), the
Company may issue shares of common stock to institutional investors for
cash. The equity facility provides for up to $190.0 million in cash
proceeds. Shares sold under the equity facility are at the market price of
the Company's common stock less a discount ranging from 2.75% to 4.25%.
During the three months ended September 29, 2000, the Company issued 8.8
million shares of common stock under the equity facility for net cash
proceeds of $42.1 million. During the corresponding period of the prior
year, the Company issued 6.2 million shares of common stock for net cash
proceeds of $32.2 million. As of September 29, 2000, the Company had
utilized $153.9 million of the equity facility. Between September 30 and
October 27, 2000, the Company sold 2.6 million additional shares under the
equity facility for cash proceeds of $14.5 million. On November 3, 2000,
the Company filed another shelf registration statement, to increase the
equity facility by $200.0 million.
During the three months ended September 29, 2000, the Company issued 6.3
million shares of common stock to redeem a portion of its 5.25% zero coupon
convertible subordinated debentures (the "Debentures") with a book value of
$49.8 million and an aggregate principal amount at maturity of $122.7
million. During the corresponding period of the prior year, the Company
issued 15.1 million shares of common stock to redeem a portion of the
Debentures with a book value of $166.4 million, and an aggregate principal
amount at maturity of $432.1 million. These redemptions were private,
individually negotiated transactions with certain institutional investors.
The redemptions resulted in extraordinary gains of $11.2 million and $90.6
million during the three months ended September 29, 2000 and October 2,
1999, respectively. As of September 29, 2000, the book value of the
remaining outstanding Debentures was $178.5 million and the aggregate
principal amount at maturity was $438.9 million. Between September 30 and
October 27, 2000, the Company issued 9.0 million shares of common stock in
exchange for Debentures with a book value of $66.8 million and an aggregate
principal amount at maturity
7
<PAGE> 8
of $164.2 million. As of October 27, 2000, the aggregate principal amount
at maturity of the remaining Debentures was $274.7 million.
The following table summarizes certain balance sheet data as reported and
on a pro forma basis, as if the October 2000 debenture redemptions and sale
of shares under the equity facility had occurred as of September 29, 2000
(in thousands):
SEP. 29, 2000
AS REPORTED PRO FORMA
----------- ---------
Working capital $ 17,942 $ 32,442
Total assets $ 562,727 $575,912
Total current liabilities $ 380,919 $380,919
Total long-term debt $ 178,512 $111,729
Total shareholders' equity (deficiency) $ (53,192) $ 26,776
5. Credit Facility
During the three months ended September 29, 2000, the Company entered into
a new three-year Senior Credit Facility for its hard drive solutions
division ("HDS"), replacing a previous facility that had matured on March
31, 2000. The new Senior Credit Facility provides up to $125 million in
revolving credit (subject to a borrowing base calculation), is secured by
HDS's accounts receivable, inventory, 65% of the stock in its foreign
subsidiaries and other assets. At the option of HDS, borrowings bear
interest at either LIBOR (with option periods of one to three months) or a
base rate, plus a margin determined by the borrowing base. The Senior
Credit Facility requires HDS to maintain certain amounts of tangible net
worth, prohibits the payment of cash dividends on common stock and contains
a number of other covenants. As of the date hereof, there were no
borrowings under the facility.
6. Real Property Transactions
On August 9, 1999, the Company sold approximately 34 acres of land in
Irvine, California, upon which it had previously planned to build a new
corporate headquarters, for $26 million (the approximate cost of the land).
The Company's current lease of its worldwide headquarters in Irvine,
California, expires in January 2001. The Company has signed a new 10-year
lease agreement for a facility in Lake Forest, California and is in the
process of relocating its worldwide headquarters to the facility.
7. Restructuring Activities
During the three months ended October 2, 1999, the Company initiated
restructuring actions to improve operational efficiency. The restructuring
actions included the reorganization of worldwide operational and management
responsibilities, transfer of hard drive production from Singapore to the
Company's manufacturing facility in Malaysia, and removal of property and
equipment from service. These actions resulted in a net reduction of
worldwide headcount of approximately 1,200, of which approximately 100 were
management, professional and administrative personnel and the remainder was
manufacturing employees. Restructuring charges recorded in connection with
these actions totaled $32.3 million during the three months ended October
2, 1999, and consisted of severance and outplacement costs of $13.0
million, the write-off of manufacturing equipment and information systems
assets of $14.1 million (taken out of service and held for disposal), and
net lease cancellation and other costs of $5.2 million.
As of June 30, 2000, the Company had approximately $3.9 million of
restructuring accruals remaining from its restructuring actions initiated
during the first three quarters of 2000. During the three months ended
September 29, 2000, the Company paid approximately $2.1 million for
severance and lease settlements, leaving an accrual balance of
approximately $1.8 million as of September 29, 2000.
8. Product Recall
During the three months ended October 2, 1999, the Company announced a
recall of its 6.8GB per platter series of WD Caviar(R) desktop hard drives
because of a reliability problem resulting from a faulty power
8
<PAGE> 9
driver chip manufactured by a third-party supplier. Approximately 1.2
million units were manufactured with the faulty chip. Replacement of the
chips involved rework of the printed circuit board assembly. Cost of
revenues for the three months ended October 2, 1999 included charges
totaling $37.7 million for estimated costs to recall and repair the
affected drives, consisting of $23.1 million for repair and retrieval, $4.5
million for freight and other, and $10.1 million for write-downs of related
inventory. The Company has resolved its claims against third parties
resulting from the recall and, as of September 29, 2000, had completed
rework on approximately 87% of the 1.2 million units. The remaining drives
have not yet been returned by end users, but the Company maintains a
warranty accrual for potential repair or replacement.
9. Investments in Marketable Securities
As of June 30, 2000, the Company owned approximately 10.8 million shares of
Komag common stock, which, when acquired on April 8, 1999, had a fair
market value of $34.9 million. During the three months ended September 29,
2000, the Company sold 4.9 million shares of the stock for $15.0 million.
The 5.9 million remaining Komag shares owned by the Company can be sold on
or after the following dates: 1.6 million shares on October 8, 2000; 3.2
million shares on October 8, 2001; and 1.1 million shares on October 8,
2002. The 1.6 million shares available for sale on October 8, 2000 have
been classified as current assets and "available for sale" under the
provisions of Statement of Financial Accounting Standards No. 115,
"Investments in Certain Debt and Equity Securities" ("SFAS 115"). These
shares were marked to market value using published closing prices of Komag
stock as of September 29, 2000 and a related unrealized gain of $1.2
million was included in accumulated other comprehensive income (loss). The
aggregate book value of the total 5.9 million Komag shares was $20.4
million as of September 29, 2000, of which $6.5 million related to the 1.6
million shares classified as current. Due to stock market conditions, the
market value of the 5.9 million Komag shares declined to $9.8 million as of
October 27, 2000, of which $2.7 million relates to the 1.6 million shares
classified as current at September 29, 2000.
As of September 29, 2000, the Company owned approximately 1.3 million
shares of Vixel Corporation ("Vixel") common stock. The Company has also
identified these shares as "available for sale" under the provisions of
SFAS 115, and accordingly, the shares were marked to market value. At
September 29, 2000 an unrealized gain of $8.6 million was included in
accumulated other comprehensive income (loss). The aggregate book value of
the shares was $8.6 million as of September 29, 2000 and was classified as
current. Due to market conditions, as of October 27, 2000, the market value
of Vixel shares held by the Company had declined to $6.2 million.
10. Other Comprehensive Income (Loss)
Other comprehensive income (loss) refers to revenue, expenses, gains and
losses that are recorded as an element of shareholders' equity (deficiency)
but are excluded from net income (loss). The Company's other comprehensive
income (loss) is comprised of unrealized gains and losses on marketable
securities categorized as "available for sale" under SFAS 115. The
components of total comprehensive loss for the three months ended September
29, 2000 were as follows (in millions):
THREE-MONTH
PERIOD ENDED
SEP. 29, 2000
-------------
Net loss $(33.5)
Other comprehensive income:
Unrealized gain on available
for sale investments, net 7.5
------
Total comprehensive loss $(26.0)
======
11. Legal Proceedings
In 1992 Amstrad plc ("Amstrad") brought suit against the Company in
California State Superior Court, County of Orange, alleging that disk
drives supplied to Amstrad by the Company in 1988 and 1989 were defective
and caused damages to Amstrad of not less than $186 million. The suit also
sought punitive damages. The Company denied the material allegations of the
complaint and filed cross-claims against Amstrad. The case was tried, and
in June 1999 the jury returned a verdict in favor of Western Digital.
9
<PAGE> 10
Amstrad has appealed the judgment and the Company has filed motions to
recover a portion of its legal and other costs of defense. The Company does
not believe that the outcome of this matter will have a material adverse
effect on its consolidated financial position, results of operation or
liquidity.
In 1994 Papst Licensing ("Papst") brought suit against the Company in
federal court in California alleging infringement by the Company of five of
its patents relating to disk drive motors that the Company purchased from
motor vendors. Later that year Papst dismissed its case without prejudice,
but it has notified the Company that it intends to reinstate the suit if
the Company does not enter into a license agreement with Papst. Papst has
also put the Company on notice with respect to several additional patents.
The Company does not believe that the outcome of this matter will have a
material adverse effect on its consolidated financial position, results of
operation or liquidity.
On October 23, 1998, Censtor Corporation ("Censtor") initiated an
arbitration proceeding against the Company in California, alleging that it
is owed royalties under a license agreement between Censtor and the
Company. In response, the Company filed a complaint in federal court in
California seeking a determination that the patents at issue are invalid.
The federal court action has been stayed pending completion of the
arbitration procedures. The Company does not believe that the outcome of
this matter will have a material adverse effect on its consolidated
financial position, results of operation or liquidity.
On June 9, 2000 a suit was brought against the Company in California State
Superior Court on behalf of a class of former employees of the Company who
were terminated as a result of a reduction in force in December 1999. The
complaint asserts claims for unpaid wages, fraud, breach of fiduciary duty,
breach of contract, and unfair business practices. The Company has removed
the suit to federal court in California on the ground that all of the
claims are preempted by the Employee Retirement Income Security Act of
1974. The Company denies the material allegations of the complaint and
intends to vigorously defend this action. The Company does not believe that
the outcome of this matter will have a material adverse effect on its
consolidated financial position, results of operation or liquidity.
In the normal course of business, the Company receives and makes inquiries
regarding possible intellectual property matters, including alleged patent
infringement. Where deemed advisable, the Company may seek or extend
licenses or negotiate settlements. Although patent holders often offer such
licenses, no assurance can be given that in a particular case a license
will be offered or that the offered terms will be acceptable to the
Company. One such matter currently pending involves Discovision Associates,
which has recently brought patents it holds to the Company's attention. The
Company does not believe that the ultimate resolution of these matters will
have a material adverse effect on its consolidated financial position,
results of operations or liquidity.
From time to time the Company receives claims and is a party to suits and
other judicial and administrative proceedings incidental to its business.
Although occasional adverse decisions (or settlements) may occur, the
Company does not believe that the ultimate resolution of these matters will
have a material adverse effect on its consolidated financial position,
results of operations or liquidity.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of
federal securities laws. The statements that are not purely historical should be
considered forward-looking statements. Often they can be identified by the use
of forward-looking words, such as "may," "will," "could," "project," "believe,"
"anticipate," "expect," "estimate," "continue," "potential," "plan,"
"forecasts," and the like. Statements concerning current conditions may also be
forward-looking if they imply a continuation of current conditions. These
statements appear in a number of places in this report and include statements
regarding the intentions, plans, strategies, beliefs or current expectations of
the Company with respect to, among other things:
10
<PAGE> 11
o the financial prospects of the Company;
o the Company's financing plans;
o litigation and other contingencies potentially affecting the Company's
financial position, operating results or liquidity;
o trends affecting the Company's financial condition or operating
results;
o the Company's strategies for growth, operations, product development
and commercialization; and
o conditions or trends in or factors affecting the computer, data
storage, home entertainment or hard drive industry.
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. Readers are urged to carefully review the
disclosures made by the Company concerning risks and other factors that may
affect the Company's business and operating results, including those made under
the captions "Risk factors related to the hard drive industry in which we
operate" and "Risk factors relating to Western Digital particularly", in this
report, as well as the Company's other reports filed with the Securities and
Exchange Commission. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. The Company
undertakes no obligation to publish revised forward-looking statements to
reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.
OVERVIEW
During 2000, the Company significantly reorganized its operations to
improve the efficiency of its hard drive business and establish the framework
for a new enterprise that leverages the Company's technological expertise in the
storage industry into new business ventures and market areas.
The 2000 reorganization of its hard drive business included the following
major restructuring actions: the transfer of all desktop hard drive production
to one highly efficient manufacturing facility in Malaysia; the closure of the
Company's Singapore manufacturing facilities; and the discontinuance of the
Company's enterprise drive product line. The hard drive reorganization also
included significant changes in the worldwide management structure and Sales
organization. Restructuring charges recorded during the three months ended
October 2, 1999 for reorganization actions initiated during that period were
$32.3 million.
The Company's new business ventures include Connex, Inc. ("Connex"),
Sagetree, Inc. ("Sagetree") and Keen Personal Media, Inc. ("Keen PM"). Connex
delivers enterprise-class storage functionality for the department and mid-sized
business markets, including storage management software, network attached
storage and storage area networks. Sagetree designs and markets packaged
analytical applications and related services for supply chain and product
lifecycle intelligence. Keen PM provides interactive broadband software,
services and hardware for television and Internet content management and
television-based electronic commerce. These new businesses do not yet have
significant revenue, but together with other ventures currently in process and
new market applications for hard disk drives, they are ultimately expected to
provide a diversified portfolio of products that will help to reduce the
Company's dependence on the traditional desktop hard drive market.
RESULTS OF OPERATIONS
Consolidated revenues were $440.2 million for the three months ended
September 29, 2000, an increase of 8%, or $33.3 million, from the three months
ended October 2, 1999 and a decrease of 7%, or $33.6 million, from the
immediately preceding quarter. The increase in revenues during the three months
ended September 29, 2000 as compared to the corresponding period of the prior
year resulted from lower than normal unit shipments during the three months
ended October 2, 1999 due to the product recall (see below). The increase was
partially offset by lower average selling prices (ASP's) and the lack of
significant shipments of enterprise hard drives due to the Company's decision in
the third quarter of 2000 to exit the high end enterprise hard drive market. The
lower revenues during the three months ended September 29, 2000 as
11
<PAGE> 12
compared to the immediately preceding quarter, resulted from a decline in the
ASP's of hard drive products due to an intensely competitive hard drive market
and a slight decrease in desktop unit shipments due to a shortage of component
parts for hard drives in the hard drive industry.
During the three months ended October 2, 1999, the Company announced a
recall of its 6.8GB per platter series of WD Caviar(R) desktop hard drives
because of a reliability problem resulting from a faulty power driver chip
manufactured by a third-party supplier. As a result, revenues of approximately
$100 million were reversed and the Caviar product line was shut down for
approximately two weeks, eliminating approximately $70 million of forecasted
revenue. In addition, charges totaling $37.7 million for estimated costs to
recall and repair the affected drives were recorded to cost of revenues during
the three months ended October 2, 1999.
The gross profit for the three months ended September 29, 2000, totaled
$25.7 million, or 6% of revenue. This compares to a negative gross profit of
$65.3 million, or negative 16% of revenue, for the three months ended October 2,
1999, and $41.6 million, or 9% of revenue, for the immediately preceding
quarter. The gross profit for the corresponding period of the prior year
included $37.7 million of special charges directly relating to the product
recall. Excluding the special charges, consolidated gross profit for that
quarter was negative $27.6 million, or negative 7% of revenue. The increase in
gross profit (excluding special charges) over the three months ended October 2,
1999 was primarily the result of lower manufacturing costs due to 2000 expense
reduction efforts. The decrease in gross profit from the immediately preceding
quarter was the result of a decline in ASP's.
Research and development ("R&D") expense for the three months ended
September 29, 2000 was $35.0 million, a decrease of $15.2 million from the three
months ended October 2, 1999 and a decrease of $0.2 million from the immediately
preceding quarter. The decrease in R&D expense from the corresponding period of
the prior year was primarily due to the Company's exit from the enterprise hard
drive market and expense reduction efforts in its desktop hard drive operations,
partially offset by increased spending at Connex and Sagetree, the Company's
subsidiaries, and other new venture development efforts.
Selling, general and administrative ("SG&A") expense in the three months
ended September 29, 2000, was $33.9 million, a decrease of $9.9 million from the
three months ended October 2, 1999 and an increase of $12.4 million from the
immediately preceding quarter. The decrease in SG&A expense from the
corresponding period of the prior year was primarily due to the Company's exit
from the enterprise hard drive market and expense reduction efforts in its
desktop hard drive operations. The decrease was partially offset by increased
spending at Connex, Sagetree and other of the Company's developing ventures. The
increase in SG&A expense from the immediately preceding quarter was primarily
due to lower than normal expenses during the three months ended June 30, 2000
resulting from an adjustment to SG&A accrual accounts of approximately $11.0
million.
Net interest and other expense for the three months ended September 29, 2000
was $1.6 million, compared to net interest and other expense of $5.3 million for
the three months ended October 2, 1999 and net interest and other expense of $.3
million in the immediately preceding quarter. The decrease in net interest and
other expense from the corresponding period of the prior year was due to accrued
interest expense incurred on a lower carrying value of the Company's convertible
debentures, due to the debenture redemptions that occurred during 2000, offset
by a reduced amount of interest income on lower average cash and cash equivalent
balances. The increase in net interest and other expense from the immediately
preceding quarter was primarily due to the reduced amount of interest income on
lower average cash and cash equivalent balances.
During the three months ended September 29, 2000, the Company issued 6.3
million shares of common stock in exchange for $122.7 million in face value of
its convertible debentures (with a book value of $49.8 million). During the
corresponding period of the prior year, the Company issued 15.1 million shares
of common stock in exchange for $432.1 million in face value of its convertible
debentures (with a book value of $166.4 million). These redemptions were
private, individually negotiated, non-cash transactions with certain
institutional investors. As a result of the redemptions the Company recognized
extraordinary gains of $11.2 million and $90.6 million during the three months
ended September 29, 2000 and October 2, 1999, respectively.
12
<PAGE> 13
The Company did not record an income tax benefit in any periods presented as
no additional loss carrybacks were available and management deemed it "more
likely than not" that the deferred tax benefits generated would not be realized.
LIQUIDITY AND CAPITAL RESOURCES
At September 29, 2000, the Company had cash and cash equivalents of $166.9
million as compared to $184.0 million at June 30, 2000. Net cash used for
operations was $66.5 million during the three months ended September 29, 2000,
as compared to $89.8 million during the three months ended October 2, 1999. The
improvement in cash used for operations was due to significantly better
performance by the Company's Hard Drives Solutions ("HDS") business group,
partially offset by increased spending on new ventures and a change in the
amount of net cash provided by the Company's conversion cycle accounts -
accounts receivable, inventories and accounts payable. During the three months
ended October 2, 1999, accounts receivable and inventories were impacted by the
end-of-quarter product recall. During that period, cash inflows from accounts
receivable collections during the first two months of the quarter greatly
exceeded cash investments made in inventories and new accounts receivable
towards the end of that quarter because of the Company's inability to ship
product. The improvement in the performance of HDS in the current period over
the corresponding period of the prior year was the result of higher sales volume
and improved cost management in all areas of the business, including component
pricing, factory utilization, and indirect expenses.
The Company's conversion cycle improved from positive 7 days for the
quarter ended October 2, 1999 to negative 9 days for the current quarter. The
current results reflect the discontinuance of the enterprise product line and
reduction in related inventory balances, coupled with the continued effective
management of the Company's accounts receivable, inventories and accounts
payable. For the current quarter, days of sales outstanding ("DSO") were 30,
days of inventory on hand were 13, and days of payables outstanding ("DPO") were
52. Although the current period results reflect a significant improvement in the
conversion cycle over the corresponding period of the prior year, there was a 1
day decline from the negative 10 days achieved for the quarter ended June 30,
2000. For the prior year period, the positive 7 day conversion cycle was 2 days
better than the conversion cycle for the quarter ended July 3, 1999. This
greater sequential quarter improvement in the prior year, combined with the
unusual decrease in volume as a result of the product recall, resulted in higher
cash flows from conversion cycle accounts in the prior period.
Other uses of cash during the three months ended September 29, 2000 included
net capital expenditures of $10.6 million, primarily to upgrade the Company's
desktop hard drive production capabilities and for normal replacement of
existing assets. Other sources of cash during the period included proceeds of
$15.0 million received upon the sale of marketable equity securities, $42.1
million received upon issuance of 8.8 million shares of the Company's stock
under the Company's equity facility, and $3.0 million received in connection
with stock option exercises and Employee Stock Purchase Plan purchases.
During the three months ended October 2, 1999 other uses of cash included
net capital expenditures of $7.5 million, repayment of bank debt of $2.5 million
and the purchase of investments of $1.1 million. Other sources of cash during
that period included $26.0 million from the sale of real property, $32.2 million
received upon issuance of 6.2 million shares of the Company's stock under the
Company's equity facility, and $1.6 million received in connection with stock
option exercises and Employee Stock Purchase Plan purchases.
The Company anticipates that capital expenditures for the remainder of 2001
will not be more than $40 million and will relate to accommodating new product
lines, normal replacement of existing assets and expansion of production
capabilities in Malaysia. The Company also anticipates cash expenditures of not
more than $9.0 million to be paid in the remainder of 2001 related to
restructuring and special charges accrued during 2000.
During the three months ended September 29, 2000, the Company issued 6.3
million shares of common stock to redeem a portion of its 5.25% zero coupon
convertible subordinated debentures (the "Debentures") with a book value of
$49.8 million and an aggregate principal amount at maturity of $122.7 million.
During the corresponding period of the prior year, the Company issued 15.1
million shares of common stock to redeem a portion of the Debentures with a book
value of $166.4 million, and an aggregate principal amount at maturity of $432.1
million. These redemptions were non-cash, private, individually negotiated
transactions with certain institutional investors. The redemptions resulted in
extraordinary gains of $11.2 million and $90.6 million during the three months
ended September 29, 2000 and October 2, 1999, respectively. As of September 29,
2000, the book value of the remaining outstanding Debentures was $178.5 million
and the aggregate principal amount at maturity was $438.9 million. Between
September 30 and October 27, 2000, the Company issued 9.0 million shares of
common stock in exchange for Debentures with a book value of $66.8 million and
an aggregate principal amount at maturity of $164.2 million. As of October 27,
2000, the aggregate principal amount at maturity of the remaining Debentures was
$274.7 million.
During the three months ended September 29, 2000, the Company entered into a
new three-year Senior Credit Facility for its hard drive solutions division
("HDS"), replacing a previous facility that had matured on
13
<PAGE> 14
March 31, 2000. The new Senior Credit Facility provides up to $125 million in
revolving credit (subject to a borrowing base calculation), is secured by HDS's
accounts receivable, inventory, 65% of the stock in its foreign subsidiaries and
other assets. At the option of HDS, borrowings bear interest at either LIBOR
(with option periods of one to three months) or a base rate, plus a margin
determined by the borrowing base. The Senior Credit Facility requires HDS to
maintain certain amounts of tangible net worth, prohibits the payment of cash
dividends on common stock and contains a number of other covenants. As of the
date hereof, there were no borrowings under the facility.
Under an existing shelf registration statement (the "equity facility"), the
Company may issue shares of common stock to institutional investors for cash.
The equity facility provides for up to $190.0 million in cash proceeds. Shares
sold under the equity facility are at the market price of the Company's common
stock less a discount ranging from 2.75% to 4.25%. During the three months ended
September 29, 2000, the Company issued 8.8 million shares of common stock under
the equity facility for net cash proceeds of $42.1 million. During the
corresponding period of the prior year, the Company issued 6.2 million shares of
common stock for net cash proceeds of $32.2 million. As of September 29, 2000,
the Company had utilized $153.9 million of the equity facility. Between
September 30 and October 27, 2000, the Company sold 2.6 million additional
shares under the equity facility for cash proceeds of $14.5 million. On November
3, 2000, the Company filed a shelf registration statement to increase the equity
facility by $200.0 million.
The following table summarizes certain balance sheet data as reported and on
a pro forma basis, as if the October 2000 debenture redemptions and sale of
shares under the equity facility had occurred as of September 29, 2000 (in
thousands):
<TABLE>
<CAPTION>
SEP. 29, 2000
AS REPORTED PRO FORMA
----------- ---------
<S> <C> <C>
Working capital $ 17,942 $ 32,442
Total assets $ 562,727 $575,912
Total current liabilities $ 380,919 $380,919
Total long-term debt $ 178,512 $111,729
Total shareholders' equity (deficiency) $ (53,192) $ 26,776
</TABLE>
The Company expects to continue to incur operating losses in 2001. However,
on a pro forma basis, at September 29, 2000, the Company had cash and cash
equivalent balances of $181.4 million, working capital of $32.4 million, and
shareholders' equity of $26.8 million. The Company has achieved significant
reductions in manufacturing labor and overhead, capital expenditures and
operating expenses resulting from the sale in late 1999 of the Company's media
operations, the closure in 2000 of the Company's two Singapore based
manufacturing facilities and its enterprise design center and the reduction in
worldwide headcount. In addition, the Company had the following additional
sources of liquidity available:
o As of November 10, 2000, $21.6 million remaining available under the
equity facility, and an additional $200.0 million which will become
available under the equity facility once the shelf registration
statement, filed on November 3, 2000, becomes effective;
o As of November 10, 2000, a Senior Credit Facility providing up to $125
million in revolving credit (subject to a borrowing base calculation);
and
o As of November 10, 2000 other equity investments that may be disposed of
during the next twelve months, including 4.8 million shares of Komag
common stock (of which 3.2 million shares have sale restrictions until
October 8, 2001) and 1.3 million shares of Vixel common stock. The
combined market value of the 4.8 million Komag shares that can be sold
in the next twelve months and the 1.3 million shares of Vixel common
stock is approximately $13.5 million as of November 10, 2000.
Based on the above factors, the Company believes its current cash and cash
equivalent balances, its existing equity and credit facilities, and other
liquidity sources currently available to it, will be sufficient to meet
14
<PAGE> 15
its working capital needs through 2001. There can be no assurance that the
Senior Credit Facility or the equity facility will continue to be available to
the Company. Also, the Company's ability to sustain its working capital position
is dependent upon a number of factors that are discussed below under the
headings "Risk factors relating to Western Digital particularly" and "Risk
factors related to the hard drive industry in which we operate".
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 was effective for all
fiscal quarters for fiscal years beginning after June 15, 1999. In August 1999,
the FASB issued Statement of Financial Accounting Standards No. 137, "Accounting
for Derivative Instruments and Hedging Activities -- Deferral of the Effective
Date of FASB Statement No. 133, an amendment of FASB Statement No. 133" ("SFAS
137"), which deferred the effective date of SFAS 133 to all fiscal quarters for
fiscal years beginning after June 15, 2000. In June 2000, the FASB issued
Statement of Financial Accounting Standards No. 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities, an Amendment of FASB
Statement No. 133". SFAS 133, as amended, establishes accounting and reporting
standards for derivative instruments embedded in other contracts and for hedging
activities. The adoption of these statements during the three months ended
September 29, 2000 did not result in a material impact on the Company's
consolidated financial position, results of operations or liquidity, and the
Company did not have a significant adjustment as a result of the transition to
these statements.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin 101 ("SAB101") "Revenue Recognition in Financial
Statements". This Staff Accounting Bulletin summarizes certain of the staff's
views in applying generally accepted accounting principles to revenue
recognition in financial statements. The Company will be required to follow the
guidance in SAB101 no later than its fourth quarter of 2001, with restatement of
earlier quarters in 2001 required, if necessary. The SEC has recently issued
further guidance with respect to adoption of specific issues addressed by
SAB101. The Company is currently assessing the impact, if any, SAB101 may have
on its consolidated financial position or results of operations.
In March 2000, the FASB issued Interpretation No. 44 "Accounting for Certain
Transactions Involving Stock Compensation -- an interpretation of APB Opinion
No. 25" ("FIN 44"). This Interpretation clarifies the definition of an employee
for purposes of applying Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" ("APB 25"), the criteria for determining whether
a plan qualifies as a noncompensatory plan, the accounting consequence of
various modifications to the terms of a previously fixed stock option or award,
and the accounting for an exchange of stock compensation awards in a business
combination. This Interpretation is effective July 1, 2000, but certain
conclusions in this Interpretation cover specific events that occur after either
December 15, 1998 or January 12, 2000. The adoption of FIN 44 during the three
months ended September 29, 2000 did not result in a material impact on the
Company's consolidated financial position, results of operations or liquidity.
YEAR 2000
On January 1, 2000, the Company incurred nominal impact on its products,
equipment, computer systems and applications as a result of the Year 2000 issue.
The Company attributes this to its Year 2000 readiness efforts. As of December
31, 1999, systems remediation and integration testing and development of the
Company's contingency plans had been completed. Supplier management is an
ongoing process, and no material impact was felt from lack of supplier readiness
at January 1, 2000. Although the Company did not experience any material
problems related to the Year 2000 issue, there can be no assurances that
problems relating to the Year 2000 issue will not manifest themselves in the
future. Expenditures related to the Year 2000 project, excluding normal
replacement of existing capital assets, totaled approximately $12.2 million.
RISK FACTORS RELATED TO THE HARD DRIVE INDUSTRY IN WHICH WE OPERATE
Our operating results depend on our being among the first-to-market and
first-to-volume with our new products.
To achieve consistent success with computer manufacturer customers we must
be an early provider of next generation hard drives featuring leading technology
and high quality. If we fail to:
15
<PAGE> 16
o consistently maintain or improve our time-to-market performance with our
new products
o produce these products in sufficient volume within our rapid product
cycle
o qualify these products with key customers on a timely basis by meeting
our customers' performance and quality specifications, or
o achieve acceptable manufacturing yields and costs with these products
then our market share would be adversely affected, which would harm our
operating results.
Short product life cycles make it difficult to recover the cost of development.
Over the past few years hard drive areal density (the gigabytes of storage
per disk) has increased at a much more rapid pace than previously, and we expect
this trend to continue. Higher areal densities mean that fewer heads and disks
are required to achieve a given drive capacity. This has significantly shortened
product life cycles, since each generation of drives is more cost effective than
the previous one. Shorter product cycles make it more difficult to recover the
cost of product development.
Short product life cycles force us to continually qualify new products with our
customers.
Due to short product life cycles, we must regularly engage in new product
qualification with our customers. To be considered for qualification we must be
among the leaders in time-to-market with our new products. Once a product is
accepted for qualification testing, any failure or delay in the qualification
process can result in our losing 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
computer manufacturers, most of which continue to consolidate their share of the
PC market. These risks are magnified because we expect cost improvements and
competitive pressures to result in declining sales and gross margins on our
current generation products.
Our average selling prices are declining.
We expect that our average selling prices for hard disk drives will continue
to decline. Rapid increases in areal density mean that the average drive we sell
has fewer heads and disks, and is therefore lower cost. Because of the
competitiveness of the hard drive industry, lower costs generally mean lower
prices. This is true even for those products that are competitive and introduced
into the market in a timely manner. Our average selling prices decline even
further when competitors lower prices to absorb excess capacity, liquidate
excess inventories, restructure or attempt to gain market share.
Unexpected technology advances in the hard drive industry could harm our
competitive position.
If one of our competitors were able to implement a significant advance in
head or disk drive technology that enables a step-change increase in areal
density allowing greater storage of data on a disk, it would harm our operating
results.
Advances in magnetic, optical, semiconductor or other data storage
technologies could result in competitive products that have better performance
or lower cost per unit of capacity than our products. If these products prove to
be superior in performance or cost per unit of capacity, we could be at a
competitive disadvantage to the companies offering those products.
The hard drive industry is highly competitive and characterized by rapid shifts
in market share among the major competitors.
The price of hard drives has fallen over time due to increases in supply,
cost reductions, technological advances and price reductions by competitors
seeking to liquidate excess inventories or gain market share. 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, taken together, result in significant and rapid shifts in market share
among the industry's major participants. For example, during 1998 and 1999, we
lost
16
<PAGE> 17
significant share of the desktop market. During the first quarter of 2000, the
Company lost market share as a result of a previously announced product recall;
however, we recovered some market share during the remainder of 2000, but our
share is still significantly below its 1997 level.
Our prices and margins are subject to declines due to unpredictable end-user
demand and oversupply of hard disk drives.
Demand for our hard drives depends on the demand for computer systems
manufactured by our customers and on storage upgrades to existing systems. The
demand for computer 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 tends to experience periods of excess capacity
which typically lead to intense price competition. If intense price competition
occurs, we may be forced to lower prices sooner and more than expected and
transition to new products sooner than expected.
Changes in the markets for hard drives require us to develop new products.
Over the past few years the consumer market for desktop computers has
shifted significantly towards lower priced systems, especially those systems
priced below $1,000. We were late to market with a value line hard drive to
serve that market, and we lost market share. If we are not able to offer a
competitively priced value line hard drive for the low-cost PC market our market
share will likely fall, which could harm our operating results.
The PC market is fragmenting into a variety of computing devices and
products. Some of these products, such as Internet appliances, may not contain a
hard drive. On the other hand, many industry analysts expect, as do we, that as
broadcasting and communications are increasingly converted to digital technology
from the older, analog technology, the technology of computers and consumer
electronics and communication devices will converge, and hard drives will be
found in many consumer products other than computers. If we are not successful
in using our hard drive technology and expertise to develop new products for
these emerging markets, it will likely harm our operating results.
We depend on our key personnel.
Our success depends upon the continued contributions of our key employees,
many of whom would be extremely difficult to replace. Worldwide competition for
skilled employees in the hard drive industry is intense. We have lost a number
of experienced hard drive engineers over the past two years as a result of the
loss of retention value of their employee stock options (because of the decrease
in price of our common stock) and aggressive recruiting of our employees. If we
are unable to retain our existing employees or hire and integrate new employees,
our operating results would likely be harmed.
RISK FACTORS RELATING TO WESTERN DIGITAL PARTICULARLY
Loss of market share with a key customer could harm our operating results.
A majority of our revenue comes from a few customers. For example, during
2000, sales to our top 10 customers accounted for approximately 57% of revenues.
These customers have a wide variety of suppliers to choose from and therefore
can make substantial demands on us. Even if we successfully qualify a product
with a customer, the customer generally is not obligated to purchase any minimum
volume of products from us and is able to terminate its relationship with us at
any time. Our ability to maintain strong relationships with our principal
customers is essential to our future performance. If we lose a key customer, or
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, our operating results
would likely be harmed. For example, this occurred early in the third quarter of
2000 in our enterprise hard drive market and is one of the factors which led to
our decision to exit the enterprise hard drive market and close our Rochester,
Minnesota facility.
Dependence on a limited number of qualified suppliers of components could lead
to delays or increased costs.
Because we do not manufacture any of the components in our hard drives, an
extended shortage of required components or the failure of key suppliers to
remain in business, adjust to market conditions, or to meet our quality, yield
or production requirements could harm us more severely than our competitors,
some of
17
<PAGE> 18
whom manufacture certain of the components for their hard drives. A number of
the components used by us are available from only a single or limited number of
qualified outside suppliers. If a component is in short supply, or a supplier
fails to qualify or has a quality issue with a component, we may experience
delays or increased costs in obtaining that component. This occurred in
September 1999 when we had to shut down our Caviar product line production for
approximately two weeks as a result of a faulty power driver chip which was
sole-sourced from a third-party supplier.
To reduce the risk of component shortages, we attempt to provide significant
lead times when buying these components. As a result, we may have to pay
significant cancellation charges to suppliers if we cancel orders, as we did in
1998 when we accelerated our transition to magnetoresistive recording head
technology, and as we did in 2000 as a result of our decision to exit the
enterprise hard drive market.
In April 1999, we entered into a three-year volume purchase agreement with
Komag under which we buy a substantial portion of our media components from
Komag. This strategic relationship has reduced our media component costs;
however, it has increased our dependence on Komag as a supplier. Our future
operating results will depend substantially on Komag's ability to timely qualify
its media components in our new development programs and to supply us with these
components in sufficient volume to meet our production requirements. Any
disruption in Komag's ability to manufacture and supply us with media would
likely harm our operating results.
To develop new products we must maintain effective partner relationships with
our strategic component suppliers.
Under our "virtual vertical integration" business model, we do not
manufacture any of the parts used in our hard drives. As a result, the success
of our products depends on our ability to gain access to and integrate parts
that are "best in class" from reliable component suppliers. To do so we must
effectively manage our relationships with our strategic component suppliers. We
must also effectively integrate different products from a variety of suppliers
and manage difficult scheduling and delivery problems.
We have only one manufacturing facility, which subjects us to the risk of damage
or loss of the facility.
Our volume manufacturing operations currently are based in one facility in
Malaysia. A fire, flood, earthquake or other disaster or condition affecting our
facility would almost certainly result in a loss of substantial sales and
revenue and harm our operating results.
Manufacturing our products abroad subjects us to numerous risks.
We are subject to risks associated with our foreign manufacturing
operations, including:
o obtaining requisite United States and foreign governmental permits and
approvals
o currency exchange rate fluctuations or restrictions
o political instability and civil unrest
o transportation delays or higher freight rates
o labor problems
o trade restrictions or higher tariffs
o exchange, currency and tax controls and reallocations
o loss or non-renewal of favorable tax treatment under agreements or
treaties with foreign tax authorities.
We have attempted to manage the impact of foreign currency exchange rate
changes by, among other things, entering into short-term, forward exchange
contracts. However, those contracts do not cover our full exposure and can be
canceled by the issuer if currency controls are put in place, as occurred in
Malaysia
18
<PAGE> 19
during the first quarter of 1999. As a result of the Malaysian currency
controls, we are no longer hedging the Malaysian currency risk.
Our plan to broaden our business in data and content management, storage and
communication takes us into new markets.
We have recently entered the storage subsystem market through our Connex
subsidiary. In this market we are facing the challenges of building volume and
market share in a market which is new to us but which has several established
and well-funded competitors. There is already significant competition for
skilled engineers, both in the hardware and software areas, in this market. Our
success will depend on Connex's ability to develop, introduce and achieve market
acceptance of new products, applications and product enhancements, and to
attract and retain skilled engineers. Additionally, our competitors in this
market have established intellectual property portfolios. Our success will also
depend on our ability to license existing intellectual property or create new
innovations. Moreover, our competitors' established intellectual property
portfolios increase our risk of intellectual property litigation.
We are also developing storage devices for the emerging audio-visual market.
We will be facing the challenge of developing products for a market that is
still evolving and subject to rapid changes and shifting consumer preferences.
There are several competitors which have also entered this emerging market, and
there is no assurance that the market for digital storage devices for
audio-visual content will materialize or support all of these competitors.
We have recently entered the data warehouse software and services market
through our SageTree subsidiary and are considering other initiatives related to
data and content management, storage and communication. In any of these
initiatives we will be facing the challenge of developing products and services
for markets that are still evolving and which have many current and potential
competitors. If we are not successful in these new initiatives it will likely
harm our operating results.
Our reliance on intellectual property and other proprietary information subjects
us to the risk of significant litigation.
The hard drive 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. We are currently
evaluating notices of alleged patent infringement or notices of patents from
patent holders. We also are a party to several judicial and other proceedings
relating to patent and other intellectual property rights. If we conclude that a
claim of infringement is valid, we may be required to obtain a license or
cross-license or modify our existing technology or design a new non-infringing
technology. Such licenses or design modifications can be extremely 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 likely increase
our costs and harm our operating results.
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. Despite safeguards, to the extent that a competitor is able to
reproduce or otherwise capitalize on our technology, 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 the laws of the United States. 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 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.
19
<PAGE> 20
Inaccurate projections of demand for our product can cause large fluctuations in
our quarterly results.
If we do not forecast total quarterly demand accurately, it can have a
material adverse effect on our quarterly results. We typically book and ship a
high percentage of our total quarterly sales in the third month of the quarter,
which makes it is difficult for us to match our production plans to customer
demands. In addition, our quarterly projections and results may be subject to
significant fluctuations as a result of a number of other factors including:
o the timing of orders from and shipment of products to major customers
o our product mix
o changes in the prices of our products
o manufacturing delays or interruptions
o acceptance by customers of competing products in lieu of our products
o variations in the cost of components for our products
o limited access to components that we obtain from a single or a limited
number of suppliers, such as Komag
o competition and consolidation in the data storage industry
o seasonal and other fluctuations in demand for computers often due to
technological advances.
Rapidly changing market conditions in the hard drive industry make it difficult
to estimate actual results.
We have made and continue to make a number of estimates and assumptions
relating to our consolidated financial reporting. The rapidly changing market
conditions with which we deal means that actual results may differ significantly
from our estimates and assumptions. Key estimates and assumptions for us
include:
o accruals for warranty against product defects
o price protection adjustments on products sold to resellers and
distributors
o inventory adjustments for write-down of inventories to fair value
o reserves for doubtful accounts
o accruals for product returns.
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 such as the following may significantly affect the
market price of our common stock:
o actual or anticipated fluctuations in our operating results
o 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
o new products introduced by us or our competitors
o periods of severe pricing pressures due to oversupply or price erosion
resulting from competitive pressures
o developments with respect to patents or proprietary rights
20
<PAGE> 21
o conditions and trends in the hard drive, data and content management,
storage and communication industries
o changes in financial estimates by securities analysts relating
specifically to us or the hard drive industry in general.
In addition, the stock market in recent months has experienced extreme price
and volume fluctuations that have particularly affected the stock price of many
high technology companies. These fluctuations are often 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 any of these litigation
matters could result in substantial costs and a diversion of resources and
management's attention.
We may be unable to raise future capital through debt or equity financing.
Due to our recent financial performance and the risks described in this
Report, in the future we may be unable to maintain adequate financial resources
for capital expenditures, working capital and research and development. Our
prior borrowing agreement with our banks matured on March 31, 2000, and we have
signed an agreement for a new credit facility for our HDS division. If we decide
to increase or accelerate our capital expenditures or research and development
efforts, or if results of operations do not meet our expectations, we could
require additional debt or equity financing. However, we cannot insure that
additional financing will be available to us or available on favorable terms. An
equity financing could also be dilutive to our existing stockholders.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DISCLOSURE ABOUT FOREIGN CURRENCY RISK
Although the majority of the Company's transactions are in U.S. Dollars,
some transactions are based in various foreign currencies. From time to time,
the Company purchases short-term, forward exchange contracts to hedge the impact
of foreign currency fluctuations on certain underlying assets, liabilities and
commitments for operating expenses denominated in foreign currencies. The
purpose of entering into these hedge transactions is to minimize the impact of
foreign currency fluctuations on the results of operations. A majority of the
increases or decreases in the Company's local currency operating expenses are
offset by gains and losses on the hedges. The contracts have maturity dates that
do not exceed twelve months. The unrealized gains and losses on these contracts
are deferred and recognized in the results of operations in the period in which
the hedged transaction is consummated. The Company does not purchase short-term
forward exchange contracts for trading purposes.
Historically, the Company has focused on hedging its foreign currency risk
related to the Singapore Dollar, the British Pound and the Malaysian Ringgit.
With the establishment of currency controls and the prohibition of purchases or
sales of the Malaysian Ringgit by offshore companies, the Company discontinued
hedging its Malaysian Ringgit currency risk in 1999. Future hedging of this
currency will depend on currency conditions in Malaysia. As a result of the
closure of the Company's Singapore operations in 2000, the Company has also
discontinued its hedging program related to the Singapore Dollar.
As of September 29, 2000, the Company had outstanding the following
purchased foreign currency forward exchange contracts (in millions, except
average contract rate):
<TABLE>
<CAPTION>
SEPTEMBER 29, 2000
-------------------------------------------
WEIGHTED
CONTRACT AVERAGE UNREALIZED
AMOUNT CONTRACT RATE LOSS
-------- ------------- ----------
(U.S. DOLLAR EQUIVALENT AMOUNTS)
<S> <C> <C> <C>
FOREIGN CURRENCY FORWARD CONTRACTS:
British Pound Sterling......................... 5.8 1.46 --
</TABLE>
21
<PAGE> 22
During the three months ended October 2, 1999 and September 29, 2000, total
realized transaction and forward exchange contract currency gains and losses
were immaterial to the consolidated financial statements. Based on historical
experience, the Company does not expect that a significant change in foreign
exchange rates (up to approximately 25%) would materially affect the Company's
consolidated financial statements.
DISCLOSURE ABOUT OTHER MARKET RISKS
Fixed Interest Rate Risk
At September 29, 2000, the market value of the Company's 5.25% zero coupon
convertible subordinated debentures due in 2018 was approximately $112.5
million, compared to the related book value of $178.5 million. The convertible
debentures will be repurchased by the Company, at the option of the holder, as
of February 18, 2003, February 18, 2008, or February 18, 2013, or if there is a
Fundamental Change (as defined in the Debenture documents), at the issue price
plus accrued original issue discount to the date of redemption. The payment on
those dates, with the exception of a Fundamental Change, can be in cash, stock
or any combination, at the Company's option.
Between September 30 and October 27, 2000, the Company issued 9.0 million
shares of common stock in exchange for Debentures with a book value of $66.8
million. As of October 27, 2000, the market value of the remaining convertible
debentures was $70.4 million, compared to the related book value of $112.2
million
The Company has various notes receivable from other companies. All of the
notes carry a fixed rate of interest. Therefore a significant change in interest
rates would not cause these notes to impact the Company's consolidated financial
statements.
Variable Interest Rate Risk
At the option of HDS, borrowings under the new Senior Credit Facility would
bear interest at either LIBOR (with option periods of one to three months) or a
base rate, plus a margin determined by the borrowing base. This is the only debt
which does not have a fixed-rate of interest. A change in interest rates
resulting in rates as high as 12% would not materially impact the Company's
consolidated financial statements.
The new Senior Credit Facility requires HDS to maintain certain amounts of
tangible net worth, prohibits the payment of cash dividends on common stock and
contains a number of other covenants. As of the date hereof, there were no
borrowings under the new Senior Credit Facility.
Fair Value Risk
The Company owned approximately 5.9 million shares of Komag, Inc. common
stock at September 29, 2000. The stock is restricted as to the percentage of
total shares which can be sold in a given time period. The unrestricted portion
of the total Komag shares acquired represents the shares which can be sold
within one year. The Company determines, on a quarterly basis, the fair market
value of the unrestricted Komag shares and records an unrealized gain or loss
resulting from the difference in the fair market value of the unrestricted
shares as of the previous quarter end and the fair market value of the
unrestricted shares on the measurement date. As of September 29, 2000, a $1.2
million total accumulated unrealized gain had been recorded in accumulated other
comprehensive income (loss). If the Company sells all or a portion of this
stock, any unrealized gain or loss on the date of sale will be recorded as a
realized gain or loss in the Company's results of operations. As of September
29, the quoted market value of the Company's Komag common stock holdings,
without regard to discounts due to sales restrictions, was $23.7 million and the
aggregate book value was $20.4 million. As a result of market conditions, as of
October 27, 2000, the market value of the shares had declined to $9.8 million.
Due to market fluctuations, an additional decline in the stock's fair market
value could occur.
The Company owns approximately 1.3 million shares of Vixel common stock. The
Company determines, on a quarterly basis, the fair market value of the Vixel
shares and records an unrealized gain or loss resulting from the difference in
the fair market value of the shares as of the previous quarter end and the fair
market value of the shares on the measurement date. As of September 29, 2000, an
$8.6 million total accumulated unrealized gain has been recorded in accumulated
other comprehensive income (loss). If the Company sells
22
<PAGE> 23
all or a portion of this common stock, any unrealized gain or loss on the date
of sale will be recorded as a realized gain or loss in the Company's results of
operations. As a result of market conditions, the market value of the shares had
declined from $8.6 million as of September 29, 2000 to $6.2 million as of
October 27, 2000. Due to market fluctuations, an additional decline in the
stock's fair market value could occur.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The following discussion contains forward-looking statements within the
meaning of the federal securities laws. These statements relate to the Company's
legal proceedings described below. Litigation is inherently uncertain and may
result in adverse rulings or decisions. Additionally, the Company may enter into
settlements or be subject to judgments that may, individually or in the
aggregate, have a material adverse effect on the Company's consolidated
financial position, results of operations or liquidity. In addition, the costs
of defending such litigation, individually or in the aggregate, may be material,
regardless of the outcome. Accordingly, actual results could differ materially
from those projected in the forward-looking statements.
In 1992 Amstrad plc ("Amstrad") brought suit against the Company in
California State Superior Court, County of Orange, alleging that disk drives
supplied to Amstrad by the Company in 1988 and 1989 were defective and caused
damages to Amstrad of not less than $186 million. The suit also sought punitive
damages. The Company denied the material allegations of the complaint and filed
cross-claims against Amstrad. The case was tried, and in June 1999 the jury
returned a verdict in favor of Western Digital. Amstrad has appealed the
judgment and the Company has filed motions to recover a portion of its legal and
other costs of defense. The Company does not believe that the outcome of this
matter will have a material adverse effect on its consolidated financial
position, results of operation or liquidity.
In 1994 Papst Licensing ("Papst") brought suit against the Company in
federal court in California alleging infringement by the Company of five of its
patents relating to disk drive motors that the Company purchased from motor
vendors. Later that year Papst dismissed its case without prejudice, but it has
notified the Company that it intends to reinstate the suit if the Company does
not enter into a license agreement with Papst. Papst has also put the Company on
notice with respect to several additional patents. The Company does not believe
that the outcome of this matter will have a material adverse effect on its
consolidated financial position, results of operation or liquidity.
On October 23, 1998, Censtor Corporation ("Censtor") initiated an
arbitration proceeding against the Company in California, alleging that it is
owed royalties under a license agreement between Censtor and the Company. In
response, the Company filed a complaint in federal court in California seeking a
determination that the patents at issue are invalid. The federal court action
has been stayed pending completion of the arbitration procedures. The Company
does not believe that the outcome of this matter will have a material adverse
effect on its consolidated financial position, results of operation or
liquidity.
On June 9, 2000 a suit was brought against the Company in California State
Superior Court on behalf of a class of former employees of the Company who were
terminated as a result of a reduction in force in December 1999. The complaint
asserts claims for unpaid wages, fraud, breach of fiduciary duty, breach of
contract, and unfair business practices. The Company has removed the suit to
federal court in California on the ground that all of the claims are preempted
by the Employee Retirement Income Security Act of 1974. The Company denies the
material allegations of the complaint and intends to vigorously defend this
action. The Company does not believe that the outcome of this matter will have a
material adverse effect on its consolidated financial position, results of
operation or liquidity.
In the normal course of business, the Company receives and makes inquiries
regarding possible intellectual property matters, including alleged patent
infringement. Where deemed advisable, the Company may seek or extend licenses or
negotiate settlements. Although patent holders often offer such licenses, no
assurance can be given that in a particular case a license will be offered or
that the offered terms will be acceptable to the Company. One such matter
currently pending involves Discovision Associates, which has recently brought
patents it holds to the Company's attention. The Company does not believe that
the ultimate resolution of these matters will have a material adverse effect on
its consolidated financial position, results of operations or liquidity.
23
<PAGE> 24
From time to time the Company receives claims and is a party to suits and
other judicial and administrative proceedings incidental to its business.
Although occasional adverse decisions (or settlements) may occur, the Company
does not believe that the ultimate resolution of these matters will have a
material adverse effect on its consolidated financial position, results of
operations or liquidity.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the period from July 1, 2000 to September 29, 2000, the Company
engaged in transactions pursuant to which it exchanged an aggregate principal
amount at maturity of $122.7 million of the Company's Zero Coupon Convertible
Subordinated Debentures due 2018, for an aggregate of 6,331,264 shares of the
Company's common stock. These transactions were undertaken in reliance upon the
exemption from the registration requirements of the Securities Act afforded by
Section 3(a)(9) thereof, as exchanges of securities by the Company with its
existing security holders. No commission or other remuneration was paid or given
directly or indirectly for soliciting such exchanges. These exchanges were
consummated in private, individually negotiated transactions with institutional
investors.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
10.46 Credit Agreement, dated as of September 20, 2000, among
Western Digital Corporation and the other credit parties
identified therein, General Electric Capital Corporation and
Bank of America, N.A.
10.47 Fiscal Year 2001 Western Digital Team-Based Incentive
Program
27 Financial Data Schedule
-----------
(b) REPORTS ON FORM 8-K:
On August 2, 2000, the Company filed a current report on Form 8-K to file
its press release dated July 27, 2000, announcing its fourth quarter and
year-end results.
24
<PAGE> 25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
WESTERN DIGITAL CORPORATION
----------------------------------------
Registrant
/s/ Teresa Hopp
----------------------------------------
Teresa Hopp
Senior Vice President
and Chief Financial Officer
Date: November 13, 2000
25
<PAGE> 26
EXHIBIT INDEX
Exhibit
Number Description
------ -----------
10.46 Credit Agreement, dated as of September 20, 2000, among Western
Digital Corporation and the other credit parties identified therein,
General Electric Capital Corporation and Bank of America, N.A.
10.47 Fiscal Year 2001 Western Digital Team-Based Incentive Program
27 Financial Data Schedule
