Western Digital 2006 Annual Report Download - page 42

compensation programs, of which $7 million related to the adoption of SFAS No. 123-R. The 2005 fiscal period included
a $19 million charge for the settlement of a patent infringement lawsuit.
Interest and Other Income. Net interest and other income was $16 million and $5 million in 2006 and 2005,
respectively. This increase in net interest income was primarily due to higher average invested cash and short-term
investment balances as well as increases in the rates of return on investments.
Income Tax Expense. Income tax (benefit) expense was $(13) million and $4 million in 2006 and 2005, respectively.
Tax (benefit) expense as a percentage of income before taxes was (3.4)% and 2.0% for 2006 and 2005, respectively.
Differences between the effective tax rates and the U.S. Federal statutory rate are primarily due to tax holidays in Malaysia
and Thailand that expire at various times ranging from 2008 to 2019. In addition to the tax holidays, the tax provision
for 2006 was favorably impacted by $22 million given the partial reduction of our valuation allowance on deferred tax
assets upon determination that it was more likely than not that a portion of our deferred tax assets will be realized. The
realization of the deferred tax assets is primarily dependent on our ability to generate sufficient earnings in certain
jurisdictions in fiscal years 2007 and 2008. A two-year period is used due to the difficulty in accurately projecting income
for longer periods of time given the cyclical nature of our industry. This assumption may change in the future based on
fluctuating industry or company conditions. The amount of deferred tax assets considered realizable may increase or
decrease in subsequent quarters when we update our estimates of future income. The 2005 effective tax rate benefited by
approximately 0.7% from the favorable resolution of certain tax contingencies.
Fiscal Year 2005 Compared to Fiscal Year 2004
Net Revenue. Net revenue was $3.6 billion for 2005, an increase of 19.4% from 2004. Total unit shipments
increased to 61.4 million as compared to 48.3 million for the prior year. This unit increase resulted from an increase in our
desktop market share, stronger overall demand for hard drives in the desktop market and our increasing focus on the non-
desktop market. For example, we shipped 3.6 million units to the DVR market in 2005 as compared to 1.0 million units
in 2004. The growth in total unit shipments was partially offset by a $4 per unit decline in ASPs to $59 per unit for 2005.
The changes in our revenue contribution by geographic region for 2005 compared to 2004 reflect our continued focus on
revenue growth in emerging geographic markets, primarily in Asia. Revenue derived from OEMs increased in 2005 due
to higher sales into the non-desktop markets, which are serviced primarily by OEMs.
Gross Margin. Gross margin percentage increased to 16.2% for 2005 from 15.2% for 2004. The increase in gross
margin percentage was impacted by continuing improvements in quality, manufacturing cost efficiencies and product
mix, partially offset by unit price declines. Gross margin also benefited from the ongoing accretive benefit of our head
manufacturing operations. Our 2004 gross margin was impacted by start-up expenses and other charges totaling
$18 million relating to our head manufacturing operations acquired in July 2003.
Operating Expenses. Total operating expenses, consisting of R&D and SG&A, were 10.9% of net revenue in 2005, as
compared to 10.1% of net revenue in 2004. R&D expense was $240 million and $202 million for 2005 and 2004,
respectively. The increase in R&D expense was primarily related to the development of new product platforms in support
of our entry into new markets, expenditures for advanced head technologies and an increase of $27 million in employee
incentive compensation programs. R&D expense in 2004 included a $26 million charge for acquired in-process research
and development related to the Read-Rite asset acquisition.
SG&A expense was $155 million and $106 million for 2005 and 2004, respectively. The increase in SG&A expense
was primarily due to an expansion of sales resources to support increasing PC demand in certain geographic regions and
the growing mobile and CE markets and an increase of $16 million in employee incentive compensation programs. Fiscal
2005 included a $19 million charge for the settlement of a patent infringement lawsuit.
Interest and Other Income. Net interest and other income was $5 million and zero for 2005 and 2004, respectively.
The increase in net interest income in 2005 over 2004 was primarily due to a higher average cash and short-term
investment balance as well as an increase in the rates of return on investments.
Income Tax Expense. Income tax expense was $4 million in both 2005 and 2004. Tax expense as a percentage of
income before taxes was 2.0% and 2.6% for 2005 and 2004, respectively. Differences between the effective tax rates and
the U.S. Federal statutory rate are primarily due to tax holidays in Malaysia and Thailand that expire at various times
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