Western Digital 1999 Annual Report Download - page 26

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associated with higher expenditures to support the development of hard drives for the desktop and enterprise storage markets and
costs of $22.0 million recorded in the fourth quarter of 1998 related principally to the start-up of the IBM Agreement.
The increase in absolute dollars spent from 1998 to 1999 was primarily due to the third quarter $12.0 million charge to in-process
research and development related to the acquisition of Connex and higher spending due to the Company's decisions to develop a full
line of enterprise hard drives, regain time-to-market leadership in the desktop hard drive market, develop a line of audio-visual products,
and continue Connex development spending. At the time of the acquisition, Connex was a development stage operation with no
commercial products yet available for sale and several in-process research and development projects which were approximately 40%
complete. The major projects acquired include industry standard storage systems and storage management software solutions for both
Windows NT and UNIX server environments. The Company's primary purpose for the acquisition was to acquire these in-process
projects and complete the development efforts as the Company believed they had economic value but had not yet reached
technological feasibility, and had no alternative future uses. Therefore, the Company allocated substantially all of the purchase price to
a one-time charge for in-process research and development of $12.0 million to the Company's results of operations in 1999.
Approximately $0.4 million of assets were acquired in the acquisition. Due to the small size of the Connex acquisition, the $12.0 million
dollar purchase price was determined based on an arms-length negotiation. Approximately $8 million in development and administrative
expenses (approximately $5 million for network attached storage systems and $3 million for network storage management software) were
incurred during fiscal 1999 after the acquisition.
The Company is continuing the Connex development efforts and expects to begin shipping the first new products developed by
Connex in January 2000. Following the acquisition, expenditures of approximately $27 million ($10 million for network attached storage
systems and $17 million for network storage management software) were estimated to complete the development of the two projects.
The primary risks and uncertainties associated with timely completion of the projects lie in the Company's ability to attract and retain
qualified software engineers in the current competitive environment. Should the projects not be completed on a timely basis, the
Company's first-to-market advantages would be reduced (e.g. lower margins), or an alternative technology might be developed by a
competitor which could severely impact the marketability of the Company's planned products. Should the projects prove to be
unsuccessful, the impact on the fiscal year 2000 results of operations would primarily consist of the engineering and start up efforts
incurred to complete the projects for which there would be no future value, plus the costs of any new efforts on replacement projects
and/or costs to unwind the infrastructure if a decision were made not to pursue new efforts.
Selling, general and administrative expenses ("SG&A") were $198.5 million, or 4.8% of revenues, $192.1 million, or 5.4% of revenues
and $196.0 million, or 7.1% of revenues, in 1997, 1998 and 1999, respectively. The decrease in absolute dollars of SG&A expense from
1997 to 1998 was primarily the result of lower expenses for the Company's pay-for-performance and profit sharing plans, partially offset
by higher expenses associated with implementing the Company's new computer information systems. The increase in absolute dollars
of SG&A expense from 1998 to 1999 was primarily the result of the special charges recorded in the first quarter for losses on terminated
forward exchange contracts on the Malaysian Ringgit, partially offset by decreased marketing expenditures due to the Company's cost-
cutting initiatives.
Net interest income was $13.2 and $3.8 million in 1997 and 1998, respectively. Net interest expense was $15.9 million in 1999. The
decline in net interest income from 1997 to 1998 was primarily attributable to interest expense incurred on the Company's long-term debt
consisting of a $50.0 million term loan, which is part of the Company's secured revolving credit and term loan facility ("Senior Bank
Facility"), and accrual of original issue discount on the Company's 5.25% zero coupon convertible subordinated debentures due 2018
(the "Debentures") which were issued in February 1998. No debt was outstanding during 1997. Partially offsetting this decrease was
incremental interest income earned on the cash and cash equivalents balance in 1998, which was higher than historical levels due to the
proceeds from the term loan and sale of the Debentures. The change in net interest income in 1998 to net interest expense in 1999 was
primarily due to a full year's accrual of original issue discount on the Debentures, a full year of interest expense incurred on the $50.0
million term loan partially offset by a reduced amount of interest income earned on the Company's cash and cash equivalent balances,
which were lower in 1999.
The Company's 1997 effective tax rate of 15% resulted primarily from the earnings of certain subsidiaries which are taxed at
substantially lower tax rates as compared with United States statutory rates and changes in the deferred tax asset valuation allowance
(see Note 5 of Notes to Consolidated Financial Statements). The income tax benefit recorded in 1998 represented the expected benefit of
loss carrybacks, partially offset by provisions for income taxes recorded in certain jurisdictions where the Company had positive
earnings. In 1999 there was no tax benefit recorded as no additional loss carrybacks were available and management deemed it was
more likely than not that the deferred tax benefits generated would not be realized.