Western Digital 2004 Annual Report Download - page 24

Revenue by sales channel for 2004 was 51% from OEMs, 42% from distributors and 7% from the retail channel,
compared to 52%, 40% and 8%, respectively, for 2003. The distribution of revenue by sales channel has remained
relatively consistent for the past several quarters.
Net revenue increased $567 million or 26% in 2003 from 2002. This increase in net revenue was primarily due to
the Company's improved market share as well as an increase in demand for hard disk drives in the PC market. Unit
shipments increased to 39.7 million in 2003 from 29.1 million in 2002, partially oÅset by a decrease in ASPs to $68 per
unit in 2003 from $74 per unit in 2002.
Gross Margin
For 2004, gross margin percentage decreased to 15.2% from 16.3% for 2003. The decrease in gross margin
percentage over the prior year was primarily the result of aggressive pricing pressures. The Company anticipates that
competitive pricing pressure may continue to adversely aÅect gross margin percentages in 2005. Also contributing to the
decrease in the gross margin percentage were start-up expenses and other charges totaling $18.1 million incurred during
the Ñrst quarter of 2004 relating to the Company's head manufacturing operations acquired in July 2003. Western
Digital was able to partially oÅset the impact of these pricing conditions and start-up related costs with the ongoing
accretive beneÑt of its head manufacturing operations. For 2003, gross margin percentage increased to 16.3% from
13.1% for 2002. This increase in gross margin percentage was primarily a result of a more moderate pricing environment,
manufacturing eÇciencies associated with higher unit volume and continuing cost reduction eÅorts, oÅset by an
$18.5 million charge related to the Cirrus Logic, Inc. litigation settlement.
Operating Expenses
Total operating expenses, consisting of research and development (""R&D'') and selling, general and administrative
(""SG&A''), were 10.1% of net revenue in 2004 as compared to 9.4% of net revenue in 2003 and 10.7% of net revenue
in 2002.
R&D expense was $201 million, $135 million and $120 million for 2004, 2003 and 2002, respectively. The
increase of $66 million in R&D expense in 2004 from 2003 was primarily related to head-design, mobile and enterprise
platform development, as well as the charge of $26 million incurred during the Ñrst quarter of 2004 for acquired IPR&D,
oÅset by reduced employee incentive payments. The $26 million charge related to IPR&D projects acquired from Read-
Rite that had not reached technological feasibility and had no alternative future use. As of July 2, 2004, progress on these
projects was consistent with management's original estimates, including the costs incurred towards completion and
projected release dates. The increase of $15 million in R&D in 2003 over 2002 was due to increases in new development
programs and higher employee incentive payments, partially oÅset by expense reduction eÅorts.
SG&A expense was $106 million, $121 million and $111 million for 2004, 2003 and 2002, respectively. The
$15 million decrease in SG&A expense in 2004 from 2003 was primarily due to a reduction in employee incentive
programs and reductions in baseline spending. The $10 million increase in SG&A expense in 2003 from 2002 was
primarily related to higher incentive payments resulting from improved operational results.
The Company will continue to manage its operating expense structure in line with its operating proÑt objectives.
Interest and Other Income
Net interest and other income was $0.3 million, $2.9 million and $1.4 million in 2004, 2003 and 2002,
respectively. This includes net investment gains of $4.4 million in 2003 and $5.4 million in 2002. Excluding these
items, net interest and other income (expense) was $0.3 million, ($1.5) million and ($4.0) million in 2004, 2003 and
2002, respectively. The increase in net interest income over the past two years was primarily due to the Company's
redemption of its convertible debentures during the third quarter of 2003, resulting in lower interest expense as
compared to 2002.
Income Tax Expense (BeneÑt)
Income tax expense was $3.9 million in 2004 as compared to $7.6 million in 2003 and an income tax beneÑt of
$1.1 million in 2002. The decrease in the income tax expense of $3.7 million in 2004 primarily related to lower overall
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