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ANNUAL REPORT
AND FORM 10-K
2005
Western Digital

Table of contents

  • Page 1
    We s t e r n D i g i t a l A N N U A L A N D R E P O R T 1 0 - K F O R M 2005

  • Page 2
    ...and organizations that collect, manage and use digital information. We produce reliable, high-performance hard drives that keep users' data close at hand and secure from loss. In addition to the design, development, manufacture, and sale of hard drives for desktop and mobile computers, WD is growing...

  • Page 3
    ... in hard drives for enterpriseclass applications, personal video recorders, and other consumer entertainment products; making a measured, rational entry into the mobile personal computer hard drive market; and extending our design and manufacturing expertise into even smaller form factor drives for...

  • Page 4
    ...RE (RAID Edition) hard drives, including new products in 400 gigabyte capacities, and we saw steadily increasing acceptance of these products. • WD more than tripled its unit volume in hard drives for personal and digital video recorders, building volume with existing customers and adding new ones...

  • Page 5
    ...a product lineup, quality reputation and track record that earn ongoing business from our long-time OEM, distribution and retail customers. The market over the coming years should be very good for our proven desktop and enterprise products, and the addition of smaller form factor drives for notebook...

  • Page 6

  • Page 7
    ... Forest Drive Lake Forest, California (Address of principal executive offices) 92630 (Zip Code) Registrant's telephone number, including area code: (949) 672-7000 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Common Stock...

  • Page 8
    ... as the parent company of its hard disk drive business, Western Digital Technologies, Inc., which was formed in 1970. The Company's principal executive offices are located at 20511 Lake Forest Drive, Lake Forest, California 92630. The Company's telephone number is (949) 672-7000 and its web site is...

  • Page 9
    ... General Western Digital Corporation (the ""Company'' or ""Western Digital'' or ""WD'') designs, develops, manufactures and sells hard disk drives. A hard disk drive is a device that stores data on one or more rotating magnetic disks to allow fast access to data. Hard disk drives are one of the key...

  • Page 10
    ...Internet onto PC hard disk drives. In addition, the Company believes the rate of PC unit growth is affected by several factors, including maturing PC markets in North America and Western Europe, an increase in first-time buyers of PCs in Eastern Europe and Asia, and the lengthening of PC replacement...

  • Page 11
    ... or Ethernet. As a result, end users are able to supplement the storage space of their PC systems with the use of external hard disk drive products that connect via these high-speed interfaces. External hard disk drive products are commonly used for storing additional programs or multimedia content...

  • Page 12
    ...thereby supporting the ability to quickly add external hard disk drive storage. One of Western Digital's external hard disk drive products now shipping is the WD Passport, a 80GB 5400 RPM portable 2.5-inch hard disk drive. Technology and Product Development Hard disk drives are used to record, store...

  • Page 13
    ... to enterprise-class standards and available with a SATA interface. Storage capacity of the hard disk drive, as manufactured by Western Digital, is determined by the number of disks and each disk's areal density, which is a measure of the amount of data that can be stored on the recording surface of...

  • Page 14
    ..., see Part II, Item 7, under the heading ""Risk Factors That May Affect Future Results.'' Sales and Distribution The Company sells its products globally to Original Equipment Manufacturers, or ""OEMs,'' distributors and retailers. OEMs purchase the Company's hard disk drives and assemble them into...

  • Page 15
    .... Western Digital also maintains customer relationships by communicating with its resellers and providing end-users with information and support through its web site. Competition The Company competes primarily with manufacturers of hard disk drives for desktop PC, mobile, enterprise and CE products...

  • Page 16
    ... Service and Warranty Western Digital generally warrants its newly manufactured hard disk drives against defects in materials and workmanship for periods of from one to five years from the date of sale depending on the type of product. The Company's warranty obligation is generally limited to repair...

  • Page 17
    ... of hard disk drives within 30 to 60 days of the placement of the order. The Company generally negotiates pricing, order lead times, product support requirements and other terms and conditions prior to receiving a computer manufacturer's first purchase order for a product. Customers' purchase orders...

  • Page 18
    ... experienced a work stoppage, none of its domestic employees are represented by a labor organization, and the Company considers its employee relations to be good. Available Information The Company maintains an Internet web site at http://www.westerndigital.com. The Company's Annual Report on Form 10...

  • Page 19
    ... Board of Directors in November 2001. Mr. Shakeel joined the Company in 1985 and has served in various executive capacities. In February 2000, he became Executive Vice President and General Manager of Hard disk drive Solutions. He was promoted to Executive Vice President and Chief Operating Officer...

  • Page 20
    ... is used as a hard disk drive return and refurbishing center. The Company also leases office space in various other locations throughout the world primarily for sales and technical support. Western Digital owns a 633,077 square foot manufacturing facility in Kuala Lumpur, Malaysia. The Company also...

  • Page 21
    ... Purchases of Equity Securities Western Digital's common stock is listed on the New York Stock Exchange, Inc. (""NYSE'') under the symbol ""WDC''. The approximate number of holders of record of common stock of the Company as of August 26, 2005 was 2,673. The Company has not paid any cash dividends...

  • Page 22
    ... capacity hard disk drives; the Company's planned entrance into 1.0-inch hard disk drive market and use of hard disk drives in consumer products; the Company's planned use of perpendicular recording in certain products; trends in the area of custom integrated circuits for hard disk drives; increase...

  • Page 23
    ..., and cell phones. The Company sells its products worldwide to original equipment manufacturers (""OEMs'') for inclusion in computer systems or subsystems, and to distributors, resellers and retailers. The Company's hard disk drive products are currently manufactured in Malaysia and Thailand. For...

  • Page 24
    ...for notebooks. As the market for consumer applications expands, additional investments by the Company will be required. For example, CE products such as handheld digital audio players currently utilize sub-2.5-inch form factor hard disk drives. In January 2005, Western Digital announced it has plans...

  • Page 25
    ...26 million in employee incentive compensation programs. The increase of $66 million in R&D in 2004 over 2003 was due to head-design, mobile and enterprise platform development, as well as a $26 million charge for acquired in-process research and development related to the Read-Rite asset acquisition...

  • Page 26
    ... of Western Digital's available funds is invested in auction rate securities, which are short-term investments in bonds with original maturities greater than 90 days. The following table summarizes the results of the Company's statements of cash flows for the three-year periods ended July 1, 2005...

  • Page 27
    ... for the Read-Rite asset acquisition and $32 million for short-term investments. The increase in capital expenditures in 2005 was primarily a result of assets purchased to upgrade the Company's head manufacturing capabilities, increased desktop and mobile hard disk drive production capabilities and...

  • Page 28
    ... line and the Company had $3 million in outstanding letters of credit. Purchase Orders In the normal course of business, the Company enters into purchase orders with suppliers for the purchase of hard disk drive components used to manufacture the Company's products. These purchase orders generally...

  • Page 29
    ... industry practice, Western Digital has agreements with resellers that provide limited price protection for inventories held by resellers at the time of published list price reductions and other incentive programs. In accordance with current accounting standards, the Company recognizes revenue upon...

  • Page 30
    ... disk drive over the warranty period, which generally ranges from one to five years. The Company has comprehensive processes with which to estimate accruals for warranty, which include specific detail on hard disk drives in the field by product type, historical field return rates and costs to repair...

  • Page 31
    ... SFAS 123R will be dependent on several factors including the levels and timing of future share-based payment grants, the assumed award forfeiture rate and the method of recognizing the fair value of awards over the service period. In March 2005, the FASB issued FIN 47, ""Accounting for Conditional...

  • Page 32
    ...due in large part to a decrease in the rate of hard disk drive areal density growth. However, there can be no assurance that this trend will continue. If longer product life cycles continue, we may need to develop new technologies or programs to reduce our costs on any particular product in order to...

  • Page 33
    ... video recorders and digital video recorders, or other products outside of the CE market, may require attributes not currently offered in our products, which have resulted in a need to expend capital to develop new interfaces, form factors, technical specifications or hard disk drive features...

  • Page 34
    ...to successfully develop and manufacture new products, customers may decrease the amount of our products that they purchase, and we may lose business to our competitors who offer these products or who use their dominance in the enterprise or mobile market to encourage sales of hard disk drives. If we...

  • Page 35
    ... fundamental shift in recording technology, hard disk drive manufacturers would need to timely adjust their designs and processes to accommodate the new technology in order to remain competitive. As a result, we could incur substantial costs in developing new technologies, media, and tools to remain...

  • Page 36
    ... any of these facilities. Our hard disk drives are manufactured in facilities in Malaysia and Thailand. In addition, we operate a head wafer fabrication and research and development facility in Fremont, California and a slider fabrication, head gimbal assembly, head stack assembly, and research and...

  • Page 37
    ... 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. If product life cycles...

  • Page 38
    ...the continued contributions of our key personnel and skilled employees, many of whom would be extremely difficult to replace. Worldwide competition for skilled employees in the hard disk drive industry is intense. Volatility or lack of positive performance in our stock price may adversely affect our...

  • Page 39
    Our prices and margins are subject to declines due to unpredictable end-user demand and oversupply of hard disk drives. Demand for our hard disk drives depends on the demand for systems manufactured by our customers and on storage upgrades to existing systems. The demand for systems has been ...

  • Page 40
    ... in product recalls and could subject us to warranty claims in excess of our warranty provisions or which are greater than anticipated due to the unenforceability of liability limitations. We warrant our products for up to five years. We test our hard disk drives in our manufacturing facilities...

  • Page 41
    ... and assumptions. Key estimates and assumptions for us include: ‚ accruals for warranty costs related to product defects; ‚ price protection adjustments and other sales promotions and allowances on products sold to retailers, resellers and distributors; ‚ inventory adjustments for write...

  • Page 42
    ... fluctuations from time to time that particularly affect the stock prices of many high technology companies. These fluctuations often appear to be unrelated to the operating performance of the companies. Securities class action lawsuits are often brought against companies after periods of volatility...

  • Page 43
    ... exchange contract currency gains and losses were not material to the consolidated financial statements. Disclosure About Other Market Risks Variable Interest Rate Risk At the option of the Company, borrowings under the Senior Credit Facility would bear interest at either LIBOR (with option periods...

  • Page 44
    ... to Financial Statements and Financial Statement Schedule Page Consolidated Financial Statements: Independent Auditors' Reports Consolidated Balance Sheets Ì July 1, 2005 and July 2, 2004 Consolidated Statements of Income Ì Three Years Ended July 1, 2005 Consolidated Statements of Cash Flows...

  • Page 45
    ..., the financial position of Western Digital Corporation and subsidiaries as of July 1, 2005 and July 2, 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended July 1, 2005, in conformity with U.S. generally accepted accounting principles...

  • Page 46
    REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors Western Digital Corporation: We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting appearing under Item 9A, that Western Digital Corporation...

  • Page 47
    WESTERN DIGITAL CORPORATION CONSOLIDATED BALANCE SHEETS (in millions) July 1, 2005 July 2, 2004 ASSETS Current assets: Cash and cash equivalents Short-term investments Accounts receivable, net Inventories Other Total current assets Property and equipment, net Intangible and other assets ...

  • Page 48
    WESTERN DIGITAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME (in millions, except per share amounts) July 1, 2005 Years Ended July 2, 2004 June 27, 2003 Revenue, net 3,638.8 Cost of revenue 3,049.0 Gross margin Operating expenses: Research and development Selling, general and administrative ...

  • Page 49
    ..., net 233.4) Purchases of short-term investments 95.4) Sales of short-term investments 14.5 Asset acquisition and other investment activities Net cash used for investing activities 314.3) Cash flows from financing activities Issuance of common stock under employee plans 57.8 Repurchase of...

  • Page 50
    ... shares issued Exercise of stock options Deferred compensation plan Repurchase of common stock Net income Unrealized loss on foreign currency contracts 214.6 $2.1 (0.9) $(11.7) $711.1 9.4 48.4 3.8 (45.0) 198.4 (0.5) $(14.6) $ 15.5 $(0.3) $702.1 $198.4 (0.5) $197.9 Balance at July 1, 2005...

  • Page 51
    ... Western Digital Corporation (the ""Company'' or ""Western Digital'' or ""WD'') designs, develops, manufactures and sells hard disk drives. A hard disk drive is a device that stores data on one or more rotating magnetic disks to allow fast access to data. The Company's hard disk drives are used...

  • Page 52
    ... during the reseller holding period, estimated amounts to be reimbursed to qualifying customers, as well as historical pricing information. If end-market demand for hard disk drives declines significantly, the Company may have to increase sell-through incentive payments to resellers, resulting...

  • Page 53
    ... Warranty covers costs of repair or replacement of the hard disk drive over the warranty period, which ranges from one to five years and is recorded in the accompanying balance sheet as current or long-term based upon when the expenditure is expected to occur. The Company has comprehensive processes...

  • Page 54
    ... with Accounting Principles Board Opinion No. 25, ""Accounting for Stock Issued to Employees'' and its related interpretations (""APB Opinion No. 25''), and to follow the pro forma net income, pro forma income per share, and stock-based compensation plan disclosure requirements set forth in SFAS...

  • Page 55
    WESTERN DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) illustrates the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation. July 1, 2005 Year Ended July 2, June...

  • Page 56
    ... SFAS 123R will be dependent on several factors including the levels and timing of future share-based payment grants, the assumed award forfeiture rate and the method of recognizing the fair value of awards over the service period. In March 2005, the FASB issued FIN 47, ""Accounting for Conditional...

  • Page 57
    ... of magnetic recording heads, commenced voluntary Chapter 7 bankruptcy proceedings. On July 31, 2003, Western Digital purchased substantially all of the assets of Read-Rite, including its wafer fabrication equipment in Fremont, California and manufacturing facility in Bang Pa-In, Thailand. The cost...

  • Page 58
    ...17.4 Property and equipment 90.2 Purchased technology 38.8 In-process research and development 25.6 $172.0 As of the date of the acquisition, Read-Rite had two in-process research and development (""IPR&D'') projects: 120 gigabyte per platter and 160 gigabyte per platter products. The fair value...

  • Page 59
    ... sold to cover the cost of repair or replacement of the hard disk drive during the warranty period. This provision is based on estimated future returns within the warranty period and costs to repair, using historical field return rates by product type and current average repair cost. Changes in the...

  • Page 60
    WESTERN DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Long-term Purchase Agreements The Company has entered into long-term purchase agreements with various component suppliers. The commitments depend on specific products ordered and may be subject to minimum quality ...

  • Page 61
    WESTERN DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) and vested over periods from one to four years. Options granted under the Prior Stock Plans expire either five or ten years from the date of grant. In November 2004, the Company's shareholders approved the 2004 ...

  • Page 62
    ...periods. During 2005, the Company also awarded certain executives and other key employees 0.5 million restricted stock units with performance-based vesting (""Performance Shares''). The Performance Shares which are earned will become payable in August 2008 in the form of Western Digital common stock...

  • Page 63
    ... have been estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted average assumptions: 2005 Stock Option Plans 2004 2003 2005 ESPP 2004 2003 Option life (in years Risk-free interest rate Stock price volatility Dividend yield Fair value 4.51 3.23...

  • Page 64
    ... as the Western Digital Corporation Retirement Savings and Profit Sharing Plan. The Plan covers substantially all domestic employees, subject to certain eligibility requirements. The Company may make annual contributions to the Plan at the discretion of the Board of Directors. For 2005, 2004 and...

  • Page 65
    WESTERN DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) International Operations The Company's operations outside the United States include manufacturing facilities in Malaysia and Thailand as well as sales offices throughout Canada, Europe, Asia, Japan, India and the ...

  • Page 66
    ..., the disqualifying disposition of stock acquired with incentive stock options and the disqualifying disposition of stock acquired under the employee stock purchase plan generally reduce taxes currently payable. However, no amounts were recorded to additional paid-in capital in 2005, 2004 and 2003...

  • Page 67
    WESTERN DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) A substantial portion of the Company's manufacturing operations in Malaysia and Thailand operate under various tax holidays and tax incentive programs which will expire in whole or in part at various dates through ...

  • Page 68
    WESTERN DIGITAL CORPORATION SCHEDULE II Ì CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS Three years ended July 1, 2005 (in millions) Allowance for Doubtful Accounts Balance at June 28, 2002 Charges to operations Deductions Balance at June 27, 2003 Charges to operations Deductions Balance ...

  • Page 69
    ... as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to the Company's management, including its Chief Executive Officer and Chief Financial...

  • Page 70
    ... 2005 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission no later than 120 days after the close of the fiscal year ended July 1, 2005, except that the information required by this Item 10 concerning executive officers is set forth in Part I of this report...

  • Page 71
    ... of Designations of Series A Junior Participating Preferred Stock of Western Digital Corporation, dated April 6, 2001(7) Western Digital Corporation Amended and Restated 2004 Performance Incentive Plan(23)* Form of Notice of Grant of Stock Option and Option Agreement Ì Executives, under the Western...

  • Page 72
    ... Employment Agreement dated as of August 25, 2005, between Western Digital Corporation and Arif Shakeel(26)* Long-Term Retention Agreement Ì Cash, between Western Digital Corporation and Hossein M. Moghadam, dated as of September 21, 2004‰* Western Digital Corporation 1999 Employee Severance Plan...

  • Page 73
    ... dated as of August 24, 1992, between Shuwa Investments Corporation and Read-Rite Corporation, together with Second Amendment to Lease, dated as of May 28, 2002(18) Volume Purchase Agreement, dated as of June 6, 2005, by and between Komag USA (Malaysia) Sdn., Komag, Incorporated, and Western Digital...

  • Page 74
    ... by reference to the Company's Current Report on Form 8-K (File No. 1-08703), as filed with the Securities and Exchange Commission on August 15, 2003. (17) Subject to confidentiality order dated September 5, 2003. (18) Incorporated by reference to the Company's Annual Report on Form 10-K (File No...

  • Page 75
    ...No. 333-122475), as filed with the Securities and Exchange Commission on February 2, 2005. (24) Incorporated by reference to the Company's Quarterly Report on Form 10-Q (File No. 1-08703), as filed with the Securities and Exchange Commission on February 9, 2005. (25) Incorporated by reference to the...

  • Page 76
    ..., thereunto duly authorized. WESTERN DIGITAL CORPORATION By: STEPHEN D. MILLIGAN Stephen D. Milligan Senior Vice President and Chief Financial Officer /s/ Dated: September 13, 2005 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the...

  • Page 77
    ... (S.E. Asia) Pte Ltd Western Digital Taiwan Co., Ltd Western Digital Technologies, Inc Western Digital (Thailand) Company Limited Western Digital (UK) Limited Western Digital Ventures, Inc Hawaii Cayman Islands Malaysia Philippines Thailand Ontario, Canada Germany France Delaware Hong Kong...

  • Page 78
    ... schedule, management's assessment of the effectiveness of internal controls over financial reporting as of July 1, 2005 and the effectiveness of internal controls over financial reporting as of July 1, 2005, which reports appear in the July 1, 2005 annual report on Form 10-K of Western Digital...

  • Page 79
    Exhibit 31.1 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Matthew E. Massengill, certify that: 1. I have reviewed this Annual Report on Form 10-K of Western Digital Corporation; 2. Based on my knowledge, this report does not contain any ...

  • Page 80
    ... 31.2 CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Stephen D. Milligan, certify that: 1. I have reviewed this Annual Report on Form 10-K of Western Digital Corporation; 2. Based on my knowledge, this report does not contain any untrue...

  • Page 81
    ... of 2002, the undersigned officer of Western Digital Corporation, a Delaware corporation (the ""Company''), hereby certifies, to his knowledge, that: (i) the accompanying Annual Report on Form 10-K of the Company for the period ended July 1, 2005 (the ""Report'') fully complies with the requirements...

  • Page 82
    ... of 2002, the undersigned officer of Western Digital Corporation, a Delaware corporation (the ""Company''), hereby certifies, to his knowledge, that: (i) the accompanying Annual Report on Form 10-K of the Company for the period ended July 1, 2005 (the ""Report'') fully complies with the requirements...

  • Page 83
    ... Executive Officer Western Digital Corporation Peter D. Behrendt Former Chairman, President and Chief Executive Officer Exabyte Corporation Computer tape storage products manufacturer Kathleen A. Cote Former Chief Executive Officer Worldport Communications, Inc. Internet managed services provider...

  • Page 84
    ...Malaysia Western Digital (S.E. Asia) Pte Ltd. Singapore Western Digital Taiwan Co., Ltd. Taipei, Taiwan R.O.C. WD Korea, Ltd. Kangnam-Gu, Seoul Korea Western Digital (UK) Limited Leatherhead, Surrey, England Prague, Czech Republic Dubai, UAE Moscow, Russia Transfer Agent and Registrar American Stock...