Western Digital 2007 Annual Report Download - page 42

Income Tax Benefit. Income tax benefit was $121 million and $13 million in 2007 and 2006, respectively. Tax
benefit as a percentage of income before taxes was 27% and 3% for 2007 and 2006, respectively. Differences between the
effective tax rates and the U.S. Federal statutory rate are primarily due to tax holidays and incentive programs and
reductions to our valuation allowance for deferred tax assets. We have tax holidays in Malaysia and Thailand that expire at
various times ranging from 2008 to 2022. In addition to the tax holidays, the tax provision was impacted by favorable
adjustments to the company’s valuation allowance for deferred tax assets of $126 and $22 million in 2007 and 2006,
respectively. These adjustments were based upon determination that it was more likely than not that all or a portion of
our deferred tax assets will be realized. In the fourth quarter of 2007, we reversed the remaining valuation allowance for
our deferred tax assets based on the weight of available evidence including our history of cumulative pretax income and
the increased likelihood of our ability to generate profits in the future. In 2006, we released a portion of the valuation
allowance on deferred tax assets due to the difficulty at the time in accurately projecting income for periods of longer than
two years given the cyclical nature of our industry. The realization of the deferred tax assets is primarily dependent on our
ability to generate sufficient earnings in certain jurisdictions in future years. The amount of deferred tax assets considered
realizable may increase or decrease in subsequent periods based on fluctuating industry or company conditions.
Fiscal Year 2006 Compared to Fiscal Year 2005
Net Revenue. Net revenue was $4.3 billion for 2006, an increase of 19% from 2005. Total unit shipments increased
to 73 million as compared to 61 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, including mobile, CE and branded products. For example, we shipped 5 million drives to the mobile market in
2006 as compared to 1 million units in 2005. Additionally, we shipped 7 million units to the DVR market in 2006 as
compared to 4 million units in 2005. ASPs remained at a relatively constant level of $59 due to an increase in the average
storage capacity of hard drives sold offset by moderate price declines. Revenue contribution by geographic region for
2006 as compared to 2005 reflects our focus on revenue growth in emerging geographic markets, primarily in Asia.
Changes in revenue by channel reflect overall market demand fluctuations for hard drives.
Gross Margin. Gross margin for 2006 was $829 million, an increase of $239 million, or 41% over the prior year.
Gross margin percentage increased to 19.1% in 2006 from 16.2% in 2005. Gross margin in 2006 benefited from a more
favorable supply/demand balance. In addition, gross margin was favorably impacted in 2006 by the following factors:
1) manufacturing efficiencies, 2) lower customer returns resulting from ongoing quality improvements that favorably
impacted warranty obligations, and 3) an increase in the average storage capacity of hard drives sold. Moderate price
declines somewhat offset the favorable impact of the aforementioned factors. During 2006 and 2005, our warranty
accrual for prior quarters’ shipments was favorably adjusted by approximately $30 million and $1 million, respectively, as
a result of improvements in quality and customer return rates and their expected impact on future levels of customer
returns under warranty.
Operating Expenses. Total operating expenses, consisting of research and development (“R&D”) and selling, general
and administrative (“SG&A”) expenses, were 10.7% of net revenue in 2006, as compared to 10.9% in 2005. R&D
expense was $297 million in 2006, an increase of $57 million, or 24% over the prior year. 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 $18 million in employee incentive compensation
programs, of which $12 million related to the adoption of Statement of Financial Accounting Standard (“SFAS”)
No. 123-R. SG&A expense was $166 million in 2006, an increase of $11 million, or 7% as compared to 2005. This
increase in SG&A expense was primarily due to an expansion of sales resources to support increasing desktop computer
demand in certain geographic regions, the growing mobile and CE markets, an increase of $15 million in employee
incentive compensation programs, of which $7 million related to the adoption of SFAS No. 123-R, and a $5 million
software write-off. 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.
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