Western Digital 2010 Annual Report Download - page 46

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unit shipments was driven by continued strength in notebook and netbook PC demand, coupled with increased customer
preference for our product offerings.
Changes in revenue by geography generally reflect normal fluctuations in market demand and competitive
dynamics, as well as demand strength in Asia, which continues to be driven by the concentration of global manufacturing
in that region. Changes in revenue by channel are a result of normal fluctuations in market demand and competitive
dynamics.
In accordance with standard industry practice, we have sales incentive and marketing programs that provide
customers with price protection and other incentives or reimbursements that are recorded as a reduction to gross revenue.
For 2010, these programs represented 8% of gross revenues compared to 11% in 2009. These amounts generally vary
according to several factors including industry conditions, seasonal demand, competitor actions, channel mix and overall
availability of product.
Gross Margin. Gross margin for 2010 was $2.4 billion, an increase of $1.1 billion, or 80% over the prior year.
Gross margin as a percentage of net revenue increased to 24.4% in 2010 from 17.9% in 2009. This increase was primarily
due to higher volume, lower costs, a favorable product mix and a moderate pricing environment.
Operating Expenses. Total research and development (“R&D”) expense and selling, general and administrative
(“SG&A”) expense decreased to 8.9% of net revenue in 2010 compared to 9.5% in 2009. R&D expense was $611 million
in 2010, an increase of $102 million, or 20% over the prior year. This increase in R&D expense was primarily due to a
$68 million increase relating to product development to support new programs and a $34 million increase in variable
incentive compensation. As a percentage of net revenue, R&D expense decreased to 6.2% in 2010 compared to 6.8% in
2009 primarily due to an increase in net revenue in 2010 compared to 2009. SG&A expense was $265 million in 2010, an
increase of $64 million, or 32%, as compared to 2009. This increase in SG&A expense was primarily due to $27 million
of expense related to litigation settlements, a $19 million increase in variable incentive compensation and an $18 million
increase in the expansion of our sales and marketing presence into new regions. SG&A expense as a percentage of net
revenue remained consistent at 2.7% in 2010 and 2009.
During 2009, we recorded a $14 million in-process research and development charge related to the acquisition of
SiliconSystems. This charge relates to projects that were not ready for commercial production and had no alternative
future use and, therefore, the fair value of the development effort did not qualify for capitalization and was immediately
expensed. During 2009, we also recorded $112 million in restructuring charges and an $18 million gain on the sale of our
substrate manufacturing facility, and related assets, in Sarawak, Malaysia.
Other Income (Expense). Other expense, net was $5 million in 2010 compared to $18 million in 2009. This decrease
was primarily due to no impairment charges related to our auction-rate securities in 2010, compared to $10 million in
other-than-temporary losses in 2009, as well as decreases in the variable interest rate on a lower amount of debt.
Income Tax Provision. Income tax expense was $138 million in 2010 as compared to $31 million in 2009. Tax
expense as a percentage of income before taxes was 9% in 2010 compared to 6% for 2009. In 2009, income tax expense
included a provision of $42 million offset by $6 million in tax benefits related to the extension of the U.S. Federal
research and development tax credit enacted into law in October 2008, and a favorable adjustment of $5 million to
previously recorded tax accruals and credits. Differences between the effective tax rate and the U.S. Federal statutory rate
are primarily due to tax holidays in Malaysia and Thailand that expire at various dates through 2022 and the current year
generation of income tax credits.
We recognized a net $94 million increase in the liability for unrecognized tax benefits during 2010. As of July 2,
2010, we had approximately $230 million of unrecognized tax benefits which, if recognized, would decrease the effective
tax rate in subsequent years.
Fiscal Year 2009 Compared to Fiscal Year 2008
Net Revenue. Net revenue was $7.5 billion for 2009, a decrease of 8% from 2008. Total unit shipments of hard
drives increased to 146 million as compared to 133 million for the prior year. The decrease in revenue primarily resulted
from a decline in our ASPs which reflected a more competitive pricing environment, particularly in the notebook and
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