Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 3, 2008

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from:              to             

Commission File Number 001-31560

 

 

SEAGATE TECHNOLOGY

(Exact name of registrant as specified in its charter)

 

 

 

Cayman Islands   98-0355609

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

P.O. Box 309, Ugland House

Grand Cayman KY1-1104, Cayman Islands

(Address of Principal Executive Offices)

Telephone: (345) 949-8066

(Registrant’s Telephone Number, Including Area Code)

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer:  x    Accelerated filer:  ¨    Non-accelerated filer:  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of October 24, 2008, 488,320,088 shares of the registrant’s common shares, par value $0.00001 per share, were issued and outstanding.

 

 

 


Table of Contents

INDEX

SEAGATE TECHNOLOGY

 

          PAGE NO.
PART I FINANCIAL INFORMATION   

Item 1.

  Financial Statements   
  Condensed Consolidated Balance Sheets — October 3, 2008 (Unaudited) and June 29, 2007    3
  Condensed Consolidated Statements of Operations — Three Months ended October 3, 2008 and September 28, 2007 (Unaudited)    4
  Condensed Consolidated Statements of Cash Flows — Three Months ended October 3, 2008 and September 28, 2007 (Unaudited)    5
  Condensed Consolidated Statement of Shareholders’ Equity — Three Months ended October 3, 2008 (Unaudited)    6
  Notes to Condensed Consolidated Financial Statements (Unaudited)    7

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations    37

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk    55

Item 4.

  Controls and Procedures    57
PART II OTHER INFORMATION   

Item 1.

  Legal Proceedings    58

Item 1A.

  Risk Factors    60

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds    77

Item 5.

  Other Information    78

Item 6.

  Exhibits    79
  SIGNATURES    82

 

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PART I

FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

SEAGATE TECHNOLOGY

CONDENSED CONSOLIDATED BALANCE SHEETS

(In millions)

(Unaudited)

 

     October 3,
2008
    June 27,
2008 (a)
 

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 1,005     $ 990  

Short-term investments

     148       151  

Accounts receivable, net

     1,393       1,410  

Inventories

     909       945  

Deferred income taxes

     272       274  

Other current assets

     640       502  
                

Total Current Assets

     4,367       4,272  

Property, equipment and leasehold improvements, net

     2,509       2,464  

Goodwill

     2,349       2,352  

Other intangible assets, net

     94       111  

Deferred income taxes

     616       616  

Other assets, net

     234       305  
                

Total Assets

   $ 10,169     $ 10,120  
                

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Current liabilities:

    

Accounts payable

   $ 1,930     $ 1,652  

Accrued employee compensation

     153       440  

Accrued warranty

     214       226  

Accrued expenses

     624       599  

Accrued income taxes

     6       10  

Current portion of long-term debt

     660       360  
                

Total Current Liabilities

     3,587       3,287  

Long-term accrued warranty

     231       219  

Long-term accrued income taxes

     191       210  

Other non-current liabilities

     145       148  

Long-term debt, less current portion

     1,370       1,670  
                

Total Liabilities

     5,524       5,534  

Commitments and contingencies

    

Shareholders’ equity:

    

Common shares and additional paid-in capital

     3,563       3,501  

Accumulated other comprehensive income (loss)

     (20 )     (16 )

Retained earnings

     1,102       1,101  
                

Total Shareholders’ Equity

     4,645       4,586  
                

Total Liabilities and Shareholders’ Equity

   $ 10,169     $ 10,120  
                

 

(a) The information in this column was derived from the Company’s audited Consolidated Balance Sheet as of June 27, 2008.

See notes to Condensed Consolidated Financial Statements.

 

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SEAGATE TECHNOLOGY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In millions, except per share data)

(Unaudited)

 

     For the Three Months Ended  
     October 3,
2008
    September 28,
2007
 

Revenue

   $ 3,033     $ 3,285  

Cost of revenue

     2,508       2,476  

Product development

     260       242  

Marketing and administrative

     148       153  

Amortization of intangibles

     14       13  

Restructuring

     23       5  
                

Total operating expenses

     2,953       2,889  
                

Income from operations

     80       396  

Interest income

     7       16  

Interest expense

     (30 )     (32 )

Other, net

     (13 )     (5 )
                

Other income (expense), net

     (36 )     (21 )
                

Income before income taxes

     44       375  

Provision for (benefit from) for income taxes

     (16 )     20  
                

Net income

   $ 60     $ 355  
                

Net income per share:

    

Basic

   $ 0.12     $ 0.67  

Diluted

   $ 0.12     $ 0.64  

Number of shares used in per share calculations:

    

Basic

     485       531  

Diluted

     494       560  

Cash dividends declared per share

   $ 0.12     $ 0.10  

See notes to Condensed Consolidated Financial Statements.

 

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SEAGATE TECHNOLOGY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)

(Unaudited)

 

     For the Three Months Ended  
     October 3,
2008
    September 28,
2007
 

OPERATING ACTIVITIES

    

Net income

   $ 60     $ 355  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     253       205  

Stock-based compensation

     27       29  

Deferred income taxes

     2       8  

Other non-cash operating activities, net

     (13 )     7  

Changes in operating assets and liabilities:

    

Accounts receivable

     16       (133 )

Inventories

     36       31  

Accounts payable

     278       250  

Accrued expenses, employee compensation and warranty

     (309 )     (2 )

Other assets and liabilities

     (46 )     4  
                

Net cash provided by operating activities

     304       754  
                

INVESTING ACTIVITIES

    

Acquisition of property, equipment and leasehold improvements

     (280 )     (150 )

Purchases of short-term investments

     (90 )     (198 )

Maturities and sales of short-term investments

     93       119  

Proceeds from sale of investment in equity securities

     10       —    

Acquisitions, net of cash and cash equivalents acquired

     —         (6 )

Other investing activities, net

     2       (3 )
                

Net cash used in investing activities

     (265 )     (238 )
                

FINANCING ACTIVITIES

    

Proceeds from exercise of employee stock options and employee stock purchase plan

     35       62  

Dividends to shareholders

     (59 )     (54 )

Repurchases of common shares

     —         (249 )
                

Net cash used in financing activities

     (24 )     (241 )
                

Increase (decrease) in cash and cash equivalents

     15       275  

Cash and cash equivalents at the beginning of the period

     990       988  
                

Cash and cash equivalents at the end of the period

   $ 1,005     $ 1,263  
                

Supplemental Disclosure of Cash Flow Information

    

Cash paid for interest

   $ 50     $ 10  

Cash paid for income taxes, net of refunds

     2       8  

See notes to Condensed Consolidated Financial Statements.

 

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SEAGATE TECHNOLOGY

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

Three Months Ended October 3, 2008

(In millions)

(Unaudited)

 

     Number
of
Common
Shares
   Par
Value
of
Shares
   Additional
Paid-in
Capital
   Accumulated
Other

Comprehensive
Income (Loss)
    Retained
Earnings
    Total  

Balance at June 27, 2008

   485    $ —      $ 3,501    $ (16 )   $ 1,101     $ 4,586  

Comprehensive income, net of tax:

               

Change in unrealized gain (loss) on cash flow hedges, net

   —        —        —        (4 )     —         (4 )

Net income

   —        —        —        —         60       60  
                     

Comprehensive income

                  56  

Issuance of common shares related to employee stock options and employee stock purchase plan

   3      —        35      —         —         35  

Dividends to shareholders

   —        —        —        —         (59 )     (59 )

Stock-based compensation

   —        —        27      —         —         27  
                                           

Balance at October 3, 2008

   488    $ —      $ 3,563    $ (20 )   $ 1,102     $ 4,645  
                                           

See notes to Condensed Consolidated Financial Statements.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Summary of Significant Accounting Policies

Nature of Operations — Seagate Technology (“Seagate” or the “Company”) designs, manufactures and markets rigid disk drives. Rigid disk drives, which are commonly referred to as disk drives or hard drives, are used as the primary medium for storing electronic information in systems ranging from desktop and notebook computers and consumer electronics devices to data centers delivering information over corporate networks and the Internet. The Company produces a broad range of disk drive products addressing enterprise applications, where its products are primarily used in enterprise servers, mainframes and workstations; desktop applications, where its products are used in desktop computers; mobile computing applications, where its products are used in notebook computers; and consumer electronics applications, where its products are used in digital video recorders and gaming devices. The Company sells its disk drives primarily to major original equipment manufacturers (OEMs), distributors and retailers. In addition to manufacturing and selling disk drives and branded storage products under the Seagate and Maxtor brands, the Company provides data storage services for small to medium size businesses, including online backup, data protection and recovery solutions.

Basis of Presentation and Consolidation — The Condensed Consolidated Financial Statements include the accounts of the Company and all its wholly-owned subsidiaries, after elimination of intercompany transactions and balances. The Condensed Consolidated Financial Statements have been prepared by the Company and have not been audited. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. The Condensed Consolidated Financial Statements reflect, in the opinion of management, all material adjustments necessary to summarize fairly the consolidated financial position, results of operations, cash flows and shareholders’ equity for the periods presented. Such adjustments are of a normal recurring nature. The Company’s Consolidated Financial Statements for the fiscal year ended June 27, 2008 are included in its Annual Report on Form 10-K as filed with the United States Securities and Exchange Commission (“SEC”) on August 13, 2008. The Company believes that the disclosures included in the unaudited Condensed Consolidated Financial Statements, when read in conjunction with its Consolidated Financial Statements as of June 27, 2008 and the notes thereto, are adequate to make the information presented not misleading.

The results of operations for the three months ended October 3, 2008, are not necessarily indicative of the results of operations to be expected for any subsequent interim period in the Company’s fiscal year ending July 3, 2009.

The Company operates and reports financial results on a fiscal year of 52 or 53 weeks ending on the Friday closest to June 30. The quarters ended October 3, 2008 and September 28, 2007 were 14 weeks and 13 weeks, respectively. Fiscal year 2009 will be comprised of 53 weeks and will end on July 3, 2009.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

1. Summary of Significant Accounting Policies (continued)

Critical Accounting Policies and Use of Estimates — The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the Company’s Condensed Consolidated Financial Statements and accompanying notes. Actual results could differ materially from those estimates. The methods, estimates and judgments the Company uses in applying its most critical accounting policies have a significant impact on the results the Company reports in its Condensed Consolidated Financial Statements. The SEC has defined the most critical accounting policies as the ones that are most important to the portrayal of the Company’s financial condition and results of operations, and require the Company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are highly uncertain at the time of estimation. Based on this definition, the Company’s most critical policies include: establishment of sales program accruals, establishment of warranty accruals, valuation of deferred tax assets as well as the valuation of intangibles and goodwill. The Company also has other key accounting policies and accounting estimates relating to uncollectible customer accounts, valuation of inventory, and valuation of share-based payments. The Company believes that these other accounting policies and accounting estimates either do not generally require it to make estimates and judgments that are as difficult or as subjective, or it is less likely that they would have a material impact on the Company’s reported results of operations for a given period.

Since the Company’s fiscal year ended June 27, 2008, there have been no significant changes in the Company’s critical accounting policies and estimates. Please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended June 27, 2008, as filed with the SEC on August 13, 2008, for a discussion of the Company’s critical accounting policies and estimates.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

1. Summary of Significant Accounting Policies (continued)

Net Income Per Share

In accordance with the provisions of SFAS No. 128, Earnings per Share (SFAS No. 128), the following table sets forth the computation of basic and diluted net income per share for the three months ended October 3, 2008 and September 28, 2007:

 

     For the Three Months Ended  
     October 3,
2008
    September 28,
2007
 
     (in millions, except per share data)  

Numerator:

    

Net income

   $ 60     $ 355  

Adjustment for interest expense on 6.8% convertible senior notes due April 2010

     —         2  
                

Net income, adjusted

   $ 60     $ 357  
                

Denominator:

    

Weighted-average common shares outstanding

     487       533  

Weighted-average nonvested shares

     (2 )     (2 )
                

Total shares for purpose of calculating basic net income per share

     485       531  

Weighted-average effect of dilutive securities:

    

Nonvested shares

     —         1  

Dilution from employee stock options

     9       19  

2.375% convertible senior notes due August 2012

     —         5  

6.8% convertible senior notes due April 2010

     —         4  
                

Dilutive potential common shares:

     9       29  
                

Total shares for purpose of calculating diluted net income per share

     494       560  
                

Net income per share:

    

Basic net income per share

   $ 0.12     $ 0.67  
                

Diluted net income per share

   $ 0.12     $ 0.64  
                

The following potential common shares were excluded from the computation of diluted net income per share, as their effect would have been anti-dilutive:

 

     For the Three Months Ended
     October 3,
2008
   September 28,
2007
     (in millions)

Stock options

   39    20

Nonvested shares

   1    —  

6.8% convertible senior notes

   4    —  

2.375% convertible senior notes

   —      —  

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

2. Balance Sheet Information

 

     October 3,
2008
    June 27,
2008
 
     (in millions)  

Accounts Receivable

  

Accounts receivable

   $ 1,400     $ 1,416  

Allowance for doubtful accounts

     (7 )     (6 )
                
   $ 1,393     $ 1,410  
                
     October 3,
2008
    June 27,
2008
 
     (in millions)  

Inventories

  

Raw materials and components

   $ 380     $ 352  

Work-in-process

     139       111  

Finished goods

     390       482  
                
   $ 909     $ 945  
                
     October 3,
2008
    June 27,
2008
 
     (in millions)  

Other Current Assets

  

Vendor non-trade receivables

   $ 403     $ 348  

Other current assets

     236       154  
                
   $ 639     $ 502  
                

The Company has non-trade receivables from certain manufacturing vendors resulting from the sale of components to these vendors who manufacture and sell completed sub-assemblies back to the Company. The Company does not reflect the sale of these components in Revenue and does not recognize any profits on these sales. The costs of the completed sub-assemblies are included in inventory upon purchase from the vendors.

 

     October 3,
2008
    June 27,
2008
 
     (in millions)  

Property, Equipment and Leasehold Improvements, net

  

Property, equipment and leasehold improvements

   $ 6,104     $ 5,845  

Accumulated depreciation and amortization

     (3,595 )     (3,381 )
                
   $ 2,509     $ 2,464  
                

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

2. Balance Sheet Information (continued)

Long-Term Debt and Credit Facilities

$300 Million Aggregate Principal Amount of Floating Rate Senior Notes due October 2009 (the “2009 Notes”). During the three months ended October 3, 2008, the 2009 Notes became due within 12 months. As such, the balance was reclassified to Current portion of long-term debt.

$326 Million Aggregate Principal Amount of 2.375% Convertible Senior Notes due August 2012 (the “2.375% Notes”). During the three months ended October 3, 2008, the 2.375% Notes were convertible and were classified as Current portion of long-term debt on the Company’s Condensed Consolidated Balance Sheet at October 3, 2008. During the three months ended October 3, 2008, the Company’s shares traded below 110% of the conversion price for the 2.375% Notes for at least 20 consecutive trading days of the last 30 trading days of the quarter. As a result, the 2.375% Notes became nonconvertible effective October 4, 2008, and will be reclassified as Long-term debt on the Company’s Condensed Consolidated Balance Sheet at January 2, 2009.

Revolving Credit Facility. As of October 3, 2008, there were no borrowings under the Company’s $500 million revolving credit facility and the Company had utilized $47 million of the $100 million sub-limit for outstanding letters of credit and bankers’ guarantees. As of October 3, 2008, the Company is in compliance with all the covenants under the credit agreement that governs the Company’s revolving credit facility.

Derivative Financial Instruments. The Company hedges portions of its forecasted expenditures denominated in foreign currencies with forward exchange contracts. At October 3, 2008, the total notional value of the Company’s outstanding foreign currency forward exchange contracts was approximately $475 million comprised of approximately $277 million to purchase Thai baht, $146 million to purchase Singapore dollars, $12 million to purchase British pounds, $12 million to purchase European euros, $11 million to purchase Chinese yuan, $11 million to purchase Czech koruna, and $6 million to purchase Japanese yen. At October 3, 2008, the fair value of the Company’s outstanding forward exchange contracts was a liability of approximately $25 million. Net foreign currency transaction losses included in the determination of consolidated net income were $6 million and $5 million for the three months ended October 3, 2008 and September 28, 2007, respectively.

3. Fair Value

During the three months ended October 3, 2008, the Company adopted the provisions of SFAS No. 157, Fair Value Measurements, (SFAS No. 157) for all financial assets and financial liabilities. SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and enhances disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements, but applies to other accounting pronouncements that require or permit fair value measurements. The adoption of SFAS No. 157 did not have a material impact on the Company’s consolidated financial statements.

In February 2008, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) 157-2, Effective Date of FASB Statement No. 157, which delays the effective date of SFAS No.157 for all non-financial assets and non-financial liabilities, except for items recognized or disclosed at fair value on a recurring basis. Accordingly, the Company will not apply the provisions of SFAS No. 157 to non-financial assets and non-financial liabilities until July 2009, the beginning of its next fiscal year.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

3. Fair Value (continued)

Measurement of Fair Value

SFAS No. 157 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability.

Fair Value Hierarchy

SFAS No. 157 establishes a fair value hierarchy based on whether the market participant assumptions used in determining fair value are obtained from independent sources (observable inputs) or reflect the Company’s own assumptions of market participant valuation (unobservable inputs). A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. SFAS No. 157 establishes three levels of inputs that may be used to measure fair value:

Level 1 – Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2 – Quoted prices for identical assets and liabilities in markets that are inactive; quoted prices for similar assets and liabilities in active markets or financial instruments for which significant inputs are observable, either directly or indirectly; or

Level 3 – Prices or valuations that require inputs that are both unobservable and significant to the fair value measurement.

The Company considers an active market to be one in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis, and views an inactive market as one in which there are few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers. Where appropriate the Company’s or the counterparty’s non-performance risk is considered in determining the fair values of liabilities and assets, respectively.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

3. Fair Value (continued)

Items Measured at Fair Value on a Recurring Basis

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis, excluding accrued interest components, at October 3, 2008, consistent with the fair value hierarchy provisions of SFAS No. 157.

 

     Fair Value Measurements at Reporting Date Using

(Dollars in millions)

   Quoted
Prices in
Active
Markets for
identical
instruments

(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs

(Level 3)
   Total
Balance

Assets:

           

Money market funds

   $ 543    $ —      $ —      $ 543

Asset-backed securities

     —        15      —        15

Agency bonds

     —        31      —        31

Corporate bonds

     —        18      —        18

Commercial paper

     —        375      —        375

Municipal bonds

     —        13      —        13

U.S. Treasuries

     —        74      —        74
                           

Total Cash Equivalents and Marketable Securities

     543      526      —        1,069
                           

Auction Rate Securities

     —        —        28      28
                           

Total Assets

   $ 543    $ 526    $ 28    $ 1,097
                           

Liabilities:

           

Derivative Liabilities(1)

   $ —      $ 25    $ —      $ 25
                           

Total Liabilities

   $ —      $ 25    $ —      $ 25
                           

 

Reported as:    Fair Value Measurements at Reporting Date Using

(Dollars in millions)

   Quoted
Prices in
Active
Markets for
identical
instruments

(Level 1)
   Significant
Other
Observable
Inputs

(Level 2)
   Significant
Unobservable
Inputs

(Level 3)
   Total
Balance
           

Assets:

           

Cash and cash equivalents

   $ 543    $ 378    $ —      $ 921

Short-term investments

     —        148      —        148

Other assets, net

     —        —        28      28
                           

Total Assets

   $ 543    $ 526    $ 28    $ 1,097
                           

Liabilities:

           

Foreign currency forward exchange contracts(1)

   $ —      $ 25    $ —      $ 25
                           

Total Liabilities

   $ —      $ 25    $ —      $ 25
                           

 

(1) The fair value of Foreign currency forward exchange contracts is classified within Accrued expenses in the Condensed Consolidated Balance Sheet at October 3, 2008.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

3. Fair Value (continued)

Level 1 assets consist of money market funds for which quoted prices are available in an active market.

The Company classifies items in Level 2 if the financial asset or liability is valued using observable inputs. Level 2 assets include: asset-backed securities, agency bonds, corporate bonds, commercial paper, municipal bonds, and U.S. Treasuries. These debt investments are priced using observable inputs and valuation models which vary by asset class. The Company uses a pricing service to assist in determining the fair values of all of its cash equivalents and marketable securities. For the cash equivalents and marketable securities in the Company’s portfolio, multiple pricing sources are generally available. The pricing service uses inputs from multiple industry standard data providers or other third party sources and various methodologies, such as weighting and models, to determine the appropriate price at the measurement date. The Company corroborates the prices obtained from the pricing service against other independent sources and as of October 3, 2008 has not found it necessary to make any adjustments.

The Company’s derivative financial instruments are also classified within Level 2. The Company’s derivative financial instruments consist of foreign currency forward contracts. The Company recognizes derivative financial instruments in its consolidated financial statements at fair value in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The Company determines the fair value of these instruments by considering the estimated amount it would pay or receive to terminate these agreements at the reporting date. The Company uses observable inputs including quoted prices in active markets for similar assets or liabilities.

Level 3 assets consist of auction rate securities with a par value of $31 million, all of which are collateralized by student loans guaranteed by the Federal Family Education Loan Program. Beginning in the March 2008 quarter, these securities failed to settle at auction and have continued to fail through the quarter ended October 3, 2008. Since there is no active market for these securities the Company valued them using a pricing model provided by a third party valuation firm. The valuation model is based on the income approach and reflects both observable and significant unobservable inputs. As of October 3, 2008, the estimated fair value of these auction rate securities was $28 million. Management believes that the impairment totaling $3 million, recorded during the three months ended June 27, 2008 and October 3, 2008, is temporary. Given the Company’s ability and intent to hold these securities until liquidity returns to this market or maturity of the securities, the impairment is recorded in Accumulated other comprehensive income and these securities are classified as Long-term investments in the Company’s Condensed Consolidated Balance Sheets.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

3. Fair Value (continued)

The table below presents a reconciliation of all assets and liabilities measured at fair value on a recurring basis, excluding accrued interest components, using significant unobservable inputs (Level 3) for the three months ended October 3, 2008:

 

     Fair Value
Measurements
Using Significant
Unobservable
Inputs

(Level 3)

(Dollars in millions)

   Auction Rate
Securities

Balance at June 27, 2008

   $ 28

Unrealized (losses)(1)

     —  

Purchases, sales, issuances, settlements

     —  

Transfers in/(out) of Level 3

     —  

Balance at October 3, 2008

   $ 28

 

(1) Unrealized gains and losses on available for sale securities are recorded as a separate component of other comprehensive income in the accumulated other comprehensive income (loss), which is a component of shareholders’ equity.

Other Fair Value Disclosures

In accordance with SFAS No. 107, Disclosures about Fair Value of Financial Instruments, the Company is required to disclose the fair value of its long-term debt at least annually or more frequently if the fair value has changed significantly.

The Company’s debt is carried at cost. The following table represents the fair value of the Company’s debt as of October 3, 2008 (in millions):

 

Reported as:    October 3, 2008    June 27, 2008

(Dollars in millions)

   Carrying
Amount
   Estimated
Fair Value
   Carrying
Amount
   Estimated
Fair Value

Floating Rate Senior Notes due October 2009

   $ 300    $ 287    $ 300    $ 293

6.375% Senior Notes due October 2011

     599      552      599      584

6.8% Senior Notes due October 2016

     599      522      599      555

6.8% Convertible Senior Notes due April 2010

     135      131      135      142

5.75% Subordinated debentures due March 2012

     41      38      41      40

2.375% Convertible Senior Notes due August 2012

     326      266      326      422

As of October 29, 2008, the total fair value of the Company’s debt noted in the table above has decreased by approximately $200 million as compared with the fair value on October 3, 2008.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

4. Income Taxes

The Company is a foreign holding company incorporated in the Cayman Islands with foreign and U.S. subsidiaries that operate in multiple taxing jurisdictions. As a result, the Company’s worldwide operating income either is subject to varying rates of tax or is exempt from tax due to tax holidays or tax incentive programs applicable in China, Malaysia, Singapore, Switzerland and Thailand. These tax holidays or incentives are scheduled to expire in whole or in part at various dates through 2020.

The income tax benefit recorded for the three months ended October 3, 2008 differs from the provision for income taxes that would be derived by applying a notional U.S. 35% rate to income before income taxes primarily due to the net effect of (i) the tax benefit related to the aforementioned tax holiday and tax incentive programs, (ii) a decrease in the Company’s valuation allowance for U.S. deferred tax assets attributable in part to tax legislation enacted during the period, (iii) tax expense related to intercompany transactions and (iv) U.S. and foreign tax benefits recorded during the quarter related to reductions in previously accrued taxes for uncertain tax positions due to settlement of tax audits and lapses of certain statutes of limitations. The income tax provision recorded for the three months ended September 28, 2007 differed from the provision for income taxes that would be derived by applying a notional U.S. 35% rate to income before income taxes primarily due to the net effect of (i) the tax benefit related to the aforementioned tax holiday and tax incentive programs, (ii) a decrease in the Company’s valuation allowance for U.S. deferred tax assets and (iii) the tax expense related to intercompany transactions.

Based on the Company’s foreign ownership structure, and subject to (i) potential future increases in the valuation allowance for deferred tax assets and (ii) limitations imposed by Internal Revenue Code Section 382 on usage of certain tax attributes, the Company anticipates that its effective tax rate in future periods will generally be less than the U.S. federal statutory rate. Dividend distributions received from the Company’s U.S. subsidiaries may be subject to U.S. withholding taxes when, and if distributed. Deferred tax liabilities have not been recorded on unremitted earnings of certain foreign subsidiaries, as these earnings will not be subject to tax in the Cayman Islands or U.S. federal income tax if remitted to the Company’s foreign parent holding company.

During the three months ended October 3, 2008, there were three major U.S. tax law changes with potential impact on the Company’s tax provision. On July 30, 2008, the Housing and Economic Recovery Act of 2008 was enacted. Under this law, companies can elect to accelerate a portion of their unused AMT and research tax credits in lieu of the 50-percent “bonus” depreciation enacted in February 2008. The Company expects that it qualifies for and will elect to accelerate approximately $11 million of R&D credit carryovers to fiscal years 2008 and 2009, of which approximately $8 million was recognized in the three months ended October 3, 2008. On October 3, 2008, the Emergency Economic Stabilization Act of 2008 was signed into law. Under this law, the R&D credit was retroactively extended through December 31, 2009 from December 31, 2007. This extension has no immediate impact on the Company’s tax provision. The California 2008-2009 Budget Bill (AB 1452), enacted on September 30, 2008, resulted in two temporary changes to the California income tax. First, the bill suspends the use of Net Operating Loss (NOL) carryovers for two years, fiscal years 2009 and 2010. Second, the bill limits the use of R&D credit carryovers to no more than 50% of the tax liability before credits. The Company estimates that the California change will result in an increase to income taxes for fiscal year 2009 of approximately $3 million as compared to the prior year.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

4. Income Taxes (continued)

As of October 3, 2008, the Company recorded net deferred tax assets of $888 million. The realization of $808 million of these deferred tax assets is primarily dependent on the Company’s ability to generate sufficient U.S. and certain foreign taxable income in future periods. Although realization is not assured, the Company’s management believes that it is more likely than not that these deferred tax assets will be realized.

During the three months ended October 3, 2008, the Company’s unrecognized tax benefits excluding interest and penalties decreased by approximately $15 million to $359 million primarily due to (i) reductions associated with audit activity of $6 million, (ii) reductions associated with the expiration of certain statutes of limitation of $5 million and (iii) other activity, primarily foreign exchange gains, of $4 million. Approximately $4 million of the three month change resulted in a reduction to goodwill with the remaining balance of $11 million reflected as a reduction to tax expense or as foreign exchange gains.

The total unrecognized tax benefits that, if recognized, would impact the effective tax rate were $55 million and $68 million as of October 3, 2008 and June 27, 2008, respectively.

During the 12 months beginning October 4, 2008, the Company expects to reduce its unrecognized tax benefits by approximately $19 million as a result of the expiration of certain statutes of limitation. The Company does not believe it is reasonably possible that other unrecognized tax benefits will materially change in the next 12 months. However, the resolution and/or timing of closure on open audits are highly uncertain as to when these events occur.

The Company files U.S. federal, U.S. state, and foreign tax returns. The statutes of limitation for U.S. Federal returns are open for fiscal year 2003 and forward. The Internal Revenue Service (IRS) has completed its examination of fiscal years ended in 2003 and 2004 and is currently examining fiscal years ending in 2005 through 2007. For state and foreign tax returns, the Company is generally no longer subject to tax examinations for years prior to fiscal year 2001.

5. Restructuring and Exit Costs

During the three months ended October 3, 2008, the Company recorded restructuring charges of $3 million in connection with the proposed closure of its research facility in Pittsburgh, Pennsylvania, as part of the Company’s ongoing focus on cost efficiencies in all areas of its business. The Company currently plans to cease operations at the Pittsburgh facility by the end of its fourth quarter in fiscal year 2009 and integrate certain activities into its other research and development facilities located within the United States. The Company currently estimates the total restructuring charges for the Pittsburgh closure to be approximately $23 million to $27 million. These remaining charges are expected to be incurred over the balance of fiscal year 2009 and include severance charges of approximately $5 million, facility lease costs after operations cease of $11 million to $15 million, and approximately $7 million of other exit costs.

The Company currently also expects to record accelerated depreciation related to the closure of the Pittsburgh facility of approximately $22 million to $28 million in Product development, of which $7 million is expected to be recorded in the second quarter of fiscal year 2009. The remaining accelerated depreciation charges are currently expected to be incurred over the balance of fiscal year 2009.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

5. Restructuring and Exit Costs (continued)

During the three months ended October 3, 2008, the Company recorded additional restructuring charges of approximately $10 million in connection with its ongoing restructuring activities. These costs were primarily a result of restructuring plans established to continue the alignment of the Company’s global workforce with existing and anticipated business requirements. The restructuring charges were comprised of employee termination costs relating to a continuing effort to optimize the Company’s production around the world and lease costs related to vacant facilities. The Company expects the majority of these restructuring activities to be completed by the fourth quarter of fiscal year 2009.

Under Emerging Issues Task Force 95-3, Recognition of Liabilities in Connection with a Business Combination (EITF 95-3), the Company accrued certain exit costs with respect to its acquisition of Maxtor in May 2006, relating to employee severance, planned exit of leased or owned excess facilities and the cancellation or settlement of contractual obligations that will not provide any future economic benefit. The Company’s accrued liability for such exit costs is comprised primarily of remaining excess facilities obligations. During the three months ended October 3, 2008, the Company recorded a $10 million adjustment to previously recorded restructuring charges to reflect its revised sub-lease expectations related to its Maxtor facilities closures and paid $2 million of the accrued exit costs. The Company expects the remaining costs associated with the exit of certain facilities to continue to the end of fiscal year 2016.

The following table summarizes the Company’s restructuring activities for the three months ended October 3, 2008:

 

     Severance and
Benefits
    Grant
Repayment
   Operating
Leases
    Total  
     (in millions)  

Accrual balances, June 27, 2008

   $ 52     $ 18    $ 17     $ 87  

Restructuring charge

     8       —        15       23  

Cash payments

     (6 )     —        (2 )     (8 )
                               

Accrual balances, October 3, 2008

   $ 54     $ 18    $ 30     $ 102  
                               

Of the accrued restructuring balance of approximately $102 million at October 3, 2008, $83 million is included in Accrued expenses and $19 million is included in Other non-current liabilities on the accompanying Condensed Consolidated Balance Sheet. Included in the accrued restructuring balance of $102 million at October 3, 2008 is $25 million for the Company’s Maxtor facilities closures, of which $10 million is classified as Accrued expenses and $15 million is classified as Other non-current liabilities.

6. Goodwill

At October 3, 2008, the Company’s goodwill totaled approximately $2.3 billion, of which approximately $2.2 billion relates to the Company’s acquisition of Maxtor Corporation in May 2006.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

7. Stock-Based Compensation

Stock-Based Benefit Plans

The Company’s stock-based benefit plans have been established to promote the Company’s long-term growth and financial success by providing incentives to its employees, directors, and consultants through grants of share-based awards. The provisions of the Company’s stock-based benefit plans, which allow for the grant of various types of equity-based awards, are also intended to provide flexibility to maintain the Company’s competitive ability to attract, retain and motivate participants for the benefit of the Company and its shareholders.

Seagate Technology 2004 Stock Compensation Plan — As of October 3, 2008, there were approximately 25 million shares available for issuance under the Seagate Technology 2004 Stock Compensation Plan.

Stock Purchase Plan — On July 31, 2008, the Company issued approximately 2.5 million common shares under its Employee Stock Purchase Plan (“ESPP”), with a weighted-average purchase price of $12.72 per share. As of October 3, 2008, there were approximately 6.4 million common shares available for issuance under the ESPP.

Determining Fair Value of Stock Options

The Company estimates the fair value of stock options granted using the Black-Scholes-Merton option-pricing formula and a single option award approach. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period or the remaining service (vesting) period.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

7. Stock-Based Compensation (continued)

The fair value of the Company’s stock options granted to employees for the three months ended October 3, 2008 and September 28, 2007, was estimated using the following weighted-average assumptions:

 

     For the Three Months Ended  
     October 3,
2008
    September 28,
2007
 

Option Plan Shares

    

Expected term (in years)

     4.0       4.0  

Volatility

     36 %     36 %

Expected dividend

     3.0 – 3.8 %     1.6 – 1.7 %

Risk-free interest rate

     3.0 %     4.2 %

Weighted-average fair value

   $ 3.26     $ 7.43  

ESPP Plan Shares

    

Expected term (in years)

     0.5       0.5  

Volatility

     39 %     31 %

Expected dividend

     3.2 %     1.7 %

Risk-free interest rate

     2.0 %     5.0 %

Weighted-average fair value

   $ 3.59     $ 5.49  

Stock Compensation Expense

Stock Compensation Expense — The Company recorded $27 million and $23 million of stock-based compensation during the three months ended October 3, 2008 and September 28, 2007, respectively. Of the $27 million recorded in the three months ended October 3, 2008, $3 million related to stock options assumed and nonvested shares exchanged in the Maxtor acquisition. Of the $23 million recorded in the three months ended September 28, 2007, $6 million related to stock options assumed and nonvested shares exchanged in the Maxtor acquisition. The Company has made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest.

Excess Tax Benefits from Stock Options — In accordance with guidance in SFAS No. 123 (Revised 2004), Share-Based Payment, the cash flows resulting from excess tax benefits (tax benefits related to the excess of proceeds from employee exercises of stock options over the stock-based compensation cost recognized for those options) are classified as financing cash flows. The Company did not recognize any excess tax benefits as a financing cash inflow during the three months ended October 3, 2008.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

8. Guarantees

Indemnifications of Officers and Directors

The Company has entered into indemnification agreements with the members of its board of directors to indemnify them to the extent permitted by law against any and all liabilities, costs, expenses, amounts paid in settlement and damages incurred by the directors as a result of any lawsuit, or any judicial, administrative or investigative proceeding in which the directors are sued as a result of their service as members of the Company’s board of directors.

Intellectual Property Indemnification Obligations

The Company has entered into agreements with customers and suppliers that include limited intellectual property indemnification obligations that are customary in the industry. These guarantees generally require the Company to compensate the other party for certain damages and costs incurred as a result of third party intellectual property claims arising from these transactions. The nature of the intellectual property indemnification obligations prevents the Company from making a reasonable estimate of the maximum potential amount it could be required to pay to its customers and suppliers. Historically, the Company has not made any significant indemnification payments under such agreements and no amount has been accrued in the accompanying Condensed Consolidated Financial Statements with respect to these indemnification obligations.

Product Warranty

The Company estimates and accrues product warranty costs at the time revenue is recognized. The Company generally warrants its products for periods from one to five years. The Company uses estimated repair or replacement costs and uses statistical modeling to estimate product return rates in order to determine its warranty obligations. In addition, estimated settlements for customer compensatory claims relating to product quality issues, if any, are accrued as warranty expense. Changes in the Company’s product warranty liability during the three months ended October 3, 2008 and September 28, 2007 were as follows:

 

     For the Three Months Ended  
     October 3,
2008
    September 28,
2007
 
     (in millions)  

Balance, beginning of period

   $ 445     $ 430  

Warranties issued

     78       60  

Repairs and replacements

     (69 )     (71 )

Changes in liability for pre-existing warranties, including expirations

     (9 )     23  
                

Balance, end of period

   $ 445     $ 442  
                

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

9. Equity

Issuance of Common Shares

During the three months ended October 3, 2008, the Company issued approximately 0.6 million of its common shares from the exercise of stock options and approximately 2.5 million of its common shares related to the Company’s ESPP.

Repurchases of Equity Securities

The Company did not repurchase any of its common shares during the three months ended October 3, 2008. As of October 3, 2008, the Company had approximately $2.0 billion remaining under the authorized $2.5 billion February 2008 stock repurchase plan.

10. Litigation

See Part II, Item 1, “Legal Proceedings.”

11. Recently Issued Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157. See Note 3 for further discussion.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115 (SFAS No. 159). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company did not elect the fair value option for any of its existing financial assets or financial liabilities.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 (SFAS No. 161). SFAS No. 161 requires disclosure of how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for and how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for fiscal years and interim periods beginning after November 15, 2008, with early adoption permitted. The Company is currently evaluating the impact of the pending adoption of SFAS No. 161 on its consolidated results of operations and financial condition.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

11. Recently Issued Accounting Pronouncements (continued)

In May 2008, the FASB issued FASB Staff Position (FSP), Accounting Principles Board (APB) Opinion No. 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) (FSP APB No. 14-1), which may require the Company to recognize additional non cash interest expense related to its Convertible Senior Notes in its consolidated statements of operations. FSP APB No. 14-1 requires the issuer to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuer’s nonconvertible debt borrowing rate. FSP APB No. 14-1 will be effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is not permitted. FSP APB No. 14-1 must be applied retrospectively to all periods presented pursuant to the guidance of SFAS No. 154, Accounting Changes and Error Corrections (SFAS No. 154). The Company will adopt FSP APB No. 14-1 in its fiscal year 2010, and is currently evaluating the impact of the pending adoption on its consolidated results of operations and financial condition.

12. Condensed Consolidating Financial Information

The Company has guaranteed obligations of Seagate Technology HDD Holdings (“HDD”) under senior notes totaling $1.5 billion comprised of $300 million aggregate principal amount of Floating Rate Senior Notes due October 2009 (the “2009 Notes”), $600 million aggregate principal amount of 6.375% Senior Notes due October 2011 (the “2011 Notes”) and $600 million aggregate principal amount of 6.8% Senior Notes due October 2016 (the “2016 Notes”, and together with the 2009 Notes and the 2011 Notes, the “Senior Notes”), on a full and unconditional basis, and prior to October 25, 2006 when the Company’s 8% Senior Notes due May 2009 (“8% Notes”) were redeemed, the Company had guaranteed HDD’s obligations under the 8% Notes. The following tables present parent guarantor, subsidiary issuer and combined non-guarantors Condensed Consolidating Balance Sheets of the Company and its subsidiaries at October 3, 2008 and June 27, 2008, the Condensed Consolidating Statements of Operations and the Condensed Consolidating Statements of Cash Flows for the three months ended October 3, 2008 and September 28, 2007. The information classifies the Company’s subsidiaries into Seagate Technology-parent company guarantor, HDD-subsidiary issuer, and the Combined Non-Guarantors based upon the classification of those subsidiaries. Under each of these instruments, dividends paid by HDD or its restricted subsidiaries would constitute restricted payments and loans between the Company and HDD or its restricted subsidiaries would constitute affiliate transactions.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

12. Condensed Consolidating Financial Information (continued)

Consolidating Balance Sheet

October 3, 2008

(In millions)

 

     Seagate
Technology
Parent
Company
Guarantor
   HDD
Subsidiary
Issuer
   Combined
Non-
Guarantors
   Eliminations     Seagate
Technology
Consolidated

Cash and cash equivalents

   $ 32    $ —      $ 973    $ —       $ 1,005

Short-term investments

     —        —        148      —         148

Accounts receivable, net

     —        —        1,393      —         1,393

Intercompany receivable

     —        —        186      (186 )     —  

Inventories

     —        —        909      —         909

Other current assets

     —        —        912      —         912
                                   

Total Current Assets

     32      —        4,521      (186 )     4,367

Property, equipment and leasehold improvements, net

     —        —        2,509      —         2,509

Goodwill

     —        —        2,349      —         2,349

Other intangible assets, net

     —        —        94      —         94

Equity investment in HDD

     7,850      —        —        (7,850 )     —  

Equity investments in Non-Guarantors

     —        6,097      297      (6,394 )     —  

Intercompany note receivable

     —        3,237      671      (3,908 )     —  

Other assets, net

     —        13      837      —         850
                                   

Total Assets

   $ 7,882    $ 9,347    $ 11,278    $ (18,338 )   $ 10,169
                                   

Accounts payable

   $ —      $ —      $ 1,930    $ —       $ 1,930

Intercompany payable

     —        —        186      (186 )     —  

Accrued employee compensation

     —        —        153      —         153

Accrued expenses

     —        —        838      —         838

Accrued income taxes

     —        —        6      —         6

Current portion of long-term debt

     —        300      360      —         660
                                   

Total Current Liabilities

     —        300      3,473      (186 )     3,587

Other non-current liabilities

     —        —        376      —         376

Intercompany note payable

     3,237      —        671      (3,908 )     —  

Long-term accrued income taxes

     —        —        191      —         191

Long-term debt, less current portion

     —        1,197      173      —         1,370

Liability for deficit of Maxtor

     —        —        607      (607 )     —  
                                   

Total Liabilities

     3,237      1,497      5,491      (4,701 )     5,524
                                   

Shareholders’ Equity

     4,645      7,850      5,787      (13,637 )     4,645
                                   

Total Liabilities and Shareholders’ Equity

   $ 7,882    $ 9,347    $ 11,278    $ (18,338 )   $ 10,169
                                   

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

12. Condensed Consolidating Financial Information (continued)

Consolidating Balance Sheet

June 27, 2008

(In millions)

 

     Seagate
Technology
Parent
Company
Guarantor
   HDD
Subsidiary
Issuer
   Combined
Non-
Guarantors
   Eliminations     Seagate
Technology
Consolidated
     (In millions)

Cash and cash equivalents

   $ 3    $ —      $ 987    $ —       $ 990

Short-term investments

     —        —        151      —         151

Accounts receivable, net

     —        —        1,410      —         1,410

Intercompany receivable

     —        —        181      (181 )     —  

Inventories

     —        —        945      —         945

Other current assets

     —        —        776      —         776
                                   

Total Current Assets

     3      —        4,450      (181 )     4,272
                                   

Property, equipment and leasehold improvements, net

     —        —        2,464      —         2,464

Goodwill

     —        —        2,352      —         2,352

Other intangible assets, net

     —        —        111      —         111

Equity investment in HDD

     7,767      —        —        (7,767 )     —  

Equity investments in Non-Guarantors

     —        6,089      294      (6,383 )     —  

Intercompany note receivable

     —        3,183      652      (3,835 )     —  

Other assets, net

     —        14      907      —         921
                                   

Total Assets

   $ 7,770    $ 9,286    $ 11,230    $ (18,166 )   $ 10,120
                                   

Accounts payable

   $ —      $ —      $ 1,652    $ —       $ 1,652

Intercompany payable

     —        —        181      (181 )     —  

Accrued employee compensation

     —        —        440      —         440

Accrued expenses

     1      22      802      —         825

Accrued income taxes

     —        —        10      —         10

Current portion of long-term debt

     —        —        360      —         360
                                   

Total Current Liabilities

     1      22      3,445      (181 )     3,287
                                   

Other liabilities

     —        —        577      —         577

Intercompany note payable

     3,183      —        652      (3,835 )     —  

Long-term debt, less current portion

     —        1,497      173      —         1,670

Liability for deficit of Maxtor

     —        —        595      (595 )     —  
                                   

Total Liabilities

     3,184      1,519      5,442      (4,611 )     5,534
                                   

Shareholders’ Equity

     4,586      7,767      5,788      (13,555 )     4,586
                                   

Total Liabilities and Shareholders’ Equity

   $ 7,770    $ 9,286    $ 11,230    $ (18,166 )   $ 10,120
                                   

 

25


Table of Contents

SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

12. Condensed Consolidating Financial Information (continued)

Consolidating Statement of Operations

Three Months Ended October 3, 2008

(In millions)

 

     Seagate
Technology
Parent
Company
Guarantor
   HDD
Subsidiary
Issuer
    Combined
Non-
Guarantors
    Eliminations     Seagate
Technology
Consolidated
 

Revenue

   $ —      $ —       $ 3,033     $ —       $ 3,033  

Cost of revenue

     —        —         2,508       —         2,508  

Product development

     —        —         260       —         260  

Marketing and administrative

     —        —         148       —         148  

Amortization of intangibles

     —        —         14       —         14  

Restructuring

     —        —         23       —         23  
                                       

Total operating expenses

     —        —         2,953       —         2,953  
                                       

Income from operations

     —        —         80       —         80  

Interest income

     —        —         15       (8 )     7  

Interest expense

     —        (23 )     (15 )     8       (30 )

Equity in income of HDD

     60      —         —         (60 )     —    

Equity in income (loss) of Non-Guarantors

     —        83       (23 )     (60 )     —    

Other, net

     —        —         (13 )     —         (13 )
                                       

Other income (expense), net

     60      60       (36 )     (120 )     (36 )
                                       

Income before income taxes

     60      60       44       (120 )     44  

Provision for (benefit from) income taxes

     —        —         (16 )     —         (16 )
                                       

Net income

   $ 60    $ 60     $ 60     $ (120 )   $ 60  
                                       

 

26


Table of Contents

SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

12. Condensed Consolidating Financial Information (continued)

Consolidating Statement of Cash Flows

Three Months Ended October 3, 2008

(In millions)

 

     Seagate
Technology
Parent
Company
Guarantor
    HDD
Subsidiary
Issuer
    Combined
Non-
Guarantors
    Eliminations     Seagate
Technology
Consolidated
 

OPERATING ACTIVITIES

          

Net income

   $ 60     $ 60     $ 60     $ (120 )   $ 60  

Adjustments to reconcile net income to net cash (used in) provided by operating activities:

          

Depreciation and amortization

     —         —         253       —         253  

Stock-based compensation

     —         —         27       —         27  

Equity in (income) of HDD

     (60 )     —         —         60       —    

Equity in (income) loss of Non-Guarantors

     —         (83 )     23       60       —    

Other non-cash operating activities, net

     —         1       (12 )     —         (11 )

Changes in operating assets and liabilities, net

     (1 )     (21 )     (3 )     —         (25 )
                                        

Net cash (used in) provided by operating activities

     (1 )     (43 )     348       —         304  

INVESTING ACTIVITIES

          

Acquisition of property, equipment and leasehold improvements

     —         —         (280 )     —         (280 )

Purchase of short-term investments

     —         —         (90 )     —         (90 )

Maturities and sales of short-term investments

     —         —         93       —         93  

Other investing activities, net

     —         —         12       —         12  
                                        

Net cash provided by (used in) investing activities

     —         —         (265 )     —         (265 )

FINANCING ACTIVITIES

          

Loan from HDD to Parent

     54       (54 )     —         —         —    

Investment by HDD in Non-Guarantor

     —         (1 )     1       —         —    

Distribution from Non-Guarantor to HDD

     —         98       (98 )     —         —    

Proceeds from exercise of employee stock options and employee stock purchase plan

     35       —         —         —         35  

Dividends to shareholders

     (59 )     —         —         —         (59 )
                                        

Net cash provided by (used in) financing activities

     30       43       (97 )     —         (24 )
                                        

Increase (decrease) in cash and cash equivalents

     29       —         (14 )     —         15  

Cash and cash equivalents at the beginning of the period

     3       —         987       —         990  
                                        

Cash and cash equivalents at the end of the period

   $ 32     $ —       $ 973     $ —       $ 1,005  
                                        

 

27


Table of Contents

SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

12. Condensed Consolidating Financial Information (continued)

Consolidating Statement of Operations

Three Months Ended September 28, 2007

(In millions)

 

     Seagate
Technology
Parent
Company
Guarantor
    HDD
Subsidiary
Issuer
    Combined
Non-
Guarantors
    Eliminations     Seagate
Technology
Consolidated
 

Revenue

   $ —       $ —       $ 3,285     $ —       $ 3,285  

Cost of revenue

     —         —         2,476       —         2,476  

Product development

     —         —         242       —         242  

Marketing and administrative

     1       —         152       —         153  

Amortization of intangibles

     —         —         13       —         13  

Restructuring

     —         —         5       —         5  
                                        

Total operating expenses

     1       —         2,888       —         2,889  
                                        

Income (loss) from operations

     (1 )     —         397       —         396  

Interest income

     —         —         26       (10 )     16  

Interest expense

     —         (24 )     (18 )     10       (32 )

Equity in income of HDD

     356       —         —         (356 )     —    

Equity in income (loss) of Non-Guarantors

     —         380       (27 )     (353 )     —    

Other, net

     —         —         (5 )     —         (5 )
                                        

Other income (expense), net

     356       356       (24 )     (709 )     (21 )
                                        

Income before income taxes

     355       356       373       (709 )     375  

Provision for (benefit from) income taxes

     —         —         20       —         20  
                                        

Net income

   $ 355     $ 356     $ 353     $ (709 )   $ 355  
                                        

 

28


Table of Contents

SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

12. Condensed Consolidating Financial Information (continued)

Consolidating Statement of Cash Flows

Three Months Ended September 28, 2007

(In millions)

 

     Seagate
Technology
Parent
Company
Guarantor
    HDD
Subsidiary
Issuer
    Combined
Non-
Guarantors
    Eliminations     Seagate
Technology
Consolidated
 

OPERATING ACTIVITIES

          

Net Income

   $ 355     $ 356     $ 353     $ (709 )   $ 355  

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

          

Depreciation and amortization

     —         —         205       —         205  

Stock-based compensation

     —         —         29       —         29  

Equity in (income) of HDD

     (356 )     —         —         356       —    

Equity in (income) loss of Non-Guarantors

     —         (380 )     27       353       —    

Other non-cash operating activities, net

     —         2       13       —         15  

Changes in operating assets and liabilities, net

     (32 )     17       165       —         150  
                                        

Net cash provided by (used in) operating activities

     (33 )     (5 )     792       —         754  

INVESTING ACTIVITIES

          

Acquisition of property, equipment and leasehold improvements

     —         —         (150 )     —         (150 )

Purchase of short-term investments

     —         —         (198 )     —         (198 )

Maturities and sales of short-term investments

     —         —         119       —         119  

Acquisitions, net of cash and cash equivalents acquired

     —         —         (6 )     —         (6 )

Other investing activities, net

     —         —         (3 )     —         (3 )
                                        

Net cash provided by (used in) investing activities

     —         —         (238 )     —         (238 )

FINANCING ACTIVITIES

          

Loan from HDD to Parent

     278       (278 )     —         —         —    

Distribution from Non-Guarantor to HDD

     —         283       (283 )     —         —    

Proceeds from exercise of employee stock options and employee stock purchase plan

     62       —         —         —         62  

Dividends to shareholders

     (54 )     —         —         —         (54 )

Repurchases of common shares

     (249 )     —         —         —         (249 )
                                        

Net cash provided by (used in) financing activities

     37       5       (283 )     —         (241 )
                                        

Increase in cash and cash equivalents

     4       —         271       —         275  

Cash and cash equivalents at the beginning of the period

     4       —         984       —         988  
                                        

Cash and cash equivalents at the end of the period

   $ 8     $ —       $ 1,255     $ —       $ 1,263  
                                        

 

29


Table of Contents

SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

12. Condensed Consolidating Financial Information (continued)

On May 19, 2006, in connection with the acquisition of Maxtor, the Company, Maxtor and the trustee under the indenture for the 2.375% Notes and 6.8% Notes entered into a supplemental indenture pursuant to which such notes became convertible into the Company’s common shares. In addition, the Company agreed to fully and unconditionally guarantee the 2.375% Notes and 6.8% Notes on a senior unsecured basis. The Company’s obligations under its guarantee rank in right of payment with all of its existing and future senior unsecured indebtedness. The indenture does not contain any financial covenants and does not restrict Maxtor from paying dividends, incurring additional indebtedness or issuing or repurchasing its other securities. The following tables present parent guarantor, subsidiary issuer and combined non-guarantors Condensed Consolidating Balance Sheets of the Company and its subsidiaries at October 3, 2008 and June 27, 2008, and the Condensed Consolidating Statements of Operations and the Condensed Consolidating Statements of Cash Flows for the three months ended October 3, 2008 and September 28, 2007. The information classifies the Company’s subsidiaries into Seagate Technology-parent company guarantor, Maxtor-subsidiary issuer and the Combined Non-Guarantors based on the classification of those subsidiaries under the terms of the 2.375% Notes and 6.8% Notes.

 

30


Table of Contents

SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

12. Condensed Consolidating Financial Information (continued)

 

Consolidating Balance Sheet

October 3, 2008

(In millions)

 

     Seagate
Technology
Parent
Company
Guarantor
   Maxtor
Subsidiary
Issuer
    Combined
Non-
Guarantors
   Eliminations     Seagate
Technology
Consolidated

Cash and cash equivalents

   $ 32    $ 1     $ 972    $ —       $ 1,005

Short-term investments

     —        —         148      —         148

Accounts receivable, net

     —        —         1,393      —         1,393

Intercompany receivable

     —        186       —        (186 )     —  

Inventories

     —        —         909      —         909

Other current assets

     —        —         912      —         912
                                    

Total Current Assets

     32      187       4,334      (186 )     4,367

Property, equipment and leasehold improvements, net

     —        3       2,506      —         2,509

Goodwill

     —        —         2,349      —         2,349

Other intangible assets, net

     —        —         94      —         94

Equity investments in Non-Guarantors

     7,850      297       6,097      (14,244 )     —  

Intercompany note receivable

     —        —         3,908      (3,908 )     —  

Other assets, net

     —        298       552      —         850
                                    

Total Assets

   $ 7,882    $ 785     $ 19,840    $ (18,338 )   $ 10,169
                                    

Accounts payable

   $ —      $ —       $ 1,930    $ —       $ 1,930

Intercompany payable

     —        —         186      (186 )     —  

Accrued employee compensation

     —        —         153      —         153

Accrued expenses

     —        29       809      —         838

Accrued income taxes

     —        6       —        —         6

Current portion of long-term debt

     —        330       330      —         660
                                    

Total Current Liabilities

     —        365       3,408      (186 )     3,587

Other non-current liabilities

     —        55       321      —         376

Intercompany note payable

     3,237      671       —        (3,908 )     —  

Long-term accrued income taxes

     —        128       63      —         191

Long-term debt, less current portion

     —        173       1,197      —         1,370

Liability for deficit of Maxtor

     —        —         607      (607 )     —  
                                    

Total Liabilities

     3,237      1,392       5,596      (4,701 )     5,524
                                    

Shareholders’ Equity (Deficit)

     4,645      (607 )     14,244      (13,637 )     4,645
                                    

Total Liabilities and Shareholders’ Equity

   $ 7,882    $ 785     $ 19,840    $ (18,338 )   $ 10,169
                                    

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

12. Condensed Consolidating Financial Information (continued)

 

Consolidating Balance Sheet

June 27, 2008

(In millions)

 

     Seagate
Technology
Parent
Company
Guarantor
   Maxtor
Subsidiary
Issuer
    Combined
Non-
Guarantors
   Eliminations     Seagate
Technology
Consolidated

Cash and cash equivalents

   $ 3    $ 1     $ 986    $ —       $ 990

Short-term investments

     —        —         151      —         151

Accounts receivable, net

     —        —         1,410      —         1,410

Intercompany receivable

     —        181       —        (181 )     —  

Inventories

     —        —         945      —         945

Other current assets

     —        —         776      —         776
                                    

Total Current Assets

     3      182       4,268      (181 )     4,272

Property, equipment and leasehold improvements, net

     —        4       2,460      —         2,464

Goodwill

     —        —         2,352      —         2,352

Other intangible assets, net

     —        —         111      —         111

Equity investments in Non-Guarantors

     7,767      294       6,089      (14,150 )     —  

Intercompany note receivable

     —        —         3,835      (3,835 )     —  

Other assets, net

     —        298       623      —         921
                                    

Total Assets

   $ 7,770    $ 778     $ 19,738    $ (18,166 )   $ 10,120
                                    

Accounts payable

   $ —      $ —       $ 1,652    $ —       $ 1,652

Intercompany payable

     —        —         181      (181 )     —  

Accrued employee compensation

     —        —         440      —         440

Accrued expenses

     1      29       795      —         825

Accrued income taxes

     —        6       4      —         10

Current portion of long-term debt

     —        330       30      —         360
                                    

Total Current Liabilities

     1      365       3,102      (181 )     3,287

Other non-current liabilities

     —        183       394      —         577

Intercompany note payable

     3,183      652       —        (3,835 )     —  

Long-term debt, less current portion

     —        173       1,497      —         1,670

Liability for deficit of Maxtor

     —        —         595      (595 )     —  
                                    

Total Liabilities

     3,184      1,373       5,588      (4,611 )     5,534
                                    

Shareholders’ Equity (Deficit)

     4,586      (595 )     14,150      (13,555 )     4,586
                                    

Total Liabilities and Shareholders’ Equity

   $ 7,770    $ 778     $ 19,738    $ (18,166 )   $ 10,120
                                    

 

32


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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

12. Condensed Consolidating Financial Information (continued)

 

Consolidating Statement of Operations

Three Months Ended October 3, 2008

(In millions)

 

     Seagate
Technology
Parent
Company
Guarantor
   Maxtor
Subsidiary
Issuer
    Combined
Non-
Guarantors
    Eliminations     Seagate
Technology
Consolidated
 

Revenue

   $ —      $ —       $ 3,033     $ —       $ 3,033  

Cost of revenue

     —        1       2,507       —         2,508  

Product development

     —        2       258       —         260  

Marketing and administrative

     —        —         148       —         148  

Amortization of intangibles

     —        —         14       —         14  

Restructuring

     —        10       13       —         23  
                                       

Total operating expenses

     —        13       2,940       —         2,953  
                                       

Income (loss) from operations

     —        (13 )     93       —         80  

Interest income

     —        —         15       (8 )     7  

Interest expense

     —        (15 )     (23 )     8       (30 )

Equity in loss of Maxtor

     —        —         (25 )     25       —    

Equity in income of Non-Guarantors

     60      2       83       (145 )     —    

Other, net

     —        —         (13 )     —         (13 )
                                       

Other income (expense), net

     60      (13 )     37       (120 )     (36 )
                                       

Income (loss) before income taxes

     60      (26 )     130       (120 )     44  

Provision for (benefit from) income taxes

     —        (1 )     (15 )     —         (16 )
                                       

Net income (loss)

   $ 60    $ (25 )   $ 145     $ (120 )   $ 60  
                                       

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

12. Condensed Consolidating Financial Information (continued)

 

Consolidating Statement of Cash Flows

Three Months Ended October 3, 2008

(In millions)

 

     Seagate
Technology
Parent
Company
Guarantor
    Maxtor
Subsidiary
Issuer
    Combined
Non-
Guarantors
    Eliminations     Seagate
Technology
Consolidated
 

OPERATING ACTIVITIES

          

Net income (loss)

   $ 60     $ (25 )   $ 145     $ (120 )   $ 60  

Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:

          

Depreciation and amortization

     —         1       252       —         253  

Stock-based compensation

     —         3       24       —         27  

Equity in loss of Maxtor

     —         —         25       (25 )     —    

Equity in (income) loss of Non-Guarantors

     (60 )     (2 )     (83 )     145       —    

Other non-cash operating activities, net

     —         —         (11 )     —         (11 )

Changes in operating assets and liabilities, net

     (1 )     (2 )     (22 )     —         (25 )
                                        

Net cash (used in) provided by operating activities

     (1 )     (25 )     330       —         304  

INVESTING ACTIVITIES

          

Acquisition of property, equipment and leasehold improvements

     —         —         (280 )     —         (280 )

Purchase of short-term investments

     —         —         (90 )     —         (90 )

Maturities and sales of short-term investments

     —         —         93       —         93  

Other investing activities, net

     —         —         12       —         12  
                                        

Net cash provided by (used in) investing activities

     —         —         (265 )     —         (265 )

FINANCING ACTIVITIES

          

Loan from Non-Guarantor to Parent

     54       —         (54 )     —         —    

Loan from Non-Guarantor to Maxtor

     —         19       (19 )     —         —    

Distribution from Non-Guarantor to HDD

     —         —         (98 )     98       —    

Distribution to HDD from Non-Guarantor

     —         —         98       (98 )     —    

Distribution from Non-Guarantor to Maxtor

     —         6       (6 )     —         —    

Proceeds from exercise of employee stock options and employee stock purchase plan

     35       —         —         —         35  

Dividends to shareholders

     (59 )     —         —         —         (59 )
                                        

Net cash provided by (used in) financing activities

     30       25       (79 )     —         (24 )
                                        

Increase (decrease) in cash and cash equivalents

     29       —         (14 )     —         15  

Cash and cash equivalents at the beginning of the period

     3       1       986       —         990  
                                        

Cash and cash equivalents at the end of the period

   $ 32     $ 1     $ 972     $ —       $ 1,005  
                                        

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

12. Condensed Consolidating Financial Information (continued)

 

Consolidating Statement of Operations

Three Months Ended September 28, 2007

(In millions)

 

     Seagate
Technology
Parent
Company
Guarantor
    Maxtor
Subsidiary
Issuer
    Combined
Non-
Guarantors
    Eliminations     Seagate
Technology
Consolidated
 

Revenue

   $ —       $ 7     $ 3,278     $ —       $ 3,285  

Cost of revenue

     —         8       2,468       —         2,476  

Product development

     —         3       239       —         242  

Marketing and administrative

     1       4       148       —         153  

Amortization of intangibles

     —         —         13       —         13  

Restructuring

     —         —         5       —         5  
                                        

Total operating expenses

     1       15       2,873       —         2,889  
                                        

Income (loss) from operations

     (1 )     (8 )     405       —         396  

Interest income

     —         —         26       (10 )     16  

Interest expense

     —         (17 )     (25 )     10       (32 )

Equity in loss of Maxtor

     —         —         (26 )     26       —    

Equity in income (loss) of Non-Guarantors

     356       (1 )     380       (735 )     —    

Other, net

     —         —         (5 )     —         (5 )
                                        

Other income (expense), net

     356       (18 )     350       (709 )     (21 )
                                        

Income (loss) before income taxes

     355       (26 )     755       (709 )     375  

Provision for income taxes

     —         —         20       —         20  
                                        

Net income (loss)

   $ 355     $ (26 )   $ 735     $ (709 )   $ 355  
                                        

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

12. Condensed Consolidating Financial Information (continued)

 

Consolidating Statement of Cash Flows

Three Months Ended September 28, 2007

(In millions)

 

     Seagate
Technology
Parent
Company
Guarantor
    Maxtor
Subsidiary
Issuer
    Combined
Non-
Guarantors
    Eliminations     Seagate
Technology
Consolidated
 

OPERATING ACTIVITIES

          

Net Income (Loss)

   $ 355     $ (26 )   $ 735     $ (709 )   $ 355  

Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:

          

Depreciation and amortization

     —         1       204       —         205  

Stock-based compensation

     —         6       23       —         29  

Equity in loss of Maxtor

     —         —         26       (26 )     —    

Equity in (income) loss of Non-Guarantors

     (356 )     1       (380 )     735       —    

Other non-cash operating activities, net

     —         7       8       —         15  

Changes in operating assets and liabilities, net

     (32 )     (10 )     192       —         150  
                                        

Net cash (used in) provided by operating activities

     (33 )     (21 )     808       —         754  

INVESTING ACTIVITIES

          

Acquisition of property, equipment and leasehold improvements

     —         —         (150 )     —         (150 )

Purchase of short-term investments

     —         —         (198 )     —         (198 )

Maturities and sales of short-term investments

     —         —         119       —         119  

Acquisitions, net of cash and cash equivalents acquired

     —         —         (6 )     —         (6 )

Other investing activities, net

     —         —         (3 )     —         (3 )
                                        

Net cash provided by (used in) investing activities

     —         —         (238 )     —         (238 )

FINANCING ACTIVITIES

          

Loan from Non-Guarantor to Parent

     278       —         (278 )     —         —    

Loan from Non-Guarantor to Maxtor

     —         14       (14 )     —         —    

Distribution from Non-Guarantor to HDD

     —         —         (283 )     283       —    

Distribution to HDD from Non-Guarantor

     —         —         283       (283 )     —    

Distribution from Non-Guarantor to Maxtor

     —         5       (5 )     —         —    

Proceeds from exercise of employee stock options and employee stock purchase plan

     62       —         —         —         62  

Dividends to shareholders

     (54 )     —         —         —         (54 )

Repurchases of common shares

     (249 )     —         —         —         (249 )
                                        

Net cash provided by (used in) financing activities

     37       19       (297 )     —         (241 )
                                        

Increase (decrease) in cash and cash equivalents

     4       (2 )     273       —         275  

Cash and cash equivalents at the beginning of the period

     4       3       981       —         988  
                                        

Cash and cash equivalents at the end of the period

   $ 8     $ 1     $ 1,254     $ —       $ 1,263  
                                        

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is a discussion of the financial condition and results of operations for our fiscal quarter ended October 3, 2008, herein referred to as “the September 2008 quarter.” Unless the context indicates otherwise, as used herein, the terms “we,” “us,” “Seagate” and “our” refer to Seagate Technology, an exempted company incorporated with limited liability under the laws of the Cayman Islands, together with its subsidiaries.

You should read this discussion in conjunction with financial information and related notes included elsewhere in this report. We operate and report financial results on a fiscal year of 52 or 53 weeks ending on the Friday closest to June 30. The quarter ended October 3, 2008 was 14 weeks and the quarters ended June 27, 2008 and September 28, 2007 were both 13 weeks. Except as noted, references to any fiscal year mean the twelve-month period ending on the Friday closest to June 30 of that year.

Some of the statements and assumptions included in this Quarterly Report on Form 10-Q are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 or Section 21E of the Securities Exchange Act of 1934, each as amended, including, in particular, statements about our plans, strategies and prospects and estimates of industry growth for the fiscal quarter ending January 2, 2009 and beyond. These statements identify prospective information and include words such as “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “projects” and similar expressions. These forward-looking statements are based on information available to us as of the date of this report. Current expectations, forecasts and assumptions involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from those anticipated by these forward-looking statements. Such risks, uncertainties and other factors may be beyond our control. In particular, uncertainty in global economic conditions pose a risk to the overall economy as consumers and businesses may defer purchases in response to tighter credit and negative financial news. Such risks and uncertainties also include the impact of the variable demand and the aggressive pricing environment for disk drives, particularly in view of current business and economic conditions; dependence on our ability to successfully qualify, manufacture and sell our disk drive products in increasing volumes on a cost-effective basis and with acceptable quality, particularly our new disk drive products with lower cost structures; the impact of competitive product announcements and possible excess industry supply with respect to particular disk drive products; our ability to achieve projected cost savings in connection with our announced restructuring plans; market conditions and alternative cash imperatives that could impact our ability to repurchase additional common shares pursuant to our previously announced share repurchase program; and the factors listed in the “Risk Factors” section of Item 1A of Part II of this Quarterly Report on Form 10-Q, which we encourage you to carefully read. We also encourage you to read our Annual Report on Form 10-K as filed with the U.S. Securities and Exchange Commission on August 13, 2008 as it contains information concerning risk, uncertainties and other factors that could cause results to differ materially from those projected in the forward-looking statements These forward-looking statements should not be relied upon as representing our views as of any subsequent date and we undertake no obligation to update forward-looking statements to reflect events or circumstances after the date they were made.

Our Company

We are the world’s leading provider of hard disk drives, based on revenue and units shipped. We design, manufacture, market and sell hard disk drives. Hard disk drives, commonly referred to as disk drives or hard drives, are devices that store digitally encoded data on rapidly rotating platters or disks with magnetic surfaces. The performance attributes of disk drives, including their cost effectiveness and high storage capacities has resulted in disk drives being used as the primary medium for storing electronic data in systems ranging from desktop and notebook computers, and consumer electronics devices to data centers delivering electronic data over corporate networks and the Internet.

 

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We produce a broad range of disk drive products addressing enterprise applications, where our products are used in enterprise servers, mainframes and workstations; desktop applications, where our products are used in desktop computers; mobile computing applications, where our products are used in notebook computers; and consumer electronics applications, where our products are used in a wide variety of devices such as digital video recorders (DVRs) and other consumer electronic devices that require storage. We also sell our branded storage solutions under both the Seagate and Maxtor brands. In addition to manufacturing and selling disk drives, we provide data storage services for small- to medium-sized businesses, including online backup, data protection and recovery solutions.

We sell our disk drives primarily to major original equipment manufacturers (OEMs), and we also market to distributors and retailers under our globally recognized brand names. We have longstanding relationships with many of our OEM customers including Hewlett-Packard, Dell, EMC, Lenovo and IBM. We also have key relationships with major distributors, who sell our disk drive products to small OEMs, dealers, system integrators and retailers throughout most of the world. Substantially all of our revenue is denominated in U.S. dollars.

The following table summarizes our disk drive revenue by channel and by geography:

 

     Fiscal Quarters Ended
     October 3,
2008
  June 27,
2008
  September 28,
2007

Revenues by Channel (%)

      

OEM

   66%   68%   66%

Distributors

   27%   25%   28%

Retailers

     7%     7%     6%

Revenues by Geography (%)

      

North America

   27%   30%   29%

Europe

   29%   27%   27%

Far East

   44%   43%   44%

For the fiscal quarters shown above, the only customers exceeding 10% of our disk drive revenue were Hewlett-Packard and Dell.

Industry Overview

Our industry is characterized by several trends that have a material impact on our strategic planning, financial condition and results of operations.

Disk Drive Industry Consolidation

Due to the significant challenges posed by the need to continually innovate and improve manufacturing efficiency and because of the increasing amounts of capital and research and development investments required, the disk drive industry has undergone significant consolidation as disk drive manufacturers and component manufacturers merged with other companies or exited the industry. Through such combinations, disk drive manufacturers have also become increasingly vertically integrated. While recent combinations have limited the opportunity for additional industry consolidation, the increasing technological challenges, associated levels of investment and competitive necessity of large-scale operations may still drive future industry consolidation. Additionally, we may in the future face indirect competition from customers who from time to time evaluate whether to offer electronic data storage products that may compete with our products.

 

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Price Erosion

Our industry has been characterized by continuous price erosion for disk drive products with comparable capacity, performance and feature sets (“like-for-like products”). Price erosion for like-for-like products (“price erosion”) is more pronounced during periods of:

 

   

economic contraction or industry consolidation in which competitors may use discounted pricing to attempt to maintain or gain market share;

 

   

few new product introductions when multiple competitors have comparable or alternative product offerings;

 

   

temporary imbalances between industry supply and demand; and

 

   

seasonally weaker demand, which may cause excess supply.

Disk drive manufacturers typically attempt to offset price erosion with an improved mix of disk drive products characterized by higher capacity, better performance and additional feature sets and/or product cost reductions.

We expect price erosion in our industry will continue for the foreseeable future. To remain competitive, we believe it will be necessary to continue to reduce prices as well as introduce new product offerings that utilize advanced technologies ahead of our competitors in order to take advantage of potentially higher initial profit margins and reduced cost structures on these new products.

Disk Drive Industry Demand Trends

We believe that the disk drive industry is experiencing the following long-term demand trends:

We believe that technological advances in storage technology and a proliferation of non-compute applications are increasingly driving the broad, global proliferation of digital content through the creation, sharing, aggregation, distribution, consumption and protection of all types of digital content. We believe that growth in digital content is being driven by increases in media-rich as well as user generated content, the digitization of content previously stored in analog format and the duplication of content in multiple locations. As a result of these factors, the nature and amount of content being created requires increasingly higher storage capacity in order to store, manage, distribute, back up and use such content, resulting in faster growth in higher capacity disk drive products.

We believe that demand for electronic data storage in the enterprise and traditional compute markets continues to grow as increasing legal and regulatory requirements and changes in the nature and amount of data being stored have necessitated additional storage. Additionally, the proliferation of digital content in the consumer space has resulted in additional demand for storage by enterprises, including those that host, aggregate, distribute or share such content.

In addition to these long-term positive demand trends, the industry is sensitive to changes in global economic activity and may be impacted by the current economic contraction.

 

   

Disk Drives for Mobile Compute. The mobile compute market is growing faster than the market for desktop computers as price and performance continue to improve. Notebook systems are increasingly becoming the preference for both

 

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consumers and enterprises as the need for mobility increases and wireless adoption continues to advance. We estimate that in the September 2008 quarter, industry shipments of disk drives for mobile compute applications grew approximately 30% and 45% from the immediately preceding and year-ago quarters, respectively.

The disk drive industry has recently seen the introduction of alternative technologies that directly compete with mobile disk drives. For example, certain manufacturers have introduced solid state drives (SSDs) using flash memory technology, which are an alternative to disk drives in certain applications. We believe that the market for these alternative technologies is still developing and because of the current high cost per gigabyte of these storage solutions, we do not expect these solutions to have a significant near-term impact on the overall demand for disk drives in the mobile compute market.

 

   

Disk Drives for Enterprise Storage. The need to address the expansion in data storage management requirements has increased the demand for new hardware storage solutions for both mission critical and business critical enterprise storage.

Mission critical enterprise storage is defined by the use of high performance, high capacity disk drives for use in applications which are vital to the operation of enterprises. We expect the market for mission critical enterprise storage solutions to grow in the long-term, driven by many enterprises continuing to move network traffic to dedicated storage area networks. In addition, many enterprises are moving away from the use of server-attached storage to network-attached storage. Both of these solutions are comprised principally of high performance, high capacity disk drives with sophisticated software and communications technologies. In addition, many enterprises are also consolidating data centers, aiming to increase speed and reliability within a smaller space, reducing network complexity and increasing energy savings, which has led to an increased demand for more energy efficient, smaller form factor disk drives. SSD storage applications have been introduced as a potential alternative to redundant system startup or boot disk drives. In addition, enterprises are considering the use of SSDs in applications where rapid processing is required for high volume transaction data. The timing of the adoption of SSDs in these applications is currently unknown as enterprises weigh the cost benefits of mission critical enterprise disk drives relative to the perceived performance benefits of SSDs.

Business critical enterprise storage is an emerging and growing application in enterprise storage whereby enterprises are using higher capacity disk drives to store less frequently accessed, less time-critical, but capacity-intensive data. Because of recent decreases in cost per gigabyte, business critical electronic data, which historically has been stored on tape or other backup and archival technologies, are now being stored on these high capacity disk drives. In the long-term, however, we believe that this trend towards business critical systems that utilize high capacity, enterprise class serial advanced technology architecture and serial attached small computer system interface will, in addition to expanding the overall enterprise market, likely absorb some of the demand for disk drives used in traditional mission critical enterprise storage.

Notwithstanding these positive long-term trends, the enterprise storage demand may be impacted by the current economic contraction and the related consolidation in the financial services industry.

 

   

Disk Drives for Branded Solutions. We believe that the proliferation of media-rich digital content has increased consumer demand for storage to augment their current desktop or notebook disk drive capacities. Consumers are increasingly using external branded storage solutions to backup and secure data in case of disaster or system failure.

 

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Disk Drives for Desktop Computing. We believe growth in disk drives for desktop computing has moderated, in part due to the growth in demand for notebook computers, particularly in developed countries. We believe that current growth in demand for disk drives in desktop computing is focused on developing markets where price remains a primary consideration. Demand for inexpensive, high capacity external storage has also driven growth of 3.5-inch desktop disk drives.

 

   

Disk Drives for Consumer Electronics. Disk drives in the consumer electronics (CE) markets are primarily used in high-capacity solutions, such as DVRs. These applications require more storage capability than can be provided in a cost-effective manner through alternative technologies such as flash memory, which is used in lower capacity CE applications. We believe the demand for disk drives in CE will become more pronounced with the increased amount of high definition content that requires larger amounts of storage capacity. Although solid state or flash memory has largely replaced disk drives in handheld applications, we believe that the demand for disk drives to store, hold or back up related media content from such handheld devices continues to grow.

Product Life Cycles and Changing Technology

Our industry has been characterized by significant advances in technology, which have contributed to rapid product life cycles. As a result, success in our industry has been dependent to a large extent on the ability to be the first-to-market with new products, allowing those disk drive manufacturers who introduce new products first to sell those products at a premium until comparable products are introduced. Also, because our industry is characterized by continuous price erosion, the existence of rapid product life cycles has necessitated the need to quickly achieve product cost effectiveness. Changing technology also necessitates the need for on-going investments in research and development, which may be difficult to recover due to rapid product life cycles. Further, there is a continued need to successfully execute product transitions and new product introductions, as factors such as quality, reliability and manufacturing yields become of increasing competitive importance.

Seasonality

The disk drive industry traditionally experiences seasonal variability in demand with higher levels of demand in the second half of the calendar year. This seasonality is driven by consumer spending in the back-to-school season from late summer to fall and the traditional holiday shopping season from fall to winter. In addition, corporate demand is typically higher during the second half of the calendar year when IT budget calendars provide for more spending. Given the current economic conditions, we expect the typical seasonal patterns of increased demand for the December 2008 quarter to be muted. Compared with the September 2008 quarter, we expect demand for the December 2008 quarter for the mobile and CE markets to experience a seasonal increase, the enterprise market to be down and the desktop market to be flat to slightly down.

Recording Heads and Media

Due to industry consolidation, there are limited number of independent suppliers of recording heads and media available to disk drive manufacturers. As a result, vertically integrated disk drive manufacturers, who manufacture their own recording heads and media, are less dependent on external supply of recording heads and media than less vertically integrated disk drive manufacturers. While we believe that there is adequate supply to meet currently identified industry demand, these consolidations may limit the supply of recording heads and media from independent suppliers in the long-term.

 

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Commodity and Other Manufacturing Costs

The production of disk drives requires precious metals, scarce alloys and industrial commodities the supply of which has at times been constrained. Prices of many commodities may be volatile as evidenced by significant increases during fiscal year 2008 and subsequent decreases during the September 2008 quarter. Commodity and fuel price increases during fiscal year 2008 resulted in higher component and transportation costs in the industry.

Industry Supply Balance

Historically, the industry has from time to time experienced periods of imbalances between supply and demand. To the extent that the disk drive industry builds capacity based on expectations of demand that do not materialize, price erosion may become more pronounced. Conversely, during periods where demand exceeds supply, price erosion is generally more benign.

Although we believe the industry has more than adequate capacity to meet current levels of demand as of the end of the September 2008 quarter, we believe, the level of distribution inventory for desktop products remained consistent with historical levels, at less than 5 weeks.

Seagate Overview

We are the world’s leading provider of hard disk drives, based on revenue and units shipped. Our products address the enterprise, desktop, mobile computing and CE and branded solutions storage markets. The Seagate 3.5-inch and 2.5-inch disk drive units used in our branded storage products are reported in the desktop and mobile market information, respectively. We maintain a highly integrated approach to our business by designing and manufacturing a significant portion of the components we view as critical to our products, such as recording heads and media. We believe that control of these key technologies, combined with our platform design and manufacturing, is necessary to achieve product performance, time-to-market leadership and manufacturing flexibility, which will allow us to respond to customers and market opportunities.

Operating Performance

 

   

Revenue—Revenue for the September 2008 quarter of approximately $3.0 billion increased approximately 5% from the immediately preceding quarter, primarily driven by an 11% increase in the number of disk drives shipped and a favorable product mix, partially offset by price erosion. The increase in unit demand was the result of seasonally higher purchases, particularly in the desktop and mobile compute markets.

Revenue for the September 2008 quarter was down 8% from the year-ago quarter, primarily driven by higher price erosion, particularly with respect to 3.5-inch and 2.5-inch ATA products, partially offset by a 2% unit shipment growth as well as an improved mix of products shipped within each market.

Our average sales price per unit (ASP) for our disk drive products was $62 for the September 2008 quarter, down from $66 and $69 in the immediately preceding and year-ago quarters respectively, as an improved mix of products shipped was more than offset by price erosion.

 

   

Enterprise—We believe we grew our market leadership position in the enterprise market, shipping 5.2 million units, an increase of 15% from the year-ago quarter and largely unchanged from the immediately preceding quarter. The increase in the number of units shipped from the year-ago quarter was primarily attributable to market demand for mission critical enterprise disk drives. This demand was primarily driven by server virtualization, which increased demand for 3.5-inch

 

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high-speed, high-capacity products used in server-attached storage applications. The market share growth and improved product mix we experienced in these periods were partially offset by price erosion.

 

   

Mobile—We shipped 9.8 million units, an increase of 43% and 25% from the immediately preceding and year-ago quarters, respectively. The increase in unit shipments from both prior periods was driven by what we believe to be a continuing trend of notebook computers increasingly becoming the preference for both consumers and enterprises as the need for mobility increases and wireless adoption continues to advance. Also, we saw an increase in the use of our mobile products in branded storage products. Our recent faster than market growth was mainly attributable to increased market access from new product introductions, allowing us to compete at most mobile capacities and to partially regain market share overall. These increases in units shipped and a favorable product mix were offset by particularly pronounced price erosion.

 

   

Desktop—In the September 2008 quarter, we believe we maintained our market leadership position with shipments of 28.2 million units, an increase of 11% from the immediately preceding quarter due to seasonally higher demand and the use of our desktop disk drives in our branded storage products. These increases in units shipped and a favorable product mix were offset by particularly pronounced price erosion. Unit shipments decreased 3% from the year-ago quarter, primarily due to the transition to notebook computers. The decrease in units shipped and price erosion were only partially offset by a favorable product mix as compared with the year-ago quarter. In the global distribution channel, we exited the September 2008 quarter with distribution channel inventory for desktop products at less than five weeks.

 

   

Consumer—In the September 2008 quarter, we shipped a total of 4.8 million units, a decrease of 15% and 16% from the immediately preceding and year-ago quarters, respectively. During the September 2008 quarter we shifted our focus to the DVR market and intentionally reduced our participation in the gaming market due to less attractive economic conditions. The decrease in units shipped and price erosion were only partially offset by a favorable product mix as compared with both the immediately preceding and year-ago quarters.

Other factors affecting income—Our results of operations for the quarter ended October 3, 2008 included restructuring related charges of approximately $51 million, of which $28 million was accelerated depreciation related to our Milpitas facility closure and is reflected in Cost of revenue and $23 million was for severance and other closing costs and is reflected in Restructuring in the Condensed Consolidated Statement of Operations. Additionally, we incurred $20 million in purchased intangibles amortization and other charges associated with acquisitions.

Seasonality

The disk drive industry traditionally experiences seasonal variability in demand with higher levels of demand in the second half of the calendar year. This seasonality is driven by consumer spending in the back-to-school season from late summer to fall and the traditional holiday shopping season from fall to winter. In addition, corporate demand is typically higher during the second half of the calendar year when IT budget calendars provide for more spending. Given the current economic conditions, we expect the typical seasonal patterns of increased demand for the December 2008 quarter to be muted. Compared with the September 2008 quarter, we expect demand for the December 2008 quarter for the mobile market to experience a seasonal increase, the enterprise and CE markets to be down and the desktop market to be flat to slightly down.

 

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Recording Heads and Media

The percentage of our requirements for recording media that we produce internally varies from quarter to quarter. Our long-term strategy is to externally purchase approximately 10% of total recording media requirements. In the September 2008 quarter, we completed the closure of our recording media manufacturing facility in Milpitas, California as part of our ongoing focus on cost efficiencies in all areas of our business.

Our new media facility in Singapore operated with meaningful output during the September 2008 quarter, and we believe we have adequate internal and external supply plans in place to support our requirements. Similar to our long-term strategy on recording media supply, our future plans include the evaluation and external purchase of up to 10% of recording heads requirements.

We purchase from third parties (mainly in Japan) all of our glass substrates, which are used to manufacture our disk drives for mobile and small form factor CE products. Historically, we purchase approximately 70% of our aluminum substrates for recording media production from third parties. In the September 2008 quarter, we completed the closure of our substrate manufacturing facility in Limavady, Northern Ireland as part of our on-going focus on cost efficiencies in all areas of our business.

Our aluminum substrate manufacturing facility in Johor, Malaysia is operating at current capacity during the September 2008 quarter.

Research and Development

On September 18, 2008, we announced the proposed closure of our research facility in Pittsburgh, Pennsylvania. The research effort currently underway in Pittsburgh will be moved into existing facilities, primarily in Minnesota and California. We currently plan to cease operations at our Pittsburgh facility during our fourth quarter of fiscal year 2009.

Commodity and Other Manufacturing Costs

The production of disk drives requires precious metals, scarce alloys and industrial commodities that are subject to fluctuations in prices, and the supply of which has at times been constrained. Prices of many commodities may be volatile as evidenced by significant increases during fiscal year 2008 and subsequent decreases during the September 2008 quarter. The increases during fiscal year 2008 resulted in higher component and transportation costs. The ability to mitigate the impact of cost increases or realize the benefit of cost decreases will depend on the overall industry supply and demand balance.

Capital Investments

In the September 2008 quarter, we made $280 million in capital investments. Investments for additional capacity will be reduced for the remainder of fiscal year 2009 as our current capacity supports expected volume requirements for the next several quarters. Consequently, we expect capital investment in fiscal year 2009 to be approximately $750 million which is a $250 million reduction from our prior estimates. The capital investments for the remainder of the fiscal year 2009 will be primarily for technology advancements and cost-reduction opportunities.

 

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Results of Operations

We list in the tables below the historical Condensed Consolidated Statements of Operations in dollars and as a percentage of revenue for the periods indicated.

 

     For the Three Months Ended  
     October 3,
2008
    September 28,
2007
 
     (in millions)  

Revenue

   $ 3,033     $ 3,285  

Cost of revenue

     2,508       2,476  
                

Gross margin

     525       809  
                

Product development

     260       242  

Marketing and administrative

     148       153  

Amortization of intangibles

     14       13  

Restructuring

     23       5  
                

Income from operations

     80       396  

Other income (expense), net

     (36 )     (21 )
                

Income before income taxes

     44       375  

Provision for (benefit from) income taxes

     (16 )     20  
                

Net income

   $ 60     $ 355  
                
     For the Three Months Ended  
     October 3,
2008
    September 28,
2007
 
     (as a percentage of revenue)  

Revenue

     100 %     100 %

Cost of revenue

     83       75  
                

Gross margin

     17       25  
                

Product development

     9       8  

Marketing and administrative

     5       5  

Amortization of intangibles

     —         —    

Restructuring

     1       —    
                

Income from operations

     2       12  

Other income (expense), net

     (1 )     (1 )
                

Income before income taxes

     1       11  

Provision for (benefit from) income taxes

     (1 )     —    
                

Net income

     2 %     11 %
                

 

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Revenue

 

     Fiscal Quarters Ended
(Dollars in millions)    October 3,
2008
   June 27,
2008
   September 28,
2007

Revenue

   $ 3,033    $ 2,899    $ 3,285

Revenue for the September 2008 quarter of approximately $3.0 billion increased approximately 5% from the immediately preceding quarter, primarily driven by an 11% increase in the number of disk drives shipped and a favorable product mix, partially offset by price erosion. The increase in unit demand was the result of seasonally higher purchases, particularly in the desktop and mobile compute markets.

Revenue for the September 2008 quarter was down 8% from the year-ago quarter, primarily driven by higher price erosion, particularly with respect to 3.5-inch and 2.5-inch ATA products, partially offset by a 2% unit shipment growth as well as an improved mix of products shipped within each market.

Our ASP for our disk drive products was $62 for the September 2008 quarter, down from $66 and $69 in the immediately preceding and year-ago quarters, respectively, as an improved mix of products shipped was more than offset by price erosion.

Unit shipments for our products in the quarter ended October 3, 2008 were as follows:

 

   

Enterprise—5.2 million, flat from the immediately preceding quarter and up from 4.6 million units in the year-ago quarter.

 

   

Mobile—9.8 million, up from 6.9 million and 7.9 million units in the immediately preceding quarter and year-ago quarters, respectively.

 

   

Desktop—28.2 million, up from 25.4 million units in the immediately preceding quarter and down from 29.0 million units in the year-ago quarter.

 

   

Consumer—4.8 million, down from 5.7 million units in both the immediately preceding and year-ago quarters.

We maintain various sales programs such as point-of-sale rebates, sales price adjustments and price protection, aimed at increasing customer demand. We exercise judgment in formulating the underlying estimates related to distributor and retail inventory levels, sales program participation and customer claims submittals in determining the provision for such programs. Sales programs recorded as contra revenue were approximately 12% of our gross revenue for the September 2008 quarter as compared to 10% and 9% in the immediately preceding and year-ago quarters, respectively. The increase in sales programs during the September 2008 quarter was due to the current competitive pricing environment.

Cost of Revenue

 

     Fiscal Quarters Ended  
(Dollars in millions)    October 3,
2008
    June 27,
2008
    September 28,
2007
 

Cost of revenue

   $ 2,508     $ 2,208     $ 2,476  

Gross margin

   $ 525     $ 691     $ 809  

Gross margin percentage

     17 %     24 %     25 %

 

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Cost of revenue for the September 2008 quarter increased approximately 14% from the immediately preceding quarter due to a higher number of units shipped, a higher mix of products with higher average capacities, feature sets and performance. Gross margin as a percentage of revenue decreased from the immediately preceding quarter primarily due to price erosion.

Cost of revenue for the September 2008 quarter was relatively flat from the year-ago quarter as the number of units shipped remained largely unchanged. Gross margin as a percentage of revenue decreased from the year-ago quarter primarily due to cost reduction not keeping pace with price erosion.

Product Development Expense

 

     Fiscal Quarters Ended
(Dollars in millions)    October 3,
2008
   June 27,
2008
   September 28,
2007

Product development

   $ 260    $ 270    $ 242

Product development expense for the September 2008 quarter decreased approximately 4% from the immediately preceding quarter primarily due to a decrease of $14 million in variable performance-based compensation and another $14 million due to a decline in the deferred compensation plan liabilities. These decreases were partially offset by approximately $11 million in additional payroll and other expenses related to a 14-week September 2008 quarter.

Product development expense for the September 2008 quarter increased approximately 7% from the year-ago quarter primarily due to $27 million in additional payroll and other expenses resulting from a combination of increased headcount, a 14-week September 2008 quarter and annual salary adjustments. In addition, we incurred $17 million of incremental material and other program expenses related to increased product development activity. These increases were partially offset by decreases of $23 million in variable performance-based compensation and $9 million due to a decline in the deferred compensation plan liabilities.

Marketing and Administrative Expense

 

     Fiscal Quarters Ended
(Dollars in millions)    October 3,
2008
   June 27,
2008
   September 28,
2007

Marketing and administrative

   $ 148    $ 175    $ 153

Marketing and administrative expense for the September 2008 quarter decreased approximately 15% from the immediately preceding quarter primarily due to decreases of $10 million in legal expenses, $8 million in variable performance-based compensation and $9 million due to a decline in the deferred compensation plan liabilities, partially offset by an increase of approximately $6 million in additional payroll and other expenses primarily related to a 14-week September 2008 quarter.

Marketing and administrative expense for the September 2008 quarter decreased approximately 3% from the year-ago quarter, primarily due to decreases of $14 million in variable performance-based compensation and $6 million due to a decline in the deferred compensation plan liabilities. These decreases were partially offset by increases of approximately $12 million in additional payroll and other expenses primarily related to a 14-week September 2008 quarter and $4 million in legal expenses.

 

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Amortization of Intangibles

 

     Fiscal Quarters Ended
(Dollars in millions)    October 3,
2008
   June 27,
2008
   September 28,
2007

Amortization of intangibles

   $ 14    $ 13    $ 13

Amortization of intangibles for the September 2008 quarter was flat when compared with both the immediately preceding and year-ago quarters.

Restructuring, net

 

     Fiscal Quarters Ended
(Dollars in millions)    October 3,
2008
   June 27,
2008
   September 28,
2007

Restructuring and other

   $ 23    $ 36    $ 5

Of the $23 million of restructuring charges recorded during the fiscal quarter ended October 3, 2008, $3 million was recorded in connection with the closure of our research facility in Pittsburgh, Pennsylvania, as part of our ongoing focus on cost efficiencies in all areas of our business. We also recorded $10 million related to our ongoing restructuring activities, primarily at our Limavady and Milpitas sites. The remaining $10 million was an adjustment to reflect our revised sub-lease expectations related to our Maxtor facilities closures.

Net Other Income (Expense)

 

     Fiscal Quarters Ended  
(Dollars in millions)    October 3,
2008
    June 27,
2008
    September 28,
2007
 

Other income (expense), net

   $ (36 )   $ (15 )   $ (21 )

The change in Net other expense from the immediately preceding quarter was primarily due to a $28 million decline in the market value of deferred compensation plan assets. The corresponding decrease in the deferred compensation plan liabilities is primarily reported in operating expenses. The Net other expense was partially offset by a $7 million gain on the sale of an equity investment.

The change in Net other expense from the year-ago quarter was primarily due to a $20 million decline in the value of deferred compensation plan assets and a $9 million decrease in interest income due primarily to lower yields on cash, cash equivalents and short-term investments. The corresponding gain or loss on deferred compensation plan liabilities is offset against compensation expenses in cost of revenue and operating expenses. These increases were partially offset by a $7 million gain on the sale of an equity investment.

Income Taxes

 

     Fiscal Quarters Ended
(Dollars in millions)    October 3,
2008
    June 27,
2008
   September 28,
2007

Provision for (benefit from) income taxes

   $ (16 )   $ 22    $ 20

We are a foreign holding company incorporated in the Cayman Islands with foreign and U.S. subsidiaries that operate in multiple taxing jurisdictions. As a result, our worldwide operating income either is subject to varying rates of tax or is exempt from tax due to tax holidays or tax incentive programs applicable in China, Malaysia, Singapore, Switzerland and Thailand. These tax holidays or incentives are scheduled to expire in whole or in part at various dates through 2020.

 

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Our benefit for income taxes recorded for the three months ended October 3, 2008 differs from the provision for income taxes that would be derived by applying a notional U.S. 35% rate to income before income taxes primarily due to the net effect of (i) the tax benefit related to the aforementioned tax holiday and tax incentive programs, (ii) a decrease in our valuation allowance for U.S. deferred tax assets attributable in part to tax legislation enacted during the period, (iii) tax expense related to intercompany transactions and (iv) U.S. and foreign tax benefits recorded during the quarter relating to reductions in previously accrued taxes for uncertain tax positions due to settlement of tax audits and lapses of certain statutes of limitations. Our provision for income taxes recorded for the three months ended September 28, 2007 differed from the provision for income taxes that would be derived by applying a notional U.S. 35% rate to income before income taxes primarily due to the net effect of (i) the tax benefit related to the aforementioned tax holiday and tax incentive programs, (ii) a decrease in our valuation allowance for U.S. deferred tax assets and (iii) the tax expense related to intercompany transactions.

Based on our foreign ownership structure and subject to (i) potential future increases in our valuation allowance for deferred tax assets and (ii) limitations imposed by Internal Revenue Code Section 382 on usage of certain tax attributes, we anticipate that our effective tax rate in future periods will generally be less than the U.S. federal statutory rate. Dividend distributions received from our U.S. subsidiaries may be subject to U.S. withholding taxes when and if distributed. Deferred tax liabilities have not been recorded on unremitted earnings of certain foreign subsidiaries, as these earnings will not be subject to tax in the Cayman Islands or U.S. federal income tax if remitted to our foreign parent holding company.

During the three months ended October 3, 2008, there were three major U.S. tax law changes with potential impact on our tax provision. On July 30, 2008, the Housing and Economic Recovery Act of 2008 was enacted. Under this law, companies can elect to accelerate a portion of their unused AMT and research tax credits in lieu of the 50-percent “bonus” depreciation enacted in February 2008. We expect that we qualify for and will elect to accelerate approximately $11 million of R&D credit carryovers to fiscal years 2008 and 2009 of which approximately $8 million was recognized in the three months ended October 3, 2008. On October 3, 2008, the Emergency Economic Stabilization Act of 2008 was signed into law. Under this law, the R&D credit was retroactively extended through December 31, 2009 from December 31, 2007. This extension has no immediate impact on our tax provision. The California 2008-2009 Budget Bill (AB 1452), enacted on September 30, 2008, resulted in two temporary changes to the California income tax. First, the bill suspends the use of Net Operating Loss (NOL) carryovers for two years, our fiscal years 2009 and 2010. Second, the bill limits the use of R&D credit carryovers to no more than 50% of the tax liability before credits. We estimate that the California change will result in an increase to income taxes for fiscal year 2009 of approximately $3 million as compared to the prior year.

As of October 3, 2008 we recorded net deferred tax assets of $888 million. The realization of $808 million of these deferred tax assets is primarily dependent on our ability to generate sufficient U.S. and certain foreign taxable income in future periods. Although realization is not assured, we believe that it is more likely than not that these deferred tax assets will be realized.

During the three months ended October 3, 2008, our unrecognized tax benefits excluding interest and penalties decreased by approximately $15 million to $359 million primarily due to (i) reductions associated with audit activity of $6 million, (ii) reductions associated with the expiration of certain statutes of limitation of $5 million and (iii) other activity, primarily foreign exchange gains of $4 million. Approximately $4 million of the three month change resulted in a reduction to goodwill with the remaining balance of $11 million reflected as a reduction to tax expense or as foreign exchange gains.

The total unrecognized tax benefits that, if recognized, would impact the effective tax rate were $68 million and $55 million as of June 27, 2008 and October 3, 2008, respectively.

 

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During the 12 months beginning October 4, 2008, we expect to reduce our unrecognized tax benefits by approximately $19 million as a result of the expiration of certain statutes of limitation. We do not believe it is reasonably possible that other unrecognized tax benefits will materially change in the next 12 months. However, the resolution and/or timing of closure on open audits are highly uncertain as to when these events occur.

We file U.S. federal, U.S. state, and foreign tax returns. The statutes of limitation for U.S. Federal returns are open for fiscal years 2003 and forward. The Internal Revenue Service (IRS) has completed its examination of fiscal years ending in 2003 and 2004 and is currently examining fiscal years ending 2005 through 2007. For state and foreign tax returns, we are generally no longer subject to tax examinations for years prior to fiscal year 2001.

Liquidity and Capital Resources

The following is a discussion of our principal liquidity requirements and capital resources.

We had approximately $1.0 billion in cash and cash equivalents at October 3, 2008 representing a $15 million increase from the $990 million held on June 27, 2008. This increase in cash and cash equivalents was primarily due to cash provided by operating activities, offset by capital expenditures, and dividends paid to shareholders. In addition to the $1.0 billion in cash and cash equivalents, we had approximately $148 million in short-term investments as of October 3, 2008 compared with $151 million held on June 27, 2008.

As of October 3, 2008, we held auction rate securities with a par value of $31 million, all of which are collateralized by student loans guaranteed by the Federal Family Education Loan Program. Beginning in the March 2008 quarter, these securities failed to settle at auction and have continued to fail through the quarter ended October 3, 2008. Since there is no active market for these securities we valued them using a pricing model provided by a third party valuation firm. The valuation model is based on the income approach and reflects both observable and significant unobservable inputs. As of October 3, 2008, the estimated fair value of these auction rate securities was $28 million. We believe that the impairment totaling $3 million, recorded during the quarters ended June 27, 2008 and October 3, 2008, are temporary. Given our ability and intent to hold these securities until liquidity returns to this market or maturity of the securities, the impairment was recorded in other comprehensive income and these securities were classified as long-term investments.

The principle objectives of our investment policy are the preservation of principal and maintenance of liquidity. We mitigate default risk by investing in high-quality investment grade securities, limiting the time to maturity and by monitoring the counter-parties and underlying obligors closely.

We believe our cash equivalents and short-term investments are liquid and safe. We are not aware of any downgrades, losses or other significant deterioration in the fair value of our cash equivalents or short-term investments. As such, we do not believe the fair value of our short-term investments has significantly changed from the values reported as of October 3, 2008.

 

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The following table summarizes the statements of cash flows for the periods indicated:

 

     For the Three Months Ended  
(Dollars in millions)    October 3,
2008
    September 28,
2007
 

Net cash provided by (used in):

    

Operating Activities

   $ 304     $ 754  

Investing Activities

   $ (265 )   $ (238 )

Financing Activities

   $ (24 )   $ (241 )

Net increase in cash and cash equivalents

   $ 15     $ 275  

Cash Provided by Operating Activities

Cash provided by operating activities for the three months ended October 3, 2008 was approximately $304 million and included the effects of:

 

   

net income adjusted for non-cash items including depreciation, amortization and stock-based compensation;

 

   

an increase of $278 million in accounts payable, primarily as a result of increased direct materials purchases;

 

   

an increase of $55 million in vendor non-trade receivables, primarily as a result of outsourcing the manufacture of certain sub-assemblies to third parties (see Note 2 to the Notes to Condensed Consolidated Financial Statements (unaudited));

 

   

a decrease of $36 million in inventories; and

 

   

a decrease of $287 million in accrued employee compensation, primarily as a result of the payment of variable performance-based compensation.

Cash Used in Investing Activities

During the three months ended October 3, 2008, we used $265 million for net cash investing activities, which was primarily attributable to expenditures for property, equipment and leasehold improvements of approximately $280 million, partially offset by $10 million of proceeds from the sale of investment in equity securities. The investments in property, equipment and leasehold improvements primarily comprised of:

 

   

$36 million for manufacturing facilities and equipment related to our subassembly and disk drive final assembly and test facilities in the Far East;

 

   

$77 million for upgrading and expansion of our recording media operations in the United States, Malaysia and Singapore;

 

   

$129 million for manufacturing facilities and equipment for our recording head operations in the United States, the Far East and Northern Ireland;

 

   

$17 million for facilities and equipment for alternative technologies in the United States; and

 

   

$21 million for research and development, information technology infrastructure and other facilities and equipment costs.

Investments for additional capacity will be reduced for the remainder of fiscal year 2009 as our current capacity supports expected volume requirements for the next several quarters. Consequently, we expect capital investment in fiscal year 2009 to be approximately $750 million, which is a $250 million reduction from our prior estimates. The capital investments for the remainder of the fiscal year 2009 will be primarily for technology advancements and cost-reduction opportunities.

 

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Cash Used in Financing Activities

Net cash used in financing activities of $24 million for the three months ended October 3, 2008 was primarily attributable to the payment of approximately $59 million in dividends to our shareholders partially offset by $35 million in cash from employee stock option exercises and employee stock purchases.

Liquidity Sources, Cash Requirements and Commitments

Our principal sources of liquidity as of October 3, 2008, consisted of: (1) approximately $1.2 billion in cash, cash equivalents, and short-term investments, (2) cash we expect to generate from operations and (3) a $500 million revolving credit facility.

Our $500 million revolving credit facility that matures in September 2011 is available for cash borrowings and for the issuance of letters of credit up to a sub-limit of $100 million. Although no borrowings have been drawn under this revolving credit facility to date, we had used $47 million for outstanding letters of credit and bankers’ guarantees as of October 3, 2008, leaving $453 million for additional borrowings, subject to compliance with financial covenants and other customary conditions to borrowing.

The credit agreement that governs our revolving credit facility contains covenants that we must satisfy in order to remain in compliance with the agreement. This credit agreement contains three financial covenants: (1) minimum cash, cash equivalents and marketable securities; (2) a fixed charge coverage ratio; and (3) a net leverage ratio. As of October 3, 2008, we are in compliance with all covenants.

Our principal liquidity requirements are primarily to meet our working capital, research and development and capital expenditure needs and to service our debt. In addition, since the second half of fiscal year 2002 and through the September 2008 quarter, we have paid dividends to our shareholders.

On August 15, 2008, we paid dividends aggregating approximately $59 million, or $0.12 per share, to our common shareholders of record as of August 1, 2008. On October 21, 2008, we declared a quarterly dividend of $0.12 per share that will be paid on or before November 21, 2008 to our common shareholders of record as of November 7, 2008. In deciding whether or not to declare quarterly dividends, our directors will take into account such factors as general business conditions within the disk drive industry, our financial results, our capital requirements, contractual and legal restrictions on the payment of dividends by our subsidiaries to us or by us to our shareholders, the impact of paying dividends on our credit ratings and such other factors as our board of directors may deem relevant.

With respect to the closure of our Limavady, Milpitas and Pittsburgh facilities, we expect to pay cash restructuring charges aggregating approximately $80 million to $90 million in the next 12 months.

Because we had current earnings and profits in excess of distributions for our taxable year ended June 27, 2008, distributions on our common shares to U.S. shareholders during this period were treated as dividend income for U.S. federal income tax purposes. We anticipate that we will have earnings and profits in excess of distributions in fiscal year 2009. Therefore, distributions to U.S. shareholders in fiscal year 2009 are anticipated to be treated as dividend income for U.S. federal income tax purposes. Non-U.S. shareholders should consult with a tax advisor to determine appropriate tax treatment.

 

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As a result of the acquisition of Maxtor, we assumed all of Maxtor’s outstanding debts, including, without limitation, its outstanding convertible senior notes. Maxtor’s 2.375% Convertible Senior Notes due August 2012 (the “2.375% Notes”), of which $326 million were outstanding as of October 3, 2008, contain a cash conversion feature that will require Seagate to deliver to the holders, upon any conversion of these notes, cash in an amount equal to the lesser of (a) the principal amount of the notes converted and (b) the as-converted value of the notes. We will also be required to deliver an additional amount equal to the difference between the as-converted value of the notes and the principal amount in either cash or stock at our election. To the extent holders of the Maxtor notes choose to convert their notes, Seagate may require additional amounts of cash to meet this obligation. The payment of dividends to holders of our common shares have in certain quarters resulted in upward adjustments to the conversion rate of the 2.375% Notes and may continue in the future. If the conversion rate continues to increase, we may be required to book an increased amount of interest expense. For the September 2008 quarter, the 2.375% Notes were convertible and were classified as Current portion of long-term debt on our Condensed Consolidated Balance Sheet at October 3, 2008. During the September 2008 quarter, our shares traded below 110% of the conversion price for the 2.375% Notes for at least 20 consecutive trading days of the last 30 trading days of the quarter. As a result, the 2.375% Notes became nonconvertible effective October 4, 2008, and will be reclassified as Long-term debt for the December 2008 quarter.

During the quarter ended October 3, 2008, our $300 million Floating Rate Senior Notes became due within 12 months. As such, we reclassified the balance to Current portion of long-term debt.

As of October 3, 2008, we had approximately $2.0 billion available to repurchase our common shares under the February 2008 stock repurchase plan. See Part II, Item 2: “Unregistered Sales of Equity Securities and Use of Proceeds – Repurchases of Equity Securities.” We did not repurchase any of our common shares during the September 2008 quarter.

As part of our strategy, we may selectively pursue strategic alliances, acquisitions and investments that are complementary to our business. Any material future acquisitions, alliances or investments will likely require additional capital. We may enter into more of these types of arrangements in the future, which could also require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all. We will require substantial amounts of cash to fund scheduled payments of principal and interest on our indebtedness, future capital expenditures, any increased working capital requirements and share repurchases. If we are unable to meet our cash requirements out of existing cash or cash flow from operations, we cannot assure you that we will be able to obtain alternative financing on terms acceptable to us, if at all.

We believe that our sources of cash will be sufficient to fund our operations and meet our cash requirements for at least the next 12 months. Our ability to fund these requirements and comply with the financial covenants under our debt agreements will depend on our future operations, performance and cash flow and is subject to prevailing economic conditions and financial, business and other factors, some of which are beyond our control.

 

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Contractual Obligations and Commitments

Our contractual cash obligations and commitments as of October 3, 2008 have been summarized in the table below:

 

          Fiscal Year(s)     
     Total    2009    2010-
2011
   2012-
2013
   Thereafter
     (in millions)

Contractual Cash Obligations:

              

Long term debt(1)

   $ 2,037    $ 361    $ 446    $ 630    $ 600

Interest payments on long-term debt

     513      66      190      114      143

Capital expenditures

     191      168      23<