WESTERN DIGITAL CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis contains forward-looking statements within the meaning of the federal securities laws, and should be read in conjunction with the disclosures we make concerning risks and other factors that may affect our business and operating results. You should read this information in conjunction with the unaudited Condensed Consolidated Financial Statements and the notes thereto included in this Quarterly Report on Form 10-Q, and the audited Consolidated Financial Statements and notes thereto included in Part II, Item 8 of our Annual Report on Form 10‑K for the fiscal year ended July 1, 2022. See also “Forward-Looking Statements” immediately prior to Part I, Item 1 in this Quarterly Report on Form 10-Q. Unless otherwise indicated, references herein to specific years and quarters are to our fiscal years and fiscal quarters. As used herein, the terms “we,” “us,” “our,” and the “Company” refer to Western Digital Corporation and its subsidiaries. Our Company We are on a mission to unlock the potential of data by harnessing the possibility to use it. We are a leading developer, manufacturer, and provider of data storage devices based on both flash-based products (“Flash”) and hard disk drives (“HDD”) technologies. With dedicated business units driving advancements in NAND flash and magnetic recording technologies, we create and drive innovations needed to help customers capture, preserve, access, and transform an ever-increasing diversity of data. Our fiscal year ends on the Friday nearest to June 30 and typically consists of 52 weeks. Approximately every five to six years, we report a 53-week fiscal year to align the fiscal year with the foregoing policy. Fiscal years 2023, which ends on June 30, 2023, and 2022, which ended on July 1, 2022, are each comprised of 52 weeks, with all quarters presented consisting of 13 weeks. Key Developments Strategic Alternatives In June 2022, we announced that we are reviewing potential strategic alternatives aimed at further optimizing long-term value for stockholders. The Executive Committee of our Board of Directors is overseeing the assessment process and evaluating a range of alternatives, including options for separating our Flash and HDD business units. As of December 30, 2022, we are still actively working with our financial advisors and our legal counsel in this strategic review process. Operational and COVID-19 Pandemic Update Macroeconomic factors such as inflation, higher interest rates and recession concerns have softened demand for our products, with certain customers reducing purchases as they adjust their production levels and right-size their inventories. As a result, we and our industry are experiencing a supply-demand imbalance, which has resulted in reduced shipments and negatively impacted pricing, particularly in Flash. We expect the market pressures on Flash pricing to continue for the next few quarters. Since the beginning of fiscal 2023, we have scaled back on capital expenditures, consolidated production lines and reduced bit growth to align with market demand and implemented measures to reduce operating expenses. This has resulted in incremental charges for Employee termination, asset impairment and other charges and manufacturing underutilization charges in HDD in the second quarter of 2023 and may impact near-term results. In addition, we have reduced wafer starts for Flash by 30% as of January 2023 and expect underutilization charges for that business unit to impact near-term results. However, we believe digital transformation will continue to drive long-term growth for data storage in both Flash and HDD and believe that the actions we are taking will position us for more profitable growth as supply and demand levels begin to balance. We believe we have made significant progress in strengthening our product portfolio to meet our customers’ growing and evolving storage needs. Our BiCS5 based products continue to play a significant role in driving top line results across our end markets. Additionally, hard drive products utilizing OptiNAND and shingled magnetic recording (“SMR”) technologies have commenced commercial shipments and our latest 26-terabyte SMR drives are undergoing qualifications at multiple cloud and OEM customers. We continued commercial shipment of consumer flash devices based on our next generation 3D-flash technology and are beginning productization of BiCS8, which incorporates new 3D-NAND architectural innovations to deliver improved performance and cost-effectiveness. We are aware of the ongoing trends in the HDD Client market as PCs shift from using HDD to Flash technology and as a result, we have and are still undergoing actions to restructure our HDD manufacturing footprint to reflect this market dynamic, including a sharp reduction in our client hard drive production capacity. 39 Table of Contents The COVID-19 environment has begun to normalize. The responses to COVID-19 taken by ourselves and others in the supply chain contributed to increases in the costs of their services which in turn impacted our operations, but these costs have now largely been normalized in our operating results. We will continue to actively monitor recent developments impacting our business and may take additional responsive actions that we determine to be in the best interests of our business and stakeholders. See “Adverse global or regional conditions could harm our business,” “Public health crises, including the COVID-19 pandemic, have had, and could in the future, have a negative effect on our business” and “We are dependent on a limited number of qualified suppliers who provide critical services, materials or components, and a disruption in our supply chain could negatively affect our business” in Part I, Item 1A, Risk Factors , of our Annual Report on Form 10-K for the year ended July 1, 2022 for more information regarding the risks we face as a result of macroeconomic conditions, the COVID-19 pandemic and supply chain disruptions. Financing Activities In December 2022, we amended the loan agreement governing our revolving credit facility and Term Loan A-2 to modify the leverage ratio requirements of our financial covenant through our quarter ending September 27, 2024 to provide additional financial flexibility as we navigate through the current dynamic economic environment. The amendment also accelerates the due date for amounts outstanding under the loan agreement from January 7, 2027 to November 2, 2023 if, as of that date, our cash and cash equivalents plus available unused capacity under our credit facilities does not exceed by $1 billion the sum of the outstanding balance of our 1.50% convertible notes due 2024 plus the outstanding principal amount of any other debt maturing within 12 months. Subsequent to the end of the second quarter of 2023, on January 25, 2023, we entered into a new delayed draw term loan agreement, which allows us to draw a single unsecured loan of up to $875 million any time through June 30, 2023. Any amount drawn will be due 364 days after funding or such earlier date that conditions for acceleration of amounts due under the loan agreement have been triggered as described above. Also, on January 31, 2023, we issued an aggregate of 900,000 shares of Series A Preferred Stock for an aggregate purchase price of $900 million. We believe these transactions will provide us with greater financial flexibility to manage our business. Additional information regarding our indebtedness, including the principal repayment terms, interest rates, covenants and other key terms of our outstanding indebtedness, is included in Part I, Item 1, Note 8, Debt , of the Notes to Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q and in Part II, Item 8, Note 8, Debt , of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended July 1, 2022. Additional information regarding the terms of our Series A Preferred Stock is included in Note 17, Subsequent Events , of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. Tax Resolution As previously disclosed, we have received statutory notices of deficiency and notices of proposed adjustments from the Internal Revenue Service (“IRS”) with respect to 2008 through 2015. During 2022, new information became available which required us to re-measure our unrecognized tax benefits for this IRS matter. Additionally, during 2022, we and the IRS tentatively reached a settlement for resolving this matter. Additional information regarding this tentative settlement and our assessment of the potential tax and interest payments we expect to pay in connection with the settlement is provided in our discussion of Income tax expense in our results of operations below, as well as in Part I, Item 1, Note 13, Income Tax Expense , of the Notes to the Condensed Consolidated Financial Statements, and in the “Short- and Long-Term Liquidity-Unrecognized Tax Benefits” section below. Russia Sanctions In February 2022, the U.S. and other countries imposed sanctions on Russia. In accordance with these sanctions, we have ceased shipments to distributors for customers located in Russia. Our revenue from distributors for customers in Russia have not been significant. We have no material assets or operations in Russia. 40 Table of Contents Results of Operations Second Quarter and First Half Overview The following table sets forth, for the periods presented, selected summary information from our Condensed Consolidated Statements of Operations by dollars and percentage of net revenue (1) : Three Months Ended December 30, 2022 December 31, 2021 $ Change % Change $ in millions Revenue, net $ 3,107 100.0 % $ 4,833 100.0 % $ (1,726) (36) % Cost of revenue 2,579 83.0 3,250 67.2 (671) (21) Gross profit 528 17.0 1,583 32.8 (1,055) (67) Operating expenses: Research and development 523 16.8 575 11.9 (52) (9) Selling, general and administrative 250 8.0 279 5.8 (29) (10) Employee termination, asset impairment, and other charges 76 2.4 2 — 74 3,700 Total operating expenses 849 27.3 856 17.7 (7) (1) Operating income (loss) (321) (10.3) 727 15.0 (1,048) (144) Interest and other income (expense): Interest income 3 0.1 1 — 2 200 Interest expense (73) (2.3) (76) (1.6) 3 (4) Other income (expense), net 6 0.2 (6) (0.1) 12 (200) Total interest and other expense, net (64) (2.1) (81) (1.7) 17 (21) Income (loss) before taxes (385) (12.4) 646 13.4 (1,031) (160) Income tax expense 61 2.0 82 1.7 (21) (26) Net income (loss) $ (446) (14.4) % $ 564 11.7 % $ (1,010) (179) % (1) Percentages may not total due to rounding. 41 Table of Contents Six Months Ended December 30, 2022 December 31, 2021 $ Change % Change $ in millions Revenue, net $ 6,843 100.0 % $ 9,884 100.0 % $ (3,041) (31) % Cost of revenue 5,334 77.9 6,636 67.1 (1,302) (20) Gross profit 1,509 22.1 3,248 32.9 (1,739) (54) Operating expenses: Research and development 1,075 15.7 1,153 11.7 (78) (7) Selling, general and administrative 497 7.3 570 5.8 (73) (13) Employee termination, asset impairment, and other charges 100 1.5 20 0.2 80 400 Total operating expenses 1,672 24.4 1,743 17.6 (71) (4) Operating income (loss) (163) (2.4) 1,505 15.2 (1,668) (111) Interest and other income (expense): Interest income 5 0.1 3 — 2 67 Interest expense (143) (2.1) (154) (1.6) 11 (7) Other income (expense), net — — (4) — 4 (100) Total interest and other expense, net (138) (2.0) (155) (1.6) 17 (11) Income (loss) before taxes (301) (4.4) 1,350 13.7 (1,651) (122) Income tax expense 118 1.7 176 1.8 (58) (33) Net income (loss) $ (419) (6.1) % $ 1,174 11.9 % $ (1,593) (136) % (1) Percentages may not total due to rounding. 42 Table of Contents The following table sets forth, for the periods presented, a summary of our segment information: Three Months Ended Six Months Ended December 30, 2022 December 31, 2021 December 30, 2022 December 31, 2021 $ in millions Net revenue: Flash $ 1,657 $ 2,620 $ 3,379 $ 5,110 HDD 1,450 2,213 3,464 4,774 Total net revenue $ 3,107 $ 4,833 $ 6,843 $ 9,884 Gross profit: Flash $ 240 $ 946 $ 662 $ 1,867 HDD 300 677 874 1,469 Unallocated corporate items: Stock-based compensation expense (12) (14) (26) (23) Amortization of acquired intangible assets — (26) (1) (65) Total unallocated corporate items (12) (40) (27) (88) Consolidated gross profit $ 528 $ 1,583 $ 1,509 $ 3,248 Gross margin: Flash 14.5 % 36.1 % 19.6 % 36.5 % HDD 20.7 % 30.6 % 25.2 % 30.8 % Consolidated gross margin 17.0 % 32.8 % 22.1 % 32.9 % 43 Table of Contents The following table sets forth for the periods presented, summary information regarding our disaggregated revenue: Three Months Ended Six Months Ended December 30, 2022 December 31, 2021 December 30, 2022 December 31, 2021 ($ in millions) Revenue by End Market Cloud $ 1,224 $ 1,920 $ 3,053 $ 4,145 Client 1,089 1,854 2,318 3,707 Consumer 794 1,059 1,472 2,032 Total Revenue $ 3,107 $ 4,833 $ 6,843 $ 9,884 Revenue by Geography Asia $ 1,494 $ 2,610 $ 3,180 $ 5,285 Americas 1,090 1,407 2,513 3,021 Europe, Middle East and Africa 523 816 1,150 1,578 Total Revenue $ 3,107 $ 4,833 $ 6,843 $ 9,884 Comparison of Three and Six Months Ended December 30, 2022 to Three and Six Months Ended December 31, 2021 Net Revenue The decrease in consolidated net revenue for the three and six months ended December 30, 2022 from the comparable periods in the prior year reflected decreases in exabytes sold primarily in HDD, as certain customers reduced purchases as they adjusted their production levels and right-sized their inventories and also reflected lower average selling prices primarily in Flash. These items are further discussed below in our discussion by segment. Flash revenue decreased 37% and 34% for the three and six months ended December 30, 2022, respectively from the comparable periods in the prior year. The decline was primarily driven by a decline in average selling prices per gigabyte caused by a supply-demand imbalance, which was exacerbated by the current macroeconomic environment. HDD revenue decreased 34% for the three months ended December 30, 2022 from the comparable period in the prior year, substantially all of which was driven by a decrease in exabytes sold. The decline in exabytes sold was primarily driven by customers primarily in our Cloud and to a lesser extent in Client and Consumer end markets due to the macroeconomic pressures noted in “Operational and COVID-19 Pandemic Update” above and our end customers right-sizing their inventories. HDD revenue decreased 27% for the six months ended December 30, 2022 from the comparable period in the prior year, primarily driven by a 22% decrease in exabytes sold as well as a decrease in the average price per gigabyte. The decrease in exabytes sold for the six-month period was largely attributable to the same factors noted above for the three-month period with pricing per gigabyte impacted by a higher mix of enterprise drives. The decrease in Cloud revenue for the three months ended December 30, 2022 from the comparable period in the prior year reflected a decline in capacity enterprise drives sold to U.S. cloud customers, as they reduced purchases to right-size their inventories. In Client, the decrease in revenue for the three months ended December 30, 2022 from the comparable period in the prior year was primarily driven by the decline in average selling price per gigabyte in Flash and, to a lesser extent, a decline in client SSD shipments for PC applications. In Consumer, the decrease in revenue for the three months ended December 30, 2022 from the comparable period in the prior year primarily reflected the decrease in average selling price per gigabyte in Flash and to a lesser extent, a decline in retail HDD shipments. The decreases in Cloud and Consumer revenue for the six months ended December 30, 2022 from the comparable period in the prior year primarily reflected the same drivers noted above for the three-month period, respectively. In Client, the decrease in revenue for the six months ended December 30, 2022 from the comparable period in the prior year primarily reflected a decline in average selling price per gigabyte in Flash and, to a lesser extent, a decline in both Flash and HDD shipments for PC applications, due to lower demand as a result of macroeconomic pressures. 44 Table of Contents The changes in net revenue by geography for the three and six months ended December 30, 2022 from the comparable periods in the prior year reflected a larger decline in Asia from lower Client revenue from OEMs in this region as they reduced purchases to align with current market demand, as well as routine variations in the mix of business. Our top 10 customers accounted for 47% of our net revenue for the three months ended December 30, 2022, compared to 46% of our net revenue for the three months ended December 31, 2021. Our top 10 customers accounted for 48% of our net revenue for the six months ended December 30, 2022, compared to 44% of our net revenue for the six months ended December 31, 2021. For each of the three and six months ended December 30, 2022 and December 31, 2021, no single customer accounted for 10% or more of our net revenue. Consistent with standard industry practice, we have sales incentive and marketing programs that provide customers with price protection and other incentives or reimbursements that are recorded as a reduction to gross revenue. These programs represented 18% of gross revenue for each period presented. The amounts attributed to our sales incentive and marketing programs generally vary according to several factors including industry conditions, list pricing strategies, seasonal demand, competitor actions, channel mix and overall availability of products. Changes in future customer demand and market conditions may require us to adjust our incentive programs as a percentage of gross revenue. Gross Profit and Gross Margin Consolidated gross profit decreased by $1.06 billion for the three months ended December 30, 2022 from the comparable period in the prior year, which reflects the impact from the decrease in revenue in both Flash and HDD as well as approximately $100 million of charges in the current period related to manufacturing underutilization in HDD. Consolidated gross margin decreased 15.8 percentage points for the three months ended December 30, 2022 from the comparable period in the prior year, which primarily reflects lower average price per gigabyte in Flash and the impact of the underutilization charges in HDD. Flash gross margin decreased by 21.6 percentage points year over year, primarily reflecting the lower average selling price per gigabyte. HDD gross margin decreased by 9.9 percentage points year over year, of which the underutilization charge reflected approximately 7 percentage points with the remainder primarily driven by lower economies of scale as we tempered production. Consolidated gross profit decreased by $1.74 billion for the six months ended December 30, 2022 from the comparable period in the prior year, which reflects the decrease in revenue in both HDD and Flash and the approximate $100 mi llion underutilization charge in HDD during the three months ended December 30, 2022 , partially offset by a $64 million decrease during the six months ended December 30, 2022 in charges related to amortization expense on acquired intangible assets, some of which became fully amortized. Consolidated gross margin decreased 10.8 percentage points for the six months ended December 30, 2022 from the comparable period in the prior year, which reflects lower gross margin in both Flash and HDD and the underutilization charges noted above. Flash and HDD gross margin decreased by 16.9 and 5.6 percentage points year over year, respectively, reflecting the same factors noted above for the three-month period. Operating Expenses Research and development (“R&D”) expense decreased $52 million and $78 million for the three and six months ended December 30, 2022, respectively, from the comparable periods in the prior year. The declines were primarily driven by a reduction in variable compensation expenses and material use as we took actions to reduce expenses in the current environment. Selling, general and administrative (“SG&A”) expense decreased $29 million and $73 million for the three and six months ended December 30, 2022, respectively, from the comparable periods in the prior year. The declines were primarily driven by a reduction in expenses related to outside services, variable compensation expenses, and material use as we took actions to reduce expenses in the current environment. Employee termination, asset impairment and other charges increased $74 million and $80 million for the three and six months ended December 30, 2022, respectively, from the comparable periods in the prior year. The increases were due to restructuring actions taken to adjust our cost structure to align with the current demand environment. For information regarding Employee termination, asset impairment and other charges, see Part I, Item 1, Note 15, Employee Termination, Asset Impairment, and Other Charges of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. Interest and Other Income (Expense) Total interest and other expense, net decreased $17 million for each of the three and six months ended December 30, 2022 from the comparable periods in the prior year reflecting lower foreign exchange losses and lower interest expense resulting from the pay-down of principal on our debt. 45 Table of Contents Income Tax Expense The Tax Cuts and Jobs Act (the “2017 Act”) includes a broad range of tax reform proposals affecting businesses. We completed our accounting for the tax effects of the enactment of the 2017 Act during the second quarter of fiscal 2019. However, the U.S. Treasury and the Internal Revenue Service (“IRS”) have issued tax guidance on certain provisions of the 2017 Act since the enactment date, and we anticipate the issuance of additional regulatory and interpretive guidance. We applied a reasonable interpretation of the 2017 Act along with the then-available guidance in finalizing our accounting for the tax effects of the 2017 Act. Any additional regulatory or interpretive guidance would constitute new information, which may require further refinements to our estimates in future periods. On August 16, 2022, President Biden signed into law the Inflation Reduction Act of 2022, which contained significant law changes related to tax, climate, energy, and health care. The tax measures include, among other things, a corporate alternative minimum tax of 15% on corporations with three-year average annual adjusted financial statement income exceeding $1 billion. The corporate alternative minimum tax will not be effective for us until fiscal year 2024. We are currently evaluating the potential effects of these legislative changes. The following table sets forth income tax information from our Condensed Consolidated Statements of Operations by dollar and effective tax rate: Three Months Ended Six Months Ended December 30, 2022 December 31, 2021 December 30, 2022 December 31, 2021 $ in millions Income (loss) before taxes $ (385) $ 646 $ (301) $ 1,350 Income tax expense 61 82 118 176 Effective tax rate (16) % 13 % (39) % 13 % Beginning in fiscal year 2023, the 2017 Act requires us to capitalize and amortize R&D expenses rather than expensing them in the year incurred. The tax effects related to the capitalization of R&D expenses are included in the effective tax rate for the three and six months ended December 30, 2022, but did not have a material impact on our effective tax rate. The primary drivers of the difference between the effective tax rate for the three and six months ended December 30, 2022 and the U.S. Federal statutory rate of 21% are the relative mix of earnings and losses by jurisdiction, the deduction for foreign derived intangible income, credits, and tax holidays in Malaysia, the Philippines and Thailand that will expire at various dates during fiscal years 2024 through 2031. The primary drivers of the difference between the effective tax rate for the three and six months ended December 31, 2021 and the U.S. Federal statutory rate of 21% are the relative mix of earnings and losses by jurisdiction, the deduction for foreign derived intangible income, credits, and tax holidays in Malaysia, the Philippines and Thailand that will expire at various dates during fiscal years 2024 through 2031. In addition, the effective tax rate for the three and six months ended December 31, 2021 included the discrete effect of an increase to unrecognized tax benefits of $8 million and $25 million, respectively, as a result of ongoing discussions with various taxing authorities. Our future effective tax rate is subject to future regulatory developments and changes in the mix of our U.S. earnings compared to foreign earnings. The 2017 Act requires us to capitalize and amortize R&D expenses rather than expensing them in the year incurred. As described above, these capitalized expenses are included in our effective tax rate for the three and six months ended December 30, 2022, but did not have a material impact on the effective tax rate in those periods due to our reduced profitability. Mandatory capitalization of R&D is expected to materially increase our effective tax rate and taxes paid in future periods, if not repealed or otherwise modified. In addition, our total tax expense in future years may also vary as a result of discrete items such as excess tax benefits or deficiencies. For additional information regarding Income tax expense, see Part I, Item 1, Note 13, Income Tax Expense , of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. 46 Table of Contents Liquidity and Capital Resources The following table summarizes our statements of cash flows: Six Months Ended December 30, 2022 December 31, 2021 (in millions) Net cash provided by (used in): Operating activities $ 41 $ 1,187 Investing activities (482) (569) Financing activities (12) (1,456) Effect of exchange rate changes on cash (3) (1) Net decrease in cash and cash equivalents $ (456) $ (839) We and the IRS tentatively reached a basis for resolving the statutory notices of deficiency and notices of proposed adjustments with respect to fiscal years 2008 through 2015. We currently expect to pay tax and interest totaling approximately $720 million to $760 million, which we expect to be partially offset by future reductions to our mandatory deemed repatriation tax obligations and tax savings from interest deductions aggregating to approximately $100 million to $150 million. See Part I, Item 1, Note 13, Income Tax Expense , of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for further details. We have an existing shelf registration statement (the “Shelf Registration Statement”) filed with the Securities and Exchange Commission that expires in August 2024, which allows us to offer and sell shares of common stock, preferred stock, warrants, and debt securities. We may use the Shelf Registration Statement or other capital sources, including other offerings of equity or debt securities or the credit markets, to satisfy future financing needs, including planned or unanticipated capital expenditures, investments, debt repayments or other expenses. Any such additional financing will be subject to market conditions and may not be available on terms acceptable to us or at all. We believe our cash, cash equivalents and cash generated from operations as well as our available credit facilities, including the availability under our new delayed term loan agreement and the proceeds from the issuance of our Series A Preferred Stock as discussed in “Key Developments - Financing Activities”, will be sufficient to satisfy our IRS obligation and meet our working capital, debt and capital expenditure needs for at least the next twelve months and for the foreseeable future thereafter. We believe we can also access the various debt capital markets to further supplement our liquidity position. Our ability to sustain our working capital position is subject to a number of risks that we discuss in Part I, Item 1A, Risk Factors, in our Annual Report on Form 10-K for the year ended July 1, 2022. As noted previously, we are scaling back on capital expenditures and consolidating production lines and reducing bit growth to align with market demand. We are now reducing our expected expenditures for property, plant and equipment for our company plus our portion of the capital expenditures by our Flash Ventures joint venture with Kioxia for its operations from our previous estimate of an aggregate of $2.7 billion down to $2.3 billion for 2023. After consideration of the Flash Ventures’ lease financing of its capital expenditures and net operating cash flow, we have reduced the expected net cash used for our purchases of property, plant and equipment and net activity in notes receivable relating to Flash Ventures from a cash outflow of $1.3 billion to an amount below $1 billion during 2023. The total expected cash to be used could vary depending on the timing and completion of various capital projects and the availability, timing and terms of related financing . A total of $1.33 billion and $1.84 billion of our Cash and cash equivalents was held by our foreign subsidiaries as of December 30, 2022 and December 31, 2021, respectively. There are no material tax consequences that were not previously accrued for on the repatriation of this cash. Our cash equivalents are primarily invested in money market funds that invest in U.S. Treasury securities and U.S. Government agency securities. In addition, from time to time, we also invest directly in certificates of deposit, asset backed securities and corporate and municipal notes and bonds. 47 Table of Contents Operating Activities Cash flow from operating activities primarily consists of net income, adjusted for non-cash charges, plus or minus changes in operating assets and liabilities. This represents our principal source of cash. Net cash used for changes in operating assets and liabilities was $257 million for the six months ended December 30, 2022, as compared to $715 million for the six months ended December 31, 2021, which largely reflects the reduction in volume of our business. Changes in our operating assets and liabilities are largely affected by our working capital requirements, which are dependent on our volume of business and the effective management of our cash conversion cycle as well as timing of payments for taxes. Our cash conversion cycle measures how quickly we can convert our products into cash through sales. The cash conversion cycles were as follows (in days): Three Months Ended December 30, 2022 December 31, 2021 Days sales outstanding 56 52 Days in inventory 133 102 Days payables outstanding (55) (68) Cash conversion cycle 134 86 Changes in days sales outstanding (“DSO”) are generally due to the timing of shipments. Changes in days in inventory (“DIO”) are generally related to the timing of inventory builds, including staging of inventory to meet expected future demand. Changes in days payables outstanding (“DPO”) are generally related to production volume and the timing of purchases during the period. From time to time, we modify the timing of payments to our vendors. We make modifications primarily to manage our vendor relationships and to manage our cash flows, including our cash balances. Generally, we make the payment term modifications through negotiations with our vendors or by granting to, or receiving from, our vendors’ payment term accommodations. For the three months ended December 30, 2022, DSO increased by 4 days from the comparable period in the prior year, primarily reflecting the timing of shipments and customer collections. DIO increased by 31 days from the comparable period in the prior year primarily reflecting a decline in products shipped. DPO decreased by 13 days from the comparable period in the prior year primarily due to reductions in capital expenditures and HDD production levels as well as routine variations in the timing of purchases and payments during the period. We have seen no significant deterioration in our receivables as a result of COVID-19 or other market conditions. Investing Activities Net cash used in investing activities for the six months ended December 30, 2022 primarily consisted of $578 million in capital expenditures partially offset by a $82 million net decrease in notes receivable issuances to Flash Ventures. Net cash used in investing activities for the six months ended December 31, 2021 primarily consisted of $551 million in capital expenditures and a $17 million net increase in notes receivable issuances to Flash Ventures. Financing Activities During the six months ended December 30, 2022, cash flows from financing activities primarily consisted of $55 million used for taxes paid on vested stock awards under employee stock plans, partially offset by $48 million from the issuance of stock under employee stock plans. In addition, we drew and repaid $1.18 billion under our revolving credit facility within the period. Cash used in financing activities for the six months ended December 31, 2021 primarily consisted of $2.43 billion for repayment of debt, as well as $80 million for taxes paid on vested stock awards under employee stock plans offset by proceeds of $998 million from the issuance of new debt, and $60 million from the issuance of stock under employee stock plans. 48 Table of Contents Off-Balance Sheet Arrangements Other than the commitments related to Flash Ventures incurred in the normal course of business and certain indemnification provisions (see “Short and Long-term Liquidity-Purchase Obligations and Other Commitments” below), we do not have any other material off-balance sheet financing arrangements or liabilities, guarantee contracts, retained or contingent interests in transferred assets, or any other obligation arising out of a material variable interest in an unconsolidated entity. We do not have any majority-owned subsidiaries that are not included in the Condensed Consolidated Financial Statements. Additionally, with the exception of Flash Ventures and our joint venture with Unisplendour Corporation Limited and Unissoft (Wuxi) Group Co. Ltd., we do not have an interest in, or relationships with, any variable interest entities. For additional information regarding our off-balance sheet arrangements, see Part I, Item 1, Note 10, Related Parties and Related Commitments and Contingencies , of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. 49 Table of Contents Short- and Long-term Liquidity Material Cash Requirements In addition to cash requirements for unrecognized tax benefits discussed below, the following is a summary of our known material cash requirements, including those for capital expenditures, as of December 30, 2022: Total 1 Year (Remaining Six Months of 2023) 2-3 Years (2024-2025) 4-5 Years (2026-2027) More than 5 Years (Beyond 2027) (in millions) Long-term debt, including current portion (1) $ 7,100 $ — $ 1,363 $ 4,738 $ 999 Interest on debt 1,256 154 609 387 106 Flash Ventures related commitments (2) 5,274 1,950 2,545 913 (134) Operating leases 344 24 91 82 147 Purchase obligations and other commitments 3,613 2,591 773 99 150 Mandatory Deemed Repatriation Tax 657 — 402 255 — Total $ 18,244 $ 4,719 $ 5,783 $ 6,474 $ 1,268 (1) Principal portion of debt, excluding discounts and issuance costs. (2) Includes reimbursement for depreciation and lease payments on owned and committed equipment, funding commitments for loans and equity investments and payments for other committed expenses, including R&D and building depreciation. Funding commitments assume no additional operating lease guarantees. Additional operating lease guarantees can reduce funding commitments. Debt In addition to our existing debt, as of December 30, 2022, we had $2.25 billion available for borrowing under our revolving credit facility until January 2027, subject to customary conditions under the loan agreement. Furthermore, we entered into a delayed draw term loan agreement as noted in “Key Developments - Financing Activities” which provides us with an additional $875 million unsecured term loan available to borrow through June 30, 2023, subject to customary conditions and certain financial covenants under the loan agreement. The agreements governing these credit facilities each include limits on secured indebtedness and certain types of unsecured subsidiary indebtedness and require certain of our subsidiaries to provide guarantees to the extent the conditions providing for such guarantees are met. Additional information regarding our indebtedness, including information about principal repayment terms, interest rates, covenants and other key terms of our outstanding indebtedness, is included in Part II, Item 8, Note 8, Debt , of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended July 1, 2022. Our delayed draw term loan agreement and the loan agreement governing our revolving credit facility and our Term Loan A-2 due 2027 require us to comply with a leverage ratio financial covenant. As of December 30, 2022, we were in compliance with the applicable financial covenant. Flash Ventures Flash Ventures sells to and leases back from a consortium of financial institutions a portion of its tools and has entered into equipment lease agreements of which we guarantee half or all of the outstanding obligations under each lease agreement. The leases are subject to customary covenants and cancellation events that relate to Flash Ventures and each of the guarantors. The occurrence of a cancellation event could result in an acceleration of the lease obligations and a call on our guarantees. As of December 30, 2022, we were in compliance with all covenants under these Japanese lease facilities. See Part I, Item 1, Note 10, Related Parties and Related Commitments and Contingencies , of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for information regarding Flash Ventures. 50 Table of Contents Purchase Obligations and Other Commitments In the normal course of business, we enter into purchase orders with suppliers for the purchase of components used to manufacture our products. These purchase orders generally cover forecasted component supplies needed for production during the next quarter, are recorded as a liability upon receipt of the components, and generally may be changed or canceled at any time prior to shipment of the components. We also enter into long-term agreements with suppliers that contain fixed future commitments, which are contingent on certain conditions such as performance, quality and technology of the vendor’s components. These arrangements are included under “Purchase obligations and other commitments” in the table above. Mandatory Deemed Repatriation Tax The following is a summary of our estimated mandatory deemed repatriation tax obligations that are payable in the following years: December 30, 2022 (in millions) 2024 $ 199 2025 203 2026 255 Total $ 657 For additional information regarding our estimate of the total tax liability for the mandatory deemed repatriation tax, see Part II, Item 8, Note 13, Income Tax Expense , of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended June 28, 2019. Unrecognized Tax Benefits As of December 30, 2022, the liability for unrecognized tax benefits (excluding accrued interest and penalties) was $1.04 billion. Accrued interest and penalties related to unrecognized tax benefits are recognized in liabilities for uncertain tax positions and are recorded in the provision for income taxes. Accrued interest and penalties included in our liability related to unrecognized tax benefits as of December 30, 2022 was $279 million. Of these amounts, approximately $1.18 billion could result in potential cash payments. As previously disclosed, the IRS issued statutory notices of deficiency and notices of proposed adjustments with respect to transfer pricing with our foreign subsidiaries and intercompany payable balances for years 2008 through 2015. In September 2018 and March 2019, we filed petitions with the U.S. Tax Court covering years 2008 through 2012, for which we had received statutory notices of deficiency, while years 2013 through 2015 remain in the jurisdiction of the IRS’s Examination function. The IRS has filed various Amendments to Answer with the U.S. Tax Court which, together with the notices of proposed adjustments, would result in additional federal income tax liabilities totaling approximately $1.6 billion and penalties totaling $449 million with respect to years 2008 through 2015. In May 2022, we and the IRS tentatively reached a settlement for resolving the statutory notices of deficiency and notices of proposed adjustments with respect to years 2008 through 2015 subject to the parties entering into final stipulations and a closing agreement. Based on the tentative settlement for resolution, we now expect to pay tax and interest totaling approximately $720 million to $760 million, which we expect to be partially offset by future reductions to our mandatory deemed repatriation tax obligations and tax savings from interest deductions aggregating to approximately $100 million to $150 million. While we continue to work with the IRS to come to a final agreement on the federal tax and interest calculations, we are uncertain as to when a final agreement will be reached and the exact timing of when any payments will be made. However, we believe it is reasonably likely that these payments may be made within the next twelve months and we have classified that portion of these unrecognized tax benefits, including interest in Income taxes payable on our Condensed Consolidated Balance Sheets as of December 30, 2022. This classification and amount may be subject to change in the next twelve months depending on when we are able to reach a final agreement with the IRS. Mandatory Research and Development Expense Capitalization Beginning in 2023, the 2017 Act requires us to capitalize and amortize R&D expenses rather than expensing them in the year incurred, which is expected to result in materially higher cash tax payments in future periods, if not repealed or otherwise modified. 51 Table of Contents Interest Rate Swap We have generally held a balance of fixed and variable rate debt and periodically have used interest rate swaps to hedge a portion of our fixed rate debt. As of December 30, 2022, our only variable rate debt outstanding was our Term Loan A-2 on which we had pay-fixed interest rate swaps of $2 billion notional amount that would mitigate the impact of fluctuations in variable interest rates on this loan only through February 2023. See Part I, Item 3, Quantitative and Qualitative Disclosures About Market Risks included in this in this Quarterly Report on Form 10-Q for additional information. Foreign Exchange Contracts We purchase foreign exchange contracts to hedge the impact of foreign currency fluctuations on certain underlying assets, liabilities and commitments for Operating expenses and product costs denominated in foreign currencies. See Part I, Item 3, Quantitative and Qualitative Disclosures About Market Risks included in this Quarterly Report on Form 10-Q for additional information. Indemnifications In the ordinary course of business, we may provide indemnifications of varying scope and terms to customers, vendors, lessors, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of our breach of agreements, products or services to be provided by us, environmental compliance or from intellectual property (“IP”) infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and certain of our officers that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. We maintain director and officer insurance, which may cover certain liabilities arising from our obligation to indemnify our directors and officers in certain circumstances. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Such indemnification agreements may not be subject to maximum loss clauses. Historically, we have not incurred material costs as a result of obligations under these agreements. Stock Repurchase Program Our Board of Directors has authorized a stock repurchase program for the repurchase of up to $5.0 billion of our common stock, which authorization is effective through July 25, 2023. We did not make any stock repurchases during the six months ended December 30, 2022 and have not repurchased any shares of our common stock pursuant to our stock repurchase program since the first quarter of fiscal 2019. Although we will reevaluate the repurchasing of our common stock when appropriate, there can be no assurance if, when or at what level we may resume such activity. The remaining amount available to be repurchased under our current stock repurchase program as of December 30, 2022 was $4.5 billion. Repurchases under the stock repurchase program may be made in the open market or in privately negotiated transactions and may be made under a Rule 10b5-1 plan. Recent Accounting Pronouncements For a description of recently issued and adopted accounting pronouncements, including the respective dates of adoption and expected effects on our results of operations and financial condition, see Part I, Item 1, Note 2, Recent Accounting Pronouncements , of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. Critical Accounting Policies and Estimates We have prepared the accompanying unaudited Condensed Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States (U.S. GAAP). The preparation of the financial statements requires the use of judgments and estimates that affect the reported amounts of revenues, expenses, assets, liabilities and shareholders’ equity. We have adopted accounting policies and practices that are generally accepted in the industry in which we operate. If these estimates differ significantly from actual results, the impact to the Condensed Consolidated Financial Statements may be material. 52 Table of Contents There have been no material changes in our critical accounting policies and estimates from those disclosed in our Annual Report on Form 10‑K for the year ended July 1, 2022. Please refer to Part II, Item 7 of our Annual Report on Form 10‑K for the year ended July 1, 2022 for a discussion of our critical accounting policies and estimates. In addition, as disclosed in Part I, Item 1, Note 3, Business Segments, Geographic Information, and Concentrations of Risk , of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, as of December 30, 2022, our management identified several factors that warranted a quantitative analysis of impairment for both the Flash and HDD reporting units as of that date. Please refer to that disclosure for additional information on the estimates included in our assessment. 53 Table of Contents