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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 2, 2009
o	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 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  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes  o   No  o

 

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

 

Large accelerated filer: x		Accelerated filer: o
Non-accelerated filer: o		Smaller reporting company: o
(Do not check if a smaller reporting company)

 

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

 

As of October 30, 2009, 497,950,186 shares of the registrant’s common shares, par value $0.00001 per share, were issued and outstanding.

 

 

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INDEX

 

SEAGATE TECHNOLOGY

 

			PAGE NO.
PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets ¾ October 2, 2009 (Unaudited) and July 3, 2009		3
	Condensed Consolidated Statements of Operations ¾ Three Months ended October 2, 2009 and October 3, 2008 (Unaudited)		4
	Condensed Consolidated Statements of Cash Flows ¾ Three Months ended October 2, 2009 and October 3, 2008 (Unaudited)		5
	Condensed Consolidated Statement of Shareholders’ Equity ¾ Three Months ended October 2, 2009 (Unaudited)		6
	Notes to Condensed Consolidated Financial Statements (Unaudited)		7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		40
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		51
Item 4.	Controls and Procedures		52
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings		53
Item 1A.	Risk Factors		53
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		53
Item 3.	Defaults Upon Senior Securities		53
Item 4.	Submission of Matters to a Vote of Securityholders		53
Item 5.	Other Information		54
Item 6.	Exhibits		55
	SIGNATURES		64

 

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PART I

FINANCIAL INFORMATION

 

ITEM 1.                 FINANCIAL STATEMENTS

 

SEAGATE TECHNOLOGY

CONDENSED CONSOLIDATED BALANCE SHEETS

(In millions)

(Unaudited)

 

		October 2, 2009			July 3, 2009 (a)
ASSETS
Current assets:
Cash and cash equivalents		$	1,530		$	1,427
Short-term investments		96			114
Restricted cash and investments		166			508
Accounts receivable, net		1,242			1,033
Inventories		622			587
Deferred income taxes		99			97
Other current assets		552			528
Total current assets		4,307			4,294
Property, equipment and leasehold improvements, net		2,039			2,229
Deferred income taxes		369			372
Other assets, net		184			192
Total Assets		$	6,899		$	7,087
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Short-term borrowings		$	215		$	350
Accounts payable		1,674			1,573
Accrued employee compensation		142			144
Accrued warranty		206			213
Accrued expenses		440			483
Accrued income taxes		13			10
Current portion of long-term debt		107			421
Total current liabilities		2,797			3,194
Long-term accrued warranty		212			224
Long-term accrued income taxes		67			69
Other non-current liabilities		134			120
Long-term debt, less current portion		1,910			1,926
Total Liabilities		5,120			5,533
Commitments and contingencies
SHAREHOLDERS’ EQUITY
Shareholders’ equity:
Common shares and additional paid-in capital		3,748			3,708
Accumulated other comprehensive income (loss)		—			(6		)
Retained earnings (accumulated deficit)		(1,969		)	(2,148		)
Total Shareholders’ Equity		1,779			1,554
Total Liabilities and Shareholders’ Equity		$	6,899		$	7,087

 

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(a)           The information in this column was derived from the Company’s audited Consolidated Balance Sheet as of July 3, 2009, as adjusted due to a required change in the accounting for convertible debt instruments implemented in the first quarter of fiscal year 2010, applied on a retrospective basis.

 

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 2, 2009			October 3, 2008 (a)
Revenue		$	2,663		$	3,033
Cost of revenue		2,010			2,507
Product development		208			260
Marketing and administrative		106			148
Amortization of intangibles		8			14
Restructuring and other, net		46			23
Impairment of long-lived assets		64			—
Total operating expenses		2,442			2,952
Income from operations		221			81
Interest income		1			7
Interest expense		(45		)	(33		)
Other, net		3			(14		)
Other income (expense), net		(41		)	(40		)
Income before income taxes		180			41
Provision for (benefit from) for income taxes		1			(16		)
Net income		$	179		$	57
Net income per share:
Basic		$	0.36		$	0.12
Diluted		$	0.35		$	0.12
Number of shares used in per share calculations:
Basic		494			485
Diluted		512			494
Cash dividends declared per share		$	—		$	0.12

 

(a)           As adjusted due to a required change in the accounting for convertible debt instruments implemented in the first quarter of fiscal year 2010, applied on a retrospective basis.

 

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 2, 2009			October 3, 2008 (a)
OPERATING ACTIVITIES
Net income		$	179		$	57
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		204			253
Stock-based compensation		11			27
Impairment of long-lived assets		64			—
Other non-cash operating activities, net		4			(8		)
Changes in operating assets and liabilities:
Accounts receivable		(209		)	16
Inventories		(35		)	36
Accounts payable		112			278
Accrued employee compensation		(2		)	(287		)
Accrued warranty		(19		)	—
Accrued expenses		(54		)	26
Other assets and liabilities		23			(94		)
Net cash provided by operating activities		278			304
INVESTING ACTIVITIES
Acquisition of property, equipment and leasehold improvements		(89		)	(280		)
Purchases of short-term investments		(41		)	(90		)
Maturities and sales of short-term investments		58			93
Decrease in restricted cash and investments		10			—
Other investing activities, net		(2		)	12
Net cash used in investing activities		(64		)	(265		)
FINANCING ACTIVITIES
Proceeds from short-term borrowings		15			—
Repayment of short-term borrowings		(150		)	—
Retirements and maturities of long-term debt		(334		)	—
Decrease in restricted cash and investments		332			—
Proceeds from exercise of employee stock options and employee stock purchase plan		26			35
Dividends to shareholders		—			(59		)
Net cash used in financing activities		(111		)	(24		)
Increase in cash and cash equivalents		103			15
Cash and cash equivalents at the beginning of the period		1,427			990
Cash and cash equivalents at the end of the period		$	1,530		$	1,005
Supplemental Disclosure of Cash Flow Information
Cash paid for interest		$	49		$	50
Cash paid for income taxes, net of refunds		1			2

 

(a)           As adjusted due to a required change in the accounting for convertible debt instruments implemented in the first quarter of fiscal year 2010, applied on a retrospective basis.

 

See Notes to Condensed Consolidated Financial Statements.

 

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SEAGATE TECHNOLOGY

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

 

Three Months Ended October 2, 2009

(In millions)

(Unaudited)

 

		Number of Common Shares		Par Value of Shares			Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Retained Earnings (Accumulated Deficit)			Total
Balance at July 3, 2009 (a)		493		$	—		$	3,708		$	(6	)	$	(2,148	)	$	1,554
Comprehensive income, net of tax:
Change in unrealized gain (loss) on cash flow hedges, net		—		—			—			6			—			6
Net income		—		—			—			—			179			179
Comprehensive income																185
Issuance of common shares related to employee stock options and employee stock purchase plan		4		—			29			—			—			29
Stock-based compensation		—		—			11			—			—			11
Balance at October 2, 2009		497		$	—		$	3,748		$	—		$	(1,969	)	$	1,779

 

(a)           As adjusted due to a required change in the accounting for convertible debt instruments implemented in the first quarter of fiscal year 2010, applied on a retrospective basis.

 

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

 

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 July 3, 2009 are included in its Annual Report on Form 10-K as filed with the United States Securities and Exchange Commission (SEC) on August 19, 2009.  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 July 3, 2009 and the notes thereto, are adequate to make the information presented not misleading.

 

The results of operations for the three months ended October 2, 2009, 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 2, 2010.

 

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 2, 2009 and October 3, 2008 were 13 weeks and 14 weeks, respectively.  Fiscal year 2010 will be comprised of 52 weeks and will end on July 2, 2010.

 

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 July 3, 2009, there have been no significant changes in the Company’s critical accounting policies and estimates.  Please refer to Note 1 of “Financial Statements and Supplementary Data” contained in Part II, Item 8 of the Company’s Annual Report on Form 10-K for the fiscal year ended July 3, 2009, as filed with the SEC on August 19, 2009, for a discussion of the Company’s critical accounting policies and estimates.

 

Change in Method of Accounting for Convertible Debt Instruments

 

On July 4, 2009, the Company implemented changes to the accounting for its convertible debt instruments on a retrospective basis.  See Note 4 for further details.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

1.  Summary of Significant Accounting Policies (continued)

 

Recently Issued Accounting Pronouncements

 

In October 2009, the FASB issued Accounting Standards Update (ASU) No. 2009-14, Software (Accounting Standards Codification (ASC) Topic 985) - Certain Revenue Arrangements That Include Software Elements , a consensus of the FASB Emerging Issues Task Force.  This guidance modifies the scope of ASC subtopic 965-605, Software-Revenue Recognition to exclude from its requirements (a) non-software components of tangible products and (b) software components of tangible products that are sold, licensed, or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s essential functionality.  This update requires expanded qualitative and quantitative disclosures and is effective for the Company’s first quarter of fiscal year 2011. However, early adoption is allowed.  The Company is currently evaluating the impact of adopting this update on its consolidated financial statements.

 

In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (ASC Topic 605) - Multiple-Deliverable Revenue Arrangements , a consensus of the FASB Emerging Issues Task Force.  This guidance modifies the fair value requirements of ASC subtopic 605-25, Revenue Recognition-Multiple Element Arrangements by allowing the use of the “best estimate of selling price” in addition to vendor-specific objective evidence (VSOE) and verifiable objective evidence (VOE) (now referred to as TPE standing for third-party evidence) for determining the selling price of a deliverable. A vendor is now required to use its best estimate of the selling price when VSOE or TPE of the selling price cannot be determined. In addition, the residual method of allocating arrangement consideration is no longer permitted.  In October 2009, the FASB also issued ASU No. 2009-14, Software (ASC Topic 985) - Certain Revenue Arrangements That Include Software Elements , a consensus of the FASB Emerging Issues Task Force.  This guidance modifies the scope of ASC subtopic 965-605, Software-Revenue Recognition to exclude from its requirements (a) non-software components of tangible products and (b) software components of tangible products that are sold, licensed, or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s essential functionality.  This update requires expanded qualitative and quantitative disclosures and is effective for the Company’s first quarter of fiscal year 2011. However, early adoption is allowed.  The Company is currently evaluating the impact of adopting this update on its consolidated financial statements.

 

In August 2009, FASB issued ASU No. 2009-05, Fair Value Measurements and Disclosures (ASC Topic 820) — Measuring Liabilities at Fair Value . This update requires clarification for circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the following techniques: 1) a valuation technique that uses either the quoted price of the identical liability when traded as an asset or quoted prices for similar liabilities or similar liabilities when traded as an asset; or 2) another valuation technique that is consistent with the principles in ASC Topic 820 such as the income and market approach to valuation. The amendments in this update also clarify that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. This update further clarifies that if the fair value of a liability is determined by reference to a quoted price in an active market for an identical liability, that price would be considered a Level 1 measurement in the fair value hierarchy. Similarly, if the identical liability has a quoted price when traded as an asset in an active market, it is also a Level 1 fair value measurement if no adjustments to the quoted price of the asset are required. This update is effective for the Company’s second quarter of fiscal year 2010.  The Company does not expect that this update will have a material impact on its results of operations and financial condition.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

2.  Balance Sheet Information

 

Investments

 

The following is a summary of the fair value of available-for-sale securities at October 2, 2009:

 

(Dollars in millions)		Amortized Cost			Unrealized Gain/ (Loss)			Fair Value
U.S. treasuries and agency bonds		$	98		$	1		$	99
Corporate bonds		28			—			28
Municipal bonds		14			—			14
Auction rate securities		21			(3		)	18
Commercial paper		254			—			254
Certificates of deposit		46			—			46
Money market funds		1,047			—			1,047
Total		$	1,508		$	(2	)	$	1,506
Included in cash and cash equivalents								$	1,392
Included in short term investments								96
Included in long term investments								18
								$	1,506

 

As of October 2, 2009, with the exception of the Company’s auction rate securities, the Company had no marketable securities that had been in a continuous unrealized loss position for a period greater than 12 months and determined no investments were other-than-temporarily impaired (see Note 7).

 

The fair value of the Company’s investment in debt securities at October 2, 2009, by remaining contractual maturity, is as follows:

 

(Dollars in millions)		Amortized Cost			Unrealized Gain/ (Loss)			Fair Value
Due in less than 1 year		$	1,459		$	—		$	1,459
Due in 1 to 3 years		28			1			29
Thereafter		21			(3		)	18
Total		$	1,508		$	(2	)	$	1,506

 

The following is a summary of the fair value of available-for-sale securities at July 3, 2009:

 

(Dollars in millions)		Amortized Cost			Unrealized Gain/ (Loss)			Fair Value
U.S. treasuries and agency bonds		$	52		$	1		$	53
Corporate bonds		16			—			16
Municipal bonds		14			—			14
Auction rate securities		21			(3		)	18
Commercial paper		348			—			348
Certificates of deposit		50			—			50
Money market funds		914			—			914
Total		$	1,415		$	(2	)	$	1,413
Included in cash and cash equivalents								$	1,281
Included in short term investments								114
Included in long term investments								18
								$	1,413

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

2.  Balance Sheet Information (continued)

 

The fair value of the Company’s investment in debt securities at July 3, 2009, by remaining contractual maturity, is as follows:

 

(Dollars in millions)		Amortized Cost			Unrealized Gain/ (Loss)			Fair Value
Due in less than 1 year		$	1,364		$	—		$	1,364
Due in 1 to 3 years		30			1			31
Thereafter		21			(3		)	18
Total		$	1,415		$	(2	)	$	1,413

 

        As of July 3, 2009, with the exception of the Company’s auction rate securities, the Company had no marketable securities that had been in a continuous unrealized loss position for a period greater than 12 months and determined no investments were other-than-temporarily impaired (see Note 7).

 

Restricted Cash and Investments

 

        As of October 2, 2009, the Company’s restricted cash and investments consisted of $85 million for cash held in trust for payment of its deferred compensation plan liabilities, $47 million of proceeds from the issuance of its 10% Senior Secured Second-Priority Notes due May 2014 (“10% Notes”) held in escrow for the repayment or repurchase of debt, and $34 million in cash collateral held at banks for various performance obligations.

 

Accounts Receivable

 

(Dollars in millions)		October 2, 2009			July 3, 2009
Accounts receivable		$	1,252		$	1,043
Allowance for doubtful accounts		(10		)	(10		)
		$	1,242		$	1,033

 

Inventories

 

(Dollars in millions)		October 2, 2009			July 3, 2009
Raw materials and components		$	217		$	201
Work-in-process		135			120
Finished goods		270			266
		$	622		$	587

 

Other Current Assets

 

(Dollars in millions)		October 2, 2009			July 3, 2009
Vendor non-trade receivables		$	340		$	326
Other		212			202
		$	552		$	528

 

Other current assets include vendor 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 as 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.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

2.  Balance Sheet Information (continued)

 

Property, Equipment and Leasehold Improvements, net

 

(Dollars in millions)		October 2, 2009			July 3, 2009
Property, equipment and leasehold improvements		$	6,189		$	6,267
Accumulated depreciation and amortization		(4,150		)	(4,038		)
		$	2,039		$	2,229

 

3.  Restructuring and Exit Costs

 

The Company’s significant restructuring plans are described below. All restructuring charges are reported in Restructuring and other, net on the Condensed Consolidated Statements of Operations, unless otherwise noted.

 

During the first quarter of fiscal year 2010, the Company recorded restructuring charges of $46 million, comprised mainly of charges related to the planned closure of the Company’s Ang Mo Kio (AMK) manufacturing operations in Singapore (the “AMK Plan”).

 

AMK Plan. In August 2009, the Company announced that it will close its AMK facility in Singapore by the end of  calendar year 2010. The hard drive manufacturing operations will be relocated to other existing Seagate facilities and the Company’s Asia International Headquarters (IHQ) will remain in Singapore. This closure and relocation is part of the Company’s ongoing focus on cost efficiencies in all areas of its business and is intended to facilitate leveraging manufacturing investments across fewer sites. The Company does not expect the closure to meaningfully change production capacity.  The Company currently estimates total restructuring charges of approximately $80 million, all in cash, including approximately $60 million for severance, approximately $10 million for the relocation of manufacturing equipment, and approximately $10 million for other plant closure and relocation costs. During the three months ended October 2, 2009, the Company accrued total restructuring charges of $37 million related to estimated post-employment benefits for the AMK Plan.  No cash payments were made relating to this plan during the three months ended October 2, 2009.

 

January and May 2009 Plans . From inception of the Company’s restructuring plans announced in January and May of 2009 through October 2, 2009, the Company has recorded restructuring charges of approximately $169 million primarily related to post employment benefits. These plans are expected to result in total restructuring charges of approximately $172 million. During the three months ended October 2, 2009, the Company recorded restructuring charges of $1 million related to other exit costs. The Company made cash payments of $52 million relating to these plans during the three months ended October 2, 2009. Payment of the remaining accrued balance of $10 million is expected to be largely completed by January 1, 2010.

 

Pittsburgh and Milpitas Closures.  The Company announced the closure of its research facility in Pittsburgh, Pennsylvania and its media manufacturing facility in Milpitas, California in September 2008 and July 2008, respectively. Operations at these facilities ceased during fiscal year 2009. During the three months ended October 2, 2009, the Company recorded approximately $6 million of restructuring charges related to additional Pittsburgh lease obligations and approximately $2 million of other exit costs. From the inception of these plans through October 2, 2009, the Company has recorded restructuring charges of approximately $105 million, net of adjustments.  These closures are expected to result in total charges of approximately $110 million. The Company made cash payments of $4 million related to these plans during the three months ended October 2, 2009. The remaining balance of $12 million as of October 2, 2009 is associated with facility lease obligations. Payment of these exit costs are expected to continue through the end of fiscal year 2017.

 

Maxtor and Other.   The Company recorded certain exit costs aggregating $265 million through fiscal year 2009 related to its acquisition of Maxtor. The Company made cash payments of $2 million related to these plans during the three months ended October 2, 2009. The remaining balance of $27 million, as of October 2, 2009, is associated with the exit of certain facilities. Payment of these exit costs are expected to continue through the end of fiscal year 2016.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

3.  Restructuring and Exit Costs (continued)

 

The following table summarizes the Company’s restructuring activities for the three months ended October 2, 2009:

 

(Dollars in millions)		Employee Benefits			Operating Leases			Other Exit Costs			Total
All Restructuring Activities
Accrual balances at July 3, 2009		$	61		$	40		$	—		$	101
Restructuring charges		37			6			3			46
Cash payments		(52		)	(4		)	(2		)	(58		)
Adjustments		—			—			—			—
Accrual balances at October 2, 2009		$	46		$	42		$	1		$	89

 

Of the $89 million accrued restructuring balance at October 2, 2009, $37 million is included in Accrued expenses and $52 million is included in Other non-current liabilities on the accompanying Condensed Consolidated Balance Sheet.

 

4.  Debt and Convertible Notes

 

Short-term Borrowings

 

During the three months ended October 2, 2009, the Company entered into $15 million of short-term borrowings.

 

Convertible Notes

 

On July 4, 2009, the Company implemented a change in accounting in accordance with ASC 470-20, Debt with Conversion and Other Options (formerly FSP APB 14-1), for its convertible debt instruments on a retrospective basis to separately account for its convertible debt in two parts, (i) a debt component which was recorded upon acquisition at the estimated fair value of a similar debt instrument without the debt-for-equity conversion feature; and (ii) an equity component that was included in paid-in capital and represents the estimated fair value of the conversion feature at issuance.  The bifurcation of the debt and equity components resulted in a discounted carrying value of the debt component compared to the principal amount.  The discount is accreted to the carrying value of the debt component through interest expense over the expected life of the debt using the effective interest method.

 

The 6.8% Convertible Senior Notes due April 2010 (the “6.8% Notes”) require semi-annual interest payments payable on April 30 and October 30.  The 6.8% Notes were recognized on May 19, 2006 as long-term debt at its par value of $136 million and a substantial premium of $17 million was recorded to Additional paid-in capital.  The debt component of the 6.8% Notes at acquisition was determined to be $136 million, based on the contractual cash flows discounted at 6.8%, which was the estimated rate of a comparable non-convertible debt instrument as of May 19, 2006.  As a result, implementation of the new requirements had no effect on the accounting for the 6.8% Notes.

 

The 2.375% Convertible Senior Notes due August 2012 (the “2.375% Notes”) require semi-annual interest payments payable on February 15 and August 15.  The 2.375% Notes were recognized on May 19, 2006 as long-term debt at its par value of $326 million and a substantial premium of $157 million was recorded to Additional paid-in capital.  The debt component of the 2.375% Notes at acquisition was determined to be $252 million, based on the contractual cash flows discounted at 6.9%, which was the estimated rate of a comparable non-convertible debt instrument as of May 19, 2006.  As a result of implementing the new standard, $74 million was recorded as an increase to Additional paid-in capital and a corresponding debt discount as of the date of acquisition.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

4.  Debt and Convertible Notes (continued)

 

The following illustrates the retrospective impact of implementing the provisions of the change in accounting for convertible debt on the Condensed Consolidated Balance Sheet as of July 3, 2009 and on the previously stated Condensed Consolidated Statement of Operations for the three months ended October 3, 2008:

 

Retrospective Impact on the Condensed Consolidated Balance Sheet as of July 3, 2009

 

(Dollars in millions)		As Originally Stated			Effect of Change in Accounting			Restated
Current assets:
Deferred income taxes		$	94		$	3		$	97
Non-current assets:
Deferred income taxes		$	375		$	(3	)	$	372
Non-current liabilities:
Long-term debt, less current portion		$	1,956		$	(30	)	$	1,926
Stockholders’ equity:
Additional paid-in capital		$	3,647		$	61		$	3,708
Accumulated deficit		$	(2,117	)	$	(31	)	$	(2,148	)

 

Retrospective Impact on the Condensed Consolidated Statement of Operations

for the Three Months Ended October 3, 2008

 

(Dollars in millions)		As Originally Stated			Effect of Change in Accounting			Restated
Interest expense		$	(30	)	$	(3	)	$	(33	)
Net income (loss)		$	60		$	(3	)	$	57

 

There was no net impact resulting from this accounting change on the Company’s cash flows from operating activities, investing activities or financing activities as reflected in the Condensed Consolidated Statements of Cash Flows.

 

The following table presents information regarding the equity and liability components of the 2.375% and 6.8% Notes:

 

		As of
(Dollars in millions)		October 2, 2009			July 3, 2009
					Restated
2.375% Notes
Principal amount		$	326		$	326
Unamortized discount		(38		)	(41		)
Liability component		$	288		$	285
Equity component		$	231		$	231
6.8% Notes
Principal amount and liability component		$	104		$	116
Equity component		$	17		$	17

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

4.  Debt and Convertible Notes (continued)

 

The remaining discount on the 2.375% Notes will continue to be amortized until maturity of the 2.375% Notes in August 2012.  The effective interest rate, contractual interest expense and amortization of debt discount for the 2.375% Notes for the three months ended October 2, 2009 and October 3, 2008 were as follows:

 

		The Three Months Ended
(Dollars in millions, except for percentages)		October 2, 2009			October 3, 2008
					Restated
Effective interest rate		6.9		%	6.9		%
Interest expense – contractual		$	2		$	2
Interest expense – amortization of debt discount due to change in accounting		$	3		$	3

 

The 2.375% and 6.8% Notes may, subject to certain conditions, be converted into the Company’s common shares based on a conversion rate of 60.2074 and 30.1733 shares, respectively, per $1,000 principal amount of notes, which represents a conversion price of approximately $16.61 and $33.14 per share, respectively.  As of October 2, 2009, these notes were not convertible and the principal values exceeded the conversion values.

 

5.  Income Taxes

 

The income tax provision of $1 million recorded in the three months ended October 2, 2009 included approximately $11 million of discrete tax benefits primarily associated with reversal of valuation allowance previously recorded for certain foreign deferred tax assets and releases of tax reserves resulting from the expiration of certain statutes of limitations. The income tax benefit of $16 million recorded in the three months ended October 3, 2008 included discrete items associated with release of tax reserves and monetization of research tax credits.

 

The Company’s provision for income taxes recorded for the three months ended October 2, 2009 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) tax benefits related to tax holiday and tax incentive programs, (ii) a decrease in valuation allowance for certain foreign deferred tax assets, (iii) a decrease in certain tax reserves, and (iv) tax expense related to intercompany transactions.

 

The tax rate differential for the three months ended October 3, 2008 was primarily due to the net effect of (i) tax benefits related to tax holiday and tax incentive programs, (ii) a decrease in 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 tax reserves due to settlement of tax audits and expiration of certain statutes of limitations.

 

During the three months ended October 2, 2009, the Company’s unrecognized tax benefits excluding interest and penalties remained at $118 million. The unrecognized tax benefits that, if recognized, would impact the effective tax rate was $118 million as of October 2, 2009 subject to certain future valuation allowance reversals.  During the 12 months beginning October 3, 2009, the Company expects to reduce its unrecognized tax benefits by approximately $10 million as a result of tax positions being effectively settled and the expiration of certain statutes of limitations.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

6.  Derivative Financial Instruments

 

The Company is exposed to foreign currency exchange rate, interest rate, and to a lesser extent, equity price risks relating to its ongoing business operations. The Company enters into various foreign currency forward exchange contracts in order to manage the foreign currency exchange rate risk on forecasted expenses denominated in foreign currencies and to mitigate the remeasurement risk of certain foreign currency denominated liabilities.  The Company had an unrealized net gain on cash flow hedges of $5 million and a net loss of $1 million included in Other comprehensive income (loss) (OCI) as of October 2, 2009 and July 3, 2009, respectively.

 

The Company dedesignates its cash flow hedges when the forecasted hedged transactions are realized or it is probable the forecasted hedged transaction will not occur in the initially identified time period. At such time, the associated gains and losses deferred in Other comprehensive income (loss) are reclassified immediately into earnings. Any subsequent changes in the fair value of such derivative instruments are also reflected in earnings. As of October 2, 2009, the Company’s existing foreign currency forward exchange contracts are expected to mature within 12 months and the deferred amount currently recorded in Other comprehensive income (loss) and expected to be recognized into earnings is approximately $5 million.

 

As of October 2, 2009, the total notional value of the Company’s outstanding foreign currency forward exchange contracts was:

 

(Dollars in millions)		Contracts Qualifying as Hedges Under ASC 815			Contracts Not Qualifying as Hedges Under ASC 815
Thai baht		$	273		$	175
Singapore dollars		37			—
British pounds		7			1
Czech koruna		—			3
		$	317		$	179

 

The Company is subject to equity market risks due to changes in the fair value of the notional investments selected by its employees as part of its non-qualified deferred compensation (NQDC) plan. In the quarter ended July 3, 2009, the Company entered into a Total Return Swap (TRS) in order to manage the equity market risks associated with the NQDC plan liabilities. The Company pays a floating rate, based on LIBOR plus a spread, on the notional amount of the TRS. The TRS is designed to substantially offset changes in the NQDC plan liability due to changes in the value of the investment options made by employees. As of October 2, 2009, the notional investments underlying the TRS amounted to $76 million. The contract term of the TRS is one year and is settled on a monthly basis therefore limiting counterparty performance risk. The terms of the TRS require the Company to pledge initial collateral of $18 million to the counterparty for the term of the contract. Additional collateral may be posted contingent on the counterparty’s exposure to the market value of the TRS. As of October 2, 2009, the Company had pledged collateral of $18 million to the counterparty and recorded the cash pledged as restricted cash. The Company did not designate the TRS as a hedge in accordance with ASC 815, Derivatives and Hedging . Rather, the Company records all changes in the fair value of the TRS to earnings to offset the market value changes of the NQDC plan liabilities.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

6.  Derivative Financial Instruments (continued)

 

The following table shows the Company’s derivative instruments measured at gross fair value as reflected in the Condensed Consolidated Balance Sheet as of October 2, 2009:

 

Fair Values of Derivative Instruments

 

		Asset Derivatives					Liability Derivatives
(Dollars in millions)		Balance Sheet Location		Fair Value			Balance Sheet Location		Fair Value
Derivatives designated as hedging instruments under ASC 815:
Foreign currency forward exchange contracts		Other current assets		$	6		Accrued expenses		$	—
Derivatives not designated as hedging instruments under ASC 815:
Foreign currency forward exchange contracts		Other current assets		$	4		Accrued expenses		$	—
Total return swap		Other current liabilities		—			Accrued expenses		(2		)
Total derivatives				$	10				$	(2	)

 

The following tables show the effect of the Company’s derivative instruments on Other comprehensive income (loss) and the Condensed Consolidated Statement of Operations for the three months ended October 2, 2009:

 

(Dollars in millions)

 

Derivatives Designated as Cash Flow Hedges under ASC 815		Amount of Gain or (Loss) Recognized in OCI on Derivative (Effective Portion)			Location of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)		Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)			Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)		Amount of Gain or (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing) (a)
Foreign currency forward exchange contracts		$	6		Cost of revenue		$	—		Cost of revenue		$	—

 

Derivatives Not Designated as Hedging Instruments under ASC 815		Location of Gain or (Loss) Recognized in Income on Derivative		Amount of Gain or (Loss) Recognized in Income on Derivative
Foreign currency forward exchange contracts		Other, net		$	4
Total return swap		Operating expenses		$	9
				$	13

 

(a)    The amount of gain or (loss) recognized in income represents $0 related to the ineffective portion of the hedging relationships and $0.4 million related to the amount excluded from the assessment of hedge effectiveness.

 

Net foreign currency transaction gains included in the determination of consolidated net income were $4 million for the three months ended October 2, 2009 and net foreign currency transaction losses were $6 million for the three months ended October 3, 2008.

 

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SEAGATE TECHNOLOGY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

6.  Derivative Financial Instruments (continued)

 

As of July 3, 2009, the total notional value of the Company’s outstanding foreign currency forward exchange contracts was:

 

(Dollars in millions)		Contracts Qualifying as Hedges Under ASC 815			Contracts Not Qualifying as Hedges Under ASC 815
Thai baht		$	104		$	64
Singapore dollars		24			3
Czech koruna		—			8
		$	128		$	75

 

The following table shows the Company’s derivative instruments measured at gross fair value as reflected in the Condensed Consolidated Balance Sheet as of July 3, 2009:

 

Fair Values of Derivative Instruments

 

		Asset Derivatives					Liability Derivatives
(Dollars in millions)		Balance Sheet Location		Fair Value			Balance Sheet Location		Fair Value
Derivatives designated as hedging instruments under ASC 815:
Foreign currency forward exchange contracts		Other current assets		$	1		Accrued expenses		$	—
Derivatives not designated as hedging instruments under ASC 815:
Foreign currency forward exchange contracts		Other current assets		$	—		Accrued expenses		$	—
Total return swap		Other current liabilities		—			Accrued expenses		(1		)
Total derivatives				$	1				$	(1	)

 

7.  Fair Value

 

For assets and liabilities recorded at fair value, the Company bases the determination of fair value upon exit price, representing the amount that would be received on the sale of an asset or paid to transfer a liability in an orderly transaction between market participants.  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.

 

As of July 4, 2009, the Company adopted the provisions of ASC 820, Fair Value Measurements and Disclosures (previously SFAS 157, Fair Value ) that apply to non-financial assets and liabilities measured at fair value on a non-recurring basis, thereby applying the fair value disclosure requirements to both the financial and non-financial assets and liabilities of the Company.  The adoption of these provisions did not have a material impact on the Company’s consolidated results of operations and financial condition.

 

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