UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K

 

 

 

 

 

Commission File No. 001-31560

 

SEAGATE TECHNOLOGY

(Exact name of Registrant as specified in its charter)

 

 

 

 

 

P.O. Box 309GT
Ugland House, South Church Street
George Town, Grand Cayman, Cayman Islands
(Address of principal executive offices)

 

Registrant’s telephone number, including area code:

(345) 949-8066

 

 

 

 

Securities registered pursuant to Section 12 (b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:
None —

 

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  YES þ     NO o          

 

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 þ     NO o

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.  YES o     NO þ

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

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

Large accelerated filer þ     Accelerated filer o  Non-accelerated filer o

 

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

 

The aggregate market value of the voting and non-voting common shares held by non-affiliates of the registrant owning 5% or more of the registrant’s outstanding common shares as of December 29, 2006, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $4.9 billion based upon a closing price of $26.50 reported for such date by the New York Stock Exchange.

 

The number of outstanding common shares of the registrant as of August 15, 2007 was 534,146,256.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Proxy Statement to be delivered to shareholders in connection with our 2007 Annual Meeting of Stockholders (the “Proxy Statement”) are incorporated herein by reference in Part III.

 

 

SEAGATE TECHNOLOGY

 

TABLE OF CONTENTS

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

Some of the statements and assumptions included in this Annual Report on Form 10-K are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 or Section 21E of the Securities Exchange Act of 1934, each as amended, including, in particular, statements about our plans, strategies and prospects in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7. These statements identify prospective information and include words such as “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “projects,” and similar expressions. These forward-looking statements are based on current expectations, forecasts and assumptions and involve a number of risks and uncertainties that could cause actual results to differ, possibly materially, from those in the forward-looking statements. These risks include, among others, risks related to price and product competition in our industry, customer demand for our products, the development and introduction of new products, the impact of technological advances, risks related to our intellectual property, general market conditions, future financial performance, the anticipated impact of acquisitions and the factors listed in the “Risk Factors” section of Item 1A of this Annual Report on Form 10-K. We undertake no obligation to update forward-looking statements to reflect events or circumstances after the date they were made.

 

We are the leader in the design, manufacture and marketing of rigid disc drives. Rigid disc drives, which are commonly referred to as disc drives or hard drives, are used as the primary medium for storing electronic information in systems ranging from desktop and notebook computers, and consumer electronics devices to data centers delivering information over corporate networks and the Internet. We produce a broad range of disc drive products addressing enterprise applications, where our products are used in enterprise servers, mainframes and workstations; desktop applications, where our products are used in desktop computers; mobile computing applications, where our products are used in notebook computers; and consumer electronics applications, where our products are used in a wide variety of devices such as digital video recorders (DVRs), gaming devices and other consumer electronic devices that require storage. We also sell storage products containing our disc drives under the Seagate Technology (“Seagate”) and Maxtor Corporation (“Maxtor”) brands.

 

We sell our disc drives primarily to major original equipment manufacturers (OEMs) and also market to distributors under our globally recognized brand names. For the fiscal years 2007, 2006 and 2005, approximately 64%, 72% and 72%, respectively, of our disc drive revenue was from sales to OEMs, of which Hewlett-Packard (“HP”) was the only customer exceeding 10% of our disc drive revenue in all of these respective periods while Dell exceeded 10% of our disc drive revenue for fiscal years 2006 and 2005. We have longstanding relationships with many of our OEM customers. We also have key relationships with major distributors who sell our disc drive products to small OEMs, dealers, system integrators and retailers throughout most of the world. Shipments to distributors were approximately 30%, 25% and 26% of our disc drive revenue in fiscal years 2007, 2006 and 2005, respectively. Retail sales of our branded storage products in fiscal year 2007, as a percentage of our disc drive revenue, was 6%, compared to 3% and 2% in fiscal years 2006 and 2005, respectively. For fiscal years 2007, 2006 and 2005, approximately 30%, 30% and 31%, respectively, of our disc drive revenue came from customers located in North America, approximately 27%, 27% and 28%, respectively, came from customers located in Europe and approximately 43%, 43% and 41%, respectively, came from customers located in the Far East. Substantially all of our revenue is denominated in U.S. dollars.

 

In addition to manufacturing and selling disc drives and branded storage products, we provide data storage services for small to medium size businesses, including online backup, data protection and recovery solutions through EVault, Inc. (“EVault”), which we acquired in fiscal year 2007.

Industry

 

Electronic Data Storage Industry

 

The electronic data storage industry is comprised of companies that participate across the entire electronic data storage value chain and information life cycle, either by providing hardware storage solutions, components for hardware storage solutions, value added storage solutions, software or services.

 

Participants in the electronic data storage industry include:

 

Major subcomponent manufacturers.  Companies that manufacture components or subcomponents used in electronic data storage devices or solutions include companies such as Komag, Inc. (“Komag”), which is in the process of being acquired by Western Digital Corporation (“Western Digital”), TDK Corporation (“TDK”), Fuji Electric Device Technology Co., Ltd. (“Fuji”), Showa Denko K.K. (“Showa”), and until the announced acquisition by TDK, Alps Electric Co. Ltd. (“Alps”), that supply heads and media to disc drive manufacturers as well as semiconductor companies such as Samsung Electronics Co. Ltd (“Samsung”), SanDisk Corporation (“SanDisk”), Micron Technology, Inc. (“Micron”), and Intel Corporation (“Intel”) who manufacture flash memory.

 

Hardware storage solutions manufacturers.  Hardware storage solutions are also provided by a variety of technologies such as disc drives, tape storage, as well as semiconductor-based storage technologies such as flash memory. Companies that make hardware storage solutions include disc drive manufacturers such as Seagate Technology, Western Digital, Samsung, Fujitsu Limited (“Fujitsu”), Hitachi Global Storage Technologies (“Hitachi”) and Toshiba Corporation (“Toshiba”), magnetic tape storage manufacturers such as Quantum Corporation (“Quantum”), as well as semiconductor companies such as Samsung, SanDisk, Micron, and Intel, whose products include flash memory.

 

System integrators.  Companies that bundle and package storage components such as hardware storage solutions and software into systems for compute, consumer electronics and enterprise applications, include personal compute OEMs such as HP, Dell, Inc. (“Dell”), Acer Inc., Lenovo Group Limited, and Apple, Inc. (“Apple”); consumer electronics OEMs such as Apple, Sony Corporation (“Sony”), Microsoft Corporation (“Microsoft”), Motorola, Inc. (“Motorola”), Directv Group, Inc., Tivo Inc. and Scientific-Atlanta Inc., a Cisco System Inc. company; enterprise storage system OEMs such as, HP, EMC Corporation (“EMC”) and Network Appliance, Inc. (“Net App”).

 

Storage services and software providers.  Companies that provide services for the backup, archiving, recovery and discovery of electronic data, or the software to enable businesses and consumers to do so, such as Symantec Corporation (“Symantec”) and EMC.

 

Demand for Electronic Data Storage

 

We believe that the amount of data stored and accessed electronically is growing rapidly. We believe the key factor driving this demand is the mass proliferation of digital content. While the electronic data storage industry has traditionally been focused on compute applications for the enterprise and corporate markets, a continued proliferation of non-compute applications in the consumer electronics market is increasingly driving the broad, global expansion of the demand for electronic data storage driven by:

 

 

We believe that because digital content is increasingly rich in media with the mass utilization of photos, video, movies and music, the related storage applications and solutions increasingly require higher storage capacity to store, manage, distribute, utilize and back up richer media digital content. This in turn has resulted in the rapid growth in demand for electronic data storage hardware solutions that either directly utilize disc drives, or indirectly drive the demand for additional disc drive storage to store, host or back up related electronic data content.

Additionally, we believe that demand for electronic data storage in the enterprise and traditional compute markets have also increased as increasing legal and regulatory requirements and changes in the nature and amount of data being stored has necessitated additional storage.

 

Demand for Disc Drives

 

Disc drives store digitally encoded data on rapidly rotating platters with magnetic surfaces. Disc drives provide reliable, large capacity data storage, and are characterized by relatively low-cost per gigabyte of storage. Disc drives are presently the most common storage solution in enterprise, desktop, mobile and higher capacity consumer electronics applications.

 

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

 

Many enterprises are moving away from the use of server-attached storage to network-attached storage for mission critical enterprise storage. We expect the market for these solutions will likely grow, resulting in greater opportunities for the sale of high-performance, high capacity disc drives. Many enterprises are also consolidating data centers, aiming to increase speed and reliability within a smaller space, reduce network complexity and increase savings associated with hardware costs and maintenance. This has led to an increased demand for more energy efficient, smaller form factor disc drives. Recently, solid state drives (SSDs) storage applications that use flash storage technology as an alternative to disc drive storage technology, have been introduced as a potential alternative to redundant system startup or boot disc drives.

 

In addition to the growth in mission critical enterprise storage, there has also been significant growth in the use of high capacity, enterprise class serial advanced technology architecture (SATA) products in business critical storage systems used by enterprises to store and access capacity-intensive non-critical data. This application is exemplified by growth in content aggregation and distribution by companies like Google Inc., Yahoo! Inc. and News Corp as well as storage service providers. We believe that this growth in demand for disc drives for use in business critical storage systems is likely to shift some demand from disc drives used in traditional mission critical enterprise storage in the longer term.

 

Disc Drives for Mobile Computing.  The mobile computing market is expected to grow faster than that for desktop computers as price and performance continue to improve. Notebooks are increasingly replacing desktop computers and are progressively more desirable to consumers as the need for mobility increases and wireless adoption continues to advance. We estimate that in fiscal year 2007, industry shipments of disc drives for mobile compute applications grew approximately 35% from fiscal year 2006.

 

The disc drive industry has recently introduced hybrid disc drives for mobile compute applications that add flash memory to a disc drive to provide customers with a single, integrated solution with enhanced performance, better power utilization, quicker start-up speed and prolonged disc drive durability. Certain companies have also recently introduced SSDs for mobile compute applications that directly compete with mobile disc drives. The current cost per gigabyte for SSDs is significantly higher than the cost per gigabyte for disc drives and is projected to remain higher for the foreseeable future, which we believe will largely inhibit the use of SSDs in many price-sensitive mass-market mobile compute applications.

 

Disc Drives for Desktop Computing.  We believe growth in disc drives for desktop computing has recently moderated, in part due to the shift from desktop computers to notebook computers, particularly in developed countries. We believe that current growth in demand for disc drives in desktop computing is concentrated in developing markets where price remains a primary consideration in compute application data storage purchases.

 

Disc Drives for Consumer Electronics.  Disc drives in the consumer electronics markets are primarily used in DVRs and gaming consoles which require more storage capability than can be provided in a cost-effective manner through alternative technologies such as flash memory, which are better suited to lower capacity consumer electronics applications. We believe the demand for disc drives in consumer electronics will become more pronounced with the increased amount of high definition content that requires larger amounts of storage capacity. With respect to handheld applications, we believe disc drive products smaller than 1.8-inch form factors have to a

large extent been replaced by competing storage technologies, such as solid state or flash memory. However, we believe that disc drives continue to be well suited in applications requiring capacities of 20 gigabytes (GB) or more, and that the demand for disc drives as additional storage to store, hold or back up related media content from such handheld devices, continues to grow.

 

Disc Drives for Branded Solutions.  We believe that industry demand for storage products like our branded storage products is increasing due to the proliferation of media-rich digital content in consumer applications and is fuelling increased consumer demand for storage. This has led to the expansion of solutions such as external storage products to provide additional storage capacity and to secure data in case of disaster or system failure, or to provide independent storage solutions for multiple users in home or small business environments.

 

Success in the Disc Drive Industry Depends on Technology and Manufacturing Leadership, High Levels of Capital and Research and Development Investments and Large Scale

 

The design and manufacturing of disc drives depends on highly advanced technology and manufacturing techniques, especially in the areas of read/write heads and recording media, thereby requiring high levels of capital and research and development investments. We believe the competitive dynamics of the disc drive industry favor integrated manufacturers such as ourselves, with the large scale and resources to make substantial technology investments and apply them across a broad product portfolio and a wide variety of customers.

 

Integrated manufacturers are companies that design and produce the critical components, including read/write heads and recording media, used in their disc drives. An integrated approach enables them to lower manufacturing costs and to improve the functionality of components so that they work together efficiently. Due to the significant challenges posed by the need to continually innovate and improve manufacturing efficiency and because of the increasing amounts of capital and research and development investments required, the disc drive industry has undergone significant consolidation as disc drive manufacturers and component suppliers merged with other companies or exited the industry. Through such combinations, disc drive manufacturers have also become increasingly vertically integrated. For instance, Maxtor acquired Quantum in April 2001. Then, International Business Machines Corporation (“IBM”) merged its rigid disc drive business with that of Hitachi through the formation of Hitachi Global Storage Technologies in December 2002. This trend of disc drive manufacturer consolidation continued with our acquisition of Maxtor in May 2006. In March 2007, TDK, a disc drive head manufacturer, announced its pending acquisition of Alps, also a disc drive head manufacturer, while in June 2007, Western Digital announced that it is acquiring Komag. We believe consolidation is likely to continue in the disc drive industry through combination of disc drive manufacturers, component manufacturers, or both, as the technological challenges and the associated levels of required investment grow, increasing the competitive necessity of larger-scale operations.

 

Disc Drive Technology

 

Overview

 

All disc drives incorporate the same basic technology although individual products vary. One or more discs are attached to a spindle assembly powered by a spindle motor that rotates the discs at a high constant speed around a hub. The discs, or recording media, are the components on which data is stored and from which it is retrieved. Each disc typically consists of a substrate of finely machined aluminum or glass with a layer of a thin-film magnetic material. Read/write heads, mounted on an arm assembly similar in concept to that of a record player, fly extremely close to each disc surface and record data on and retrieve it from concentric tracks in the magnetic layers of the rotating discs. The read/write heads are mounted vertically on an E-shaped assembly. The E-block and the recording media are mounted inside a metal casing, called the base casing.

 

Upon instructions from the drive’s electronic circuitry, a head positioning mechanism, or actuator, guides the heads to the selected track of a disc where the data is recorded or retrieved. Application specific integrated circuits (ASICs) and ancillary electronic control chips are collectively mounted on printed circuit boards. ASICs move data to and from the read/write head and the internal controller, or interface, which communicates with the host computer. Disc drive manufacturers typically use one or more of several industry standard interfaces such as

advanced technology architecture (ATA); SATA, which provides higher data transfer rates than the previous ATA standard; small computer system interface (SCSI); serial attached SCSI (SAS); and Fibre Channel.

 

Disc Drive Performance

 

Disc drive performance is commonly assessed by six key characteristics:

 

 

Areal Density

 

Areal density is a measure of storage capacity per square inch on the recording surface of a disc. Current areal densities are sufficient to meet the requirements of most applications today. We expect the long-term demand for increased drive capacities will continue to grow proportionately with the shift in storage applications from predominantly compute applications to more high-resolution media content. In particular, audio, video and image storage data continue to increase in size, with high definition video content an example of data requiring many multiples of the storage capacity of standard video. Demand will further intensify by the proliferation of these forms of content. We have pursued, and expect to continue to pursue, a number of technologies to increase areal densities across the entire range of our products to increase disc drive capacities and to enable the production of higher capacity, smaller form factor disc drives. We led the industry in transitioning from longitudinal to perpendicular recording technology, in which data bits are oriented vertically on the disc platter (perpendicular to the disc surface), rather than flat to the surface in order to increase areal density and capacity.

 

Manufacturing

 

We pursue an integrated business strategy based on the ownership of critical component technologies. This vertical integration strategy allows us to maintain control over our product roadmap and component cost, quality and availability. Our manufacturing efficiency and flexibility are critical elements of our integrated business strategy. We continuously seek to improve our manufacturing efficiency and cost by:

 

 

Manufacturing our disc drives is a complex process that begins with the production of individual components and ends with a fully assembled unit. We design, fabricate and/or assemble a number of the most important

components found in our disc drives, including read/write heads, recording media and printed circuit boards. Our design and manufacturing operations are based on technology platforms that are used to produce various disc drive products that serve multiple disc drive applications and markets. As an example, our 3.5-inch ATA disc drive with perpendicular recording technology platform is sold to customers for use in desktop, enterprise and consumer electronics applications. Our main technology platforms are primarily focused around areal density of media and read/write head technologies. In addition, we also invest in certain other technology platforms including motors, servo formatting read/write channels, solid-state technologies and sealed drive technologies. Our integrated platform technologies and manufacturing allow our set of products to be used in a wide range of electronic data storage applications and in a wide range of industries.

 

We believe that because of our vertical design and manufacturing strategy, we are well suited to meet the challenges posed by the close interdependence of components for disc drives, which is especially critical in the design and production of products incorporating perpendicular recording technology.

 

Read/Write Heads.  The function of the read/write head is to scan across the disc as it spins, magnetically recording or reading information. The tolerances of recording heads are extremely demanding and require state-of-the-art equipment and processes. Our read/write heads are manufactured with thin-film and photolithographic processes similar to those used to produce semiconductor integrated circuits, though challenges in magnetic film properties and topographical structures are unique to the disc drive industry. Beginning with six and eight-inch round ceramic wafers, we process more than 30,000 head elements at one time. Each of these head elements goes through more than 500 steps, all in clean room environments. As we expect to essentially complete our product transition to perpendicular recording technology by the end of calendar year 2008, we have upgraded our fabrication facilities in capital equipment and systems to deliver the required complexity and precision. Additional capital investments will be driven primarily by volume. We perform all primary stages of design and manufacture of read/write heads at our facilities. We currently manufacture virtually all of our read/write heads.

 

Recording Media.  The function of the recording media is to magnetically store information. The domains where each bit of magnetic code is stored are extremely small and precisely placed. As a result, the manufacturing of recording media requires sophisticated thin-film processes. Each disc is a sequentially processed set of sputtered layers that consist of structural, magnetic, protective and lubricating materials deposited on a disc substrate. Once complete, the disc must have a high degree of physical uniformity to assure reliable and error-free storage. Recording media is deposited on aluminum or glass substrates.

 

The percentage of our requirements for recording media that we produce internally varies from quarter to quarter. We are continuing to expand our media production facilities in Singapore, and have relocated certain of the acquired Maxtor media manufacturing equipment to Asia. We do not expect our new media facility in Singapore to be fully operational until towards the end of fiscal year 2008. Our long-term strategy is to externally purchase no more than 15% of total recording media requirements.

 

We purchase approximately 70% of our aluminum substrates for recording media production from third parties. We are in the process of adding an aluminum substrate manufacturing facility in Johor, Malaysia which will allow us to decrease our purchases of aluminum substrates from third parties. We also purchase all of our glass substrates from third parties (mainly in Japan), which are used in manufacturing our disc drives for mobile and small form factor consumer electronics products.

 

Recently, substantially all of our purchases of recording media and a significant portion of our aluminum substrates from third-party suppliers have been sourced from Komag, which is in the process of being acquired by Western Digital. We are engaged in discussions with all our suppliers to ensure supply continuity. See “Item 1A. Risk Factors Related to Our Business — Dependence on Supply of Components, Equipment, and Raw Materials — If we experience shortages or delays in the receipt of critical components, equipment or raw materials necessary to manufacture our products, we may suffer lower operating margins, production delays and other material adverse effects.”

 

Raw Materials.  Perpendicular recording technology requires recording media with more layers and the use of more precious metals and scarce alloys in the sputtering process required to create such layers. As a result, products utilizing perpendicular recording technology are more sensitive to fluctuations in prices and availability of

precious metals and scarce alloys such as platinum and ruthenium. As our product offerings have transitioned to perpendicular recording technology, we have increased inventory of these precious metals and scarce alloys and may continue to be required to increase inventory over time.

 

Printed Circuit Boards.  We assemble and test a significant portion of the printed circuit boards used in our disc drives. Printed circuit boards are the boards that contain the electronic circuitry and ASICs that provide the electronic controls of the disc drive and on which the head-disc assembly is mounted. We assemble printed circuit boards at our facilities in Malaysia and China.

 

Spindle Motors.  We participate in the design of many of our spindle motors and purchase them principally from outside vendors in Asia, whom we have licensed to use our intellectual property and technology.

 

ASICs.  We participate in the design of many of the ASICs used in our disc drives for motor and actuator control, such as interface controllers, read/write channels and pre-amplifiers. We do not manufacture any ASICs but, rather, buy them from third-party suppliers.

 

Disc Drive Assembly.  Following the production of the individual components of the disc drive, the first step in the manufacture of a disc drive itself is the assembly of the actuator arm, read/write heads, discs and spindle motor in a housing to form the head-disc assembly. The production of the head-disc assembly involves largely automated processes. Printed circuit boards are then mated to the head-disc assembly and the completed unit is tested prior to packaging and shipment. Disc drive assembly and test operations occur primarily at facilities located in China, Singapore and Thailand. We perform subassembly and component manufacturing operations at our facilities in China, Malaysia, Northern Ireland, Singapore, Thailand, and in the United States, in California and Minnesota. In addition, third parties manufacture and assemble components for us in various Asian countries, including China, Japan, Korea, Malaysia, the Philippines, Singapore, Taiwan, Thailand and Vietnam, in Europe and the United States.

 

Products

 

We offer a broad range of disc drive products for the enterprise, mobile computing, desktop, consumer electronics and branded solutions markets of the disc drive industry. We now produce perpendicular recording technology based products for all major markets described below, with products shipping for revenue in all major markets in fiscal year 2007. Currently, the majority of our disc drive unit shipments are perpendicular recording technology based products. In addition, we have recently announced our intention to introduce SSD products for select markets in the future.

 

We offer more than one product within each product family, and differentiate products on the basis of price/performance and form factor, the dimensions of the disc drive, capacity, or interface. Historically, our industry has been characterized by continuous and significant advances in technology, which contributed to rapid product life cycles. We list below our main current product offerings.

 

Enterprise Storage

 

Cheetah SCSI/SAS/Fibre Channel Family.  Our Cheetah 3.5-inch disc drives ships in 10,000 and 15,000 RPM and in storage capacities ranging from 36GB to 400GB. Commercial uses for Cheetah disc drives include Internet and e-commerce servers, data mining and data warehousing, mainframes and supercomputers, department/enterprise servers and workstations, transaction processing, professional video and graphics and medical imaging.

 

Savvio SCSI/SAS/Fibre Channel Family.  Savvio, our 2.5-inch enterprise disc drives, first introduced in fiscal year 2004, designed to enable space optimization, maximized performance and availability, ships in 10,000 and 15,000 RPM and in storage capacities ranging from 36GB to 146GB. This disc drive is our first enterprise disc drive in the smaller 2.5-inch form factor and, as such, allows the installation of more disc drives per square foot, thus facilitating faster access to data. We believe that end-user customers are increasingly adopting the smaller 2.5-inch form factor enterprise class disc drives. We are currently shipping our 2nd generation Savvio disc drive which utilizes perpendicular recording technology with increased throughput and improved power consumption, allowing improved space optimized enterprise storage systems.

 

Barracuda ES SATA Family.  Our Barracuda ES 3.5-inch disc drives using perpendicular recording technology ships in 7,200 RPM and in storage capacities ranging from 250GB to 750GB. The Barracuda ES

addresses the emerging market in enterprise storage of the use of business critical storage systems for capacity-intensive enterprise applications that require space optimization, maximized performance and availability. In June 2007, we announced storage capacities of up to 1 TB for this drive.

 

Mobile Computing

 

Momentus ATA/SATA Family.  The Momentus family of disc drives for mobile computing disc drive products, ships in 5,400 and 7,200 RPM and in capacities ranging from 30GB to 160GB. Commercial uses for Momentus disc drives include notebook computers running popular office applications and notebook computers for business, government and education environments. Consumer uses for Momentus disc drives include notebook computers, tablet computers and digital audio applications. We have started to ship three new products for the mobile compute market, all utilizing perpendicular recording technology, including the Momentus 5400 PSD, a 2.5-inch notebook hybrid drive that combines rotating disc storage with flash memory for greater power efficiency, faster boot-ups and increased reliability; the Momentus 5400.2 FDE, the industry’s only 2.5-inch encrypting disc drive that delivers the highest levels of protection for data on lost, stolen or retired notebooks; and the Momentus 7200.2, a 7,200 RPM disc drive for high-performance notebooks.

 

LD25.2 Family.  Our LD25.2 Series 2.5-inch disc drives deliver storage capacities of 40GB and 80GB at 5,400 RPM, a solution with optimized capacity and size for notebook computers.

 

Desktop Storage

 

Barracuda ATA/SATA Family.  Our Barracuda 3.5-inch disc drive is in its 11th generation and delivers storage capacities of up to 1TB at 7,200 RPM and is used in applications such as PCs, workstations and personal external storage devices. The majority of our desktop storage products currently utilize perpendicular recording technology. Additionally, we are currently shipping a 3.5-inch disc drive with 250GB of capacity on a single disc which utilizes 2nd generation perpendicular recording technology.

 

DiamondMax Family.  Our DiamondMax 3.5-inch disc drives deliver storage capacities of up to 500GB at 7,200 RPM. DiamondMax drives are targeted at entry-level and mainstream PCs with non-traditional ATA applications that require a value solution with solid performance.

 

LD25.2 Family.  Our LD25.2 Series 2.5-inch disc drives deliver storage capacities of 40GB and 80GB at 5,400 RPM.

 

Consumer Electronics Storage

 

Barracuda ATA/SATA Family.  We also sell some of our 3.5-inch Barracuda disc drives for use in DVR’s, audio jukeboxes, home media centers and home and industrial security systems. Our DB35 Series disc drive, with storage capacities up to 750GB, uses perpendicular recording technology to help set-top box manufacturers optimize performance for leading-edge digital entertainment.

 

Momentus ATA/SATA Family.  We sell our 2.5-inch, 7,200 and 5,400 RPM Momentus disc drives, including our recently announced LD25 Series of Momentus family of disc drives with capacities ranging from 20GB up to 160GB, for use in low-profile DVR’s, gaming consoles, home entertainment devices and small footprint media PCs. We also offer our 2.5-inch EE25 Series of Momentus disc drives which is designed for the temperature, vibration, humidity and other environmental extremes of automotive, marine and aircraft applications, delivering storage capacities of up to 80GB.

 

Seagate ST18 Series.  Our Seagate ST18 Series disc drives uses Seagate’s perpendicular recording technology to deliver 60GB on a single platter in a compact 1.8-inch disc drive designed for use in portable media players, global positioning systems (GPS), digital video camcorders and ultra-mobile PCs.

 

Branded Solutions

 

Our branded solutions business, which was expanded with the acquisition and integration of the retail and branded sales operations of Maxtor and the related right to use the Maxtor brand and other related trade names such as “OneTouch”, provides storage products including various home and office storage appliances and applications.

During fiscal year 2007, we launched our FreeAgent product line of external backup storage and we also currently ship the Maxtor OneTouch^TM product line of external backup storage, with both these product lines utilizing our 3.5-inch Barracuda and 2.5-inch Momentus disc drives with capacities up to 750GB.

 

Customers

 

We sell our disc drive products primarily to major OEMs and distributors. OEM customers incorporate our disc drives into computer systems and storage systems for resale. Distributors typically sell our disc drives to small OEMs, dealers, system integrators and other resellers. Shipments to OEMs were approximately 64%, 72% and 72% of our disc drive revenue in fiscal years 2007, 2006 and 2005, respectively. Shipments to distributors were approximately 30%, 25% and 26% of our disc drive revenue in fiscal years 2007, 2006 and 2005, respectively. Sales to HP accounted for approximately 16%, 17% and 18% of our disc drive revenue in fiscal years 2007, 2006 and 2005, respectively, while sales to Dell, as a percentage of our disc drive revenue, were 9%, 11% and 12% in fiscal years 2007, 2006 and 2005, respectively. No other customer accounted for 10% or more of our disc drive revenue in fiscal years 2007, 2006 and 2005. Retail sales of our branded storage products in fiscal year 2007 as a percentage of our disc drive revenue increased to 6% from 3% and 2% in fiscal years 2005 and 2004, respectively. See “Item 1A. Risk Factors Related to Our Business — Dependence on Key Customers — We may be adversely affected by the loss of, or reduced, delayed or cancelled purchases by, one or more of our larger customers.”

 

OEM customers typically enter into master purchase agreements with us. These agreements provide for pricing, volume discounts, order lead times, product support obligations and other terms and conditions. The term of these agreements is usually 12 to 36 months, although our product support obligations generally extend substantially beyond this period. These master agreements typically do not commit the customer to buy any minimum quantity of products, or create exclusive relationships. Deliveries are scheduled only after receipt of purchase orders. In addition, with limited lead-time, customers may cancel or defer most purchase orders without significant penalty. Anticipated orders from many of our customers have in the past failed to materialize or OEM delivery schedules have been deferred or altered as a result of changes in their business needs.

 

Our distributors generally enter into non-exclusive agreements for the redistribution of our products. They typically furnish us with a non-binding indication of their near-term requirements and product deliveries are generally scheduled based on a weekly confirmation by the distributor of its requirements for that week. The agreements typically provide the distributors with price protection with respect to their inventory of our disc drives at the time of a reduction by us in our selling price for the disc drives and also provide limited rights to return the product.

 

We have significantly increased our sales of branded storage products to retail customers in the last two years with the Maxtor acquisition further expanding our retail customer base. Retail sales typically require higher marketing support, sales incentives and longer price protection periods.

 

We also regularly enter into agreements with our customers, which obligate us to provide a limited indemnity against losses resulting from intellectual property claims. These agreements are customary in our industry and typically require us to indemnify our customer against certain damages and costs incurred as a result of third party intellectual property claims arising as a result of their use of our products.

 

Sales, Marketing and Customer Service

 

Our marketing organization works to increase demand for our disc drive products through strategic collaboration with key OEM customers and distribution partners to align our respective product roadmaps and to build our brand and end-customer relationships. As customer and markets increasingly demand a broad variety of products with different performance and cost attributes, we have recently organized our marketing organization with groups focused on the strategic needs of our increasingly diverse customer base. We believe this enables us to serve both our core markets and better identify, develop and serve emerging markets.

 

Our sales organization focuses on deepening our relationship with our customers. The worldwide sales group focuses on geographic coverage of OEMs and distributors throughout most of the world. The worldwide sales group is organized by customer type and regionally among North America, Japan, Asia-Pacific (excluding Japan) and

Europe, Africa and the Middle East. In addition, we have a sales operation group which focuses on aligning our production levels with customers’ product requirements. Our sales force works directly with our marketing organization to coordinate our OEM and distribution channel relationships. We maintain sales offices throughout the United States and in Australia, China, France, Germany, Japan, Singapore, Taiwan and the United Kingdom.

 

With the acquisition of Maxtor, we acquired the right to the use the Maxtor and other related brand names. We believe the Maxtor brand is a valuable asset, and we intend to continue to offer the Maxtor brand of products to consumers globally to broaden our reach into and coverage of these channels as well as optimize the impact of our marketing investments.

 

Our customer service organization maintains a global network of service points to process warranty returns and manage outsourced repair vendors. We generally warrant our products for periods ranging from one year to five years.

 

Foreign sales are subject to foreign exchange controls and other restrictions, including, in the case of some countries, approval by the Office of Export Administration of the U.S. Department of Commerce and other U.S. governmental agencies.

 

Competition

 

The markets that we compete in are intensely competitive, with disc drive manufacturers not only competing for a limited number of major disc drive customers, but also increasingly competing with other companies in the electronic data storage industry that provide alternative storage solutions, such as flash memory and SSDs. Some of the principal factors used by customers to differentiate among electronic data storage solutions manufacturers are storage capacity; price per unit and price per gigabyte; storage/retrieval access times; data transfer rates; product quality and reliability; production volume capability; form factor; responsiveness to customer preferences and demands; warranty; and brand.

 

We believe that our disc drive products are competitive with respect to each of these factors in the markets that we currently address. We summarize below our principal disc drive competitors, other competitors, the effect of competition on price erosion for our products and product life cycles and technology.

 

Principal Disc Drive Competitors.  We have experienced and expect to continue to experience intense competition from a number of domestic and foreign companies, some of which have greater financial and other resources than we have. These competitors include independent disc drive manufacturers such as Western Digital, as well as large captive manufacturers such as Fujitsu, Samsung, Hitachi, and Toshiba. Because they produce complete computer systems and other non-compute consumer electronics and mobile devices, these “captive manufacturers” can derive a greater portion of their operating margins from other components, which reduces their need to realize a profit on the disc drives included in their computer systems and allows them to sell disc drives to third parties at very low margins. Many captive manufacturers are also formidable competitors because they have more substantial resources and greater access to their internal customers than we do. In addition, Hitachi (together with affiliated entities), Toshiba and Samsung, each are increasingly integrating other storage technologies such as flash memory, hybrid disc drives and SSDs into its product offerings. Not only may they be willing to sell their disc drives at a lower margin to advance their overall business strategy, their portfolio allows them to be indifferent to which technology prevails over the other. They can offer a broad range of storage media and solutions and focus on those with lowest costs and greatest sales. In connection with our branded storage products, in addition to competing with our disc drive competitors, we also compete with companies such as LaCie S.A. that purchase disc drives for use in their branded storage products from us and our competitors.

 

Other Competitors.  We also are experiencing competition from companies that provide alternative storage technologies such as flash memory, which have substantially replaced disc drives in lower capacity handheld devices. Principal competitors include Samsung, Hitachi, Micron and SanDisk.

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

 

 

Disc drive manufacturers typically attempt to off-set price erosion with an improved mix of disc drive products characterized by higher capacity, better performance and additional feature sets and/or product cost reductions.

 

We expect that price erosion in our industry will continue for the foreseeable future. To remain competitive, it will be necessary to continue to reduce our prices, as well as introduce new product offerings with increased disc drive capacities and/or improved feature sets, utilizing advanced technologies prior to our competitors to take advantage of potentially higher initial profit margins and reduced cost structure on these new products. We have established production facilities in China, Malaysia, Singapore and Thailand to achieve cost reductions.

 

Product Life Cycles and Changing Technology.  Historically, competition and changing customer preference and demand in the electronic data storage industry have shortened product life cycles and caused acceleration in the development and introduction of new technology. We believe that our future success will depend upon our ability to develop, manufacture and market products of high quality and reliability which meet changing user needs and which successfully anticipate or respond to changes in technology and standards on a cost-effective and timely basis. Introduction of any technology that delivers storage at an attractive price, or has other features not available to disc drives, will be disruptive to the disc drive industry. Product life cycles are also being shortened with the increasing capabilities of flash and SSD. For example, our 1-inch disc drive’s life cycle was shortened when it was replaced by flash memory in smaller capacity handheld consumer electronics applications.

 

Seasonality

 

The disc drive industry traditionally experiences seasonal variability in demand with higher levels of demand in the second half of the calendar year. This seasonality is driven by consumer spending in the back-to-school season from late summer to fall and the traditional holiday shopping season from fall to winter. In addition, corporate demand is higher during the second half of the calendar year when IT budget calendars typically provide for more spending.

 

Research and Development

 

We are committed to developing new component technologies and products and evaluating alternative storage technologies, including flash storage technology. We have increased our focus on research and development and realigned our disc drive development process. This structured product process is designed to bring new products to market in a high volume environment and with quality attributes that our customers expect. Our research group, which is based in Pittsburgh, Pennsylvania, is dedicated to the transition and extending the capacity of perpendicular recording technology as well as exploring alternative data storage technologies. Our advanced technology integration effort focuses disc drive and component research on recording subsystems, including read/write heads and recording media, market-specific product technology as well as technology focused towards new business opportunities. The primary purpose of our advanced technology integration effort is to ensure timely availability of mature component technologies to our product development teams as well as allowing us to leverage and coordinate those technologies in the design centers across our products in order to take advantage of opportunities in the marketplace. During fiscal years 2007, 2006 and 2005, we had product development expenses of $904 million, $805 million and $645 million, respectively, which represented 8%, 9% and 9% of our consolidated revenue, respectively.

Patents and Licenses

 

As of June 29, 2007, we had approximately 3,857 U.S. patents and 761 patents issued in various foreign jurisdictions as well as approximately 1,287 U.S. and 651 foreign patent applications pending. The number of patents and patent applications will vary at any given time as part of our ongoing patent portfolio management activity. Due to the rapid technological change that characterizes the information storage industry, we believe that the improvement of existing products, reliance upon trade secret law, the protection of unpatented proprietary know-how and development of new products are generally more important than patent protection in establishing and maintaining a competitive advantage. Nevertheless, we believe that patents are valuable to our business and intend to continue our efforts to obtain patents, where available, in connection with our research and development program.

 

The information storage industry is characterized by significant litigation relating to patent and other intellectual property rights. Because of rapid technological development in the information storage industry, some of our products have been, and in the future could be, alleged to infringe existing patents of third parties. From time to time, we receive claims that our products infringe patents of third parties. Although we have been able to resolve some of those claims or potential claims by obtaining licenses or rights under the patents in question without a material adverse affect on us, other claims have resulted in adverse decisions or settlements. In addition, other claims are pending which if resolved unfavorably to us could have a material adverse effect on our business and results of operations. For more information on these claims, see “Item 3. Legal Proceedings.” The costs of engaging in intellectual property litigation in the past have been and may be substantial regardless of the merit of the claim or the outcome. We have patent cross-licenses with a number of companies. Additionally, as part of our normal intellectual property practices, we are engaged in negotiations with other major disc drive companies and component manufacturers with respect to ongoing patent cross-licenses.

 

Backlog

 

In view of customers’ rights to cancel or defer orders with little or no penalty, we believe backlog in the disc drive industry is of limited indicative value in estimating future performance and results.

 

Employees

 

At June 29, 2007, we employed approximately 54,000 employees, temporary employees and contractors worldwide, of which approximately 43,000 employees were located in our Asian operations. We believe that our future success will depend in part on our ability to attract and retain qualified employees at all levels. We believe that our employee relations are good.

 

Environmental Matters

 

Our operations are subject to comprehensive U.S. and foreign laws and regulations relating to the protection of the environment, including those governing discharges of pollutants into the air and water, the management and disposal of hazardous substances and wastes and the cleanup of contaminated sites. Some of our operations require environmental permits and controls to prevent and reduce air and water pollution, and these permits are subject to modification, renewal and revocation by issuing authorities.

 

We believe that our operations are currently in substantial compliance with all environmental laws, regulations and permits. We incur operating and capital costs on an ongoing basis to comply with environmental laws. If additional or more stringent requirements are imposed on us in the future, we could incur additional operating costs and capital expenditures.

 

Some environmental laws, such as the U.S. federal superfund law and similar state statutes, can impose liability for the cost of cleanup of contaminated sites upon any of the current or former site owners or operators or upon parties who sent waste to these sites, regardless of whether the owner or operator owned the site at the time of the release of hazardous substances or the lawfulness of the original disposal activity. We have been identified as a potentially responsible party at several superfund sites. At each of these sites, the government has assigned to us a

portion of the financial liability based on the type and amount of hazardous substances disposed of by each party at the site and the number of financially viable parties.

 

Some of our current and former sites have a history of commercial and industrial operations, including the use of hazardous substances. Groundwater and soil contamination resulting from historical operations has been identified at several of our current and former facilities and we are addressing the cleanup of these sites in cooperation with the relevant government agencies.

 

While our ultimate costs in connection with these sites is difficult to predict with complete accuracy, based on our current estimates of cleanup costs and our expected allocation of these costs, we do not expect costs in connection with these superfund sites and contaminated sites to be material.

 

We may be subject to various state, federal and international laws and regulations governing the environment, including those restricting the presence of certain substances in electronic products. For example, the European Union (“EU”) has enacted the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (“RoHS”), which prohibits the use of certain substances, including lead, in certain products, including hard drives, put on the market after July 1, 2006 as well as the Waste Electrical and Electronic Equipment (“WEEE”) directive, which makes producers of electrical goods, including disc drives, financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. Similar legislation has been or may be enacted in other jurisdictions, including in the United States, Canada, Mexico, China and Japan. We will need to ensure that we comply with such laws and regulations as they are enacted, and that our component suppliers also timely comply with such laws and regulations. If we fail to timely comply with the legislation, our customers may refuse to purchase our products, which would have a materially adverse effect on our business, financial condition and results of operations.

 

Executive Officers

 

The following sets forth the name, age and position of each of the persons who were serving as executive officers as of August 10, 2007. There are no family relationships among any of our executive officers.

 

 

Financial Information

 

Financial information for the Company’s reportable business segments and about geographic areas is set forth in “Item 8. Financial Statements and Supplementary Data — Note 6, Business Segment and Geographic Information.”

 

Available Information

 

Availability of Reports.  We are a reporting company under the Securities Exchange Act of 1934, as amended, and we file reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”). The public may read and copy any of our filings at the SEC’s Public Reference Room at 450 Fifth Street N.W., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Because the Company makes filings to the SEC electronically, you may access this information at the SEC’s Internet site: www.sec.gov. This site contains reports, proxies and information statements and other information regarding issuers that file electronically with the SEC.

 

Web Site Access.  Our Internet web site address is www.seagate.com. We make available, free of charge at the “Investor Relations” portion of this web site, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the 1934 Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Reports of beneficial ownership filed pursuant to Section 16(a) of the 1934 Act are also available on our web site. Information in, or that can be accessed through, our web site is not part of this annual report on Form 10-K.

 

Corporate Information

 

We were formed in 2000 as an exempted company incorporated with limited liability under the laws of the Cayman Islands.

 

Risks Related to Our Business

 

Competition — Our industry is highly competitive and our products have experienced and will continue to experience significant price erosion and market share variability.

 

Even during periods when demand is stable, the disc drive industry is intensely competitive and vendors typically experience substantial price erosion over the life of a product. Our competitors have historically offered existing products at lower prices as part of a strategy to gain or retain market share and customers, and we expect these practices to continue. We will need to continually reduce our prices to retain our market share, which could adversely affect our results of operations.

 

We believe this basic industry condition of continuing price erosion and market share variability will continue, as our competitors engage in aggressive pricing actions targeted to encourage shifting of customer demand. As a result, the pricing environment in 2007 continued to be very competitive, especially in the March and June 2007 quarters in the mobile compute market and the market for high capacity 3.5-inch ATA disc drives, and we expect pricing to remain competitive for the remainder of fiscal year 2008 as our competitors continue these efforts.

 

To the extent that historical price erosion patterns continue, product life cycles may lengthen, our competitors may have more time to enter the market for a particular product and we may be unable to offset these factors with new product introductions at higher average prices. A second general industry trend that may contribute to increased average price erosion is the growth of sales to distributors that serve producers of non-branded products in the personal storage sector. These customers generally have limited product qualification programs, which increases the number of competing products available to satisfy their demand. As a result, purchasing decisions for these customers are based largely on price and terms. Any increase in our average price erosion would have an adverse effect on our result of operations.

 

Additionally, a significant portion of our success in the past has been a result of increasing our market share at the expense of our competitors, particularly in the notebook and small form factor enterprise markets. Our market share for our products can be negatively affected by our customers’ diversifying their sources of supply as our competitors enter the market for particular products. When our competitors successfully introduce product offerings, which are competitive with our recently introduced new products, our customers may quickly diversify their sources of supply. Any significant decline in our market share would adversely affect our results of operations.

 

Principal Competitors — We compete with both independent manufacturers, whose primary focus is producing technologically advanced disc drives, and captive manufacturers, who do not depend solely on sales of disc drives to maintain their profitability.

 

We have experienced and expect to continue to experience intense competition from a number of domestic and foreign companies, including other independent disc drive manufacturers and large captive manufacturers such as:

 

 

The term “independent” in this context refers to manufacturers that primarily produce disc drives as a stand-alone product, and the term “captive” refers to disc drive manufacturers who themselves or through affiliated entities produce complete computer or other systems that contain disc drives or other information storage products. Captive manufacturers are formidable competitors because they have the ability to determine pricing for complete systems without regard to the margins on individual components. Because components other than disc drives generally contribute a greater portion of the operating margin on a complete computer system than do disc drives, captive manufacturers do not necessarily need to realize a profit on the disc drives included in a computer system and, as a result, may be willing to sell disc drives to third parties at very low margins. Many captive manufacturers are also formidable competitors because they have more substantial resources than we do. In addition, Samsung and

Hitachi (together with affiliated entities) also sell other products to our customers, including critical components like flash memory, ASICs and flat panel displays, and may be willing to sell their disc drives at a lower margin to advance their overall business strategy. This may improve their ability to compete with us. To the extent we are not successful competing with captive or independent disc drive manufacturers, our results of operations will be adversely affected.

 

In addition, in response to customer demand for high-quality, high-volume and low-cost disc drives, manufacturers of disc drives have had to develop large, in some cases global, production facilities with highly developed technological capabilities and internal controls. The development of large production facilities and industry consolidation can contribute to the intensification of competition. We also face indirect competition from present and potential customers who evaluate from time to time whether to manufacture their own disc drives or other information storage products.

 

We have also experienced competition from other companies that produce alternative storage technologies like flash memory, where increased capacity, improving cost, lower power consumption and performance ruggedness have resulted in competition with our lower capacity, smaller form factor disc drives in handheld applications. While this competition has traditionally been in the markets for handheld consumer electronics applications like personal media players, these competitors have recently announced SSD products for notebook and enterprise compute applications. Some of these companies, like Samsung, also sell disc drives.

 

Volatility of Quarterly Results — Our quarterly operating results fluctuate significantly from period to period, and this may cause our shares prices to decline.

 

In the past, our quarterly revenue and operating results have fluctuated significantly from period to period. We expect this fluctuation to continue for a variety of reasons, including:

 

 

As a result, we believe that quarter-to-quarter comparisons of our revenue and operating results may not be meaningful, and that these comparisons may not be an accurate indicator of our future performance. Our operating

results in one or more future quarters may fail to meet the expectations of investment research analysts or investors, which could cause an immediate and significant decline in the trading price of our common shares.

 

New Product Offerings — Market acceptance of new product introductions cannot be accurately predicted, and our results of operations will suffer if there is less demand for our new products than is anticipated.

 

We are continually developing new products with the goal that we will be able to introduce technologically advanced and lower cost disc drives into the marketplace ahead of our competitors. We are particularly depending on the successful introduction, qualification and volume sales of new lower cost products for our results in the next few quarters.

 

The success of our new product introductions is dependent on a number of factors, including market acceptance, our ability to manage the risks associated with product transitions, the effective management of inventory levels in line with anticipated product demand, and the risk that our new products will have quality problems or other defects in the early stages of introduction that were not anticipated in the design of those products. Accordingly, we cannot accurately determine the ultimate effect that our new products will have on our results of operations.

 

In addition, the success of our new product introductions is dependent upon our ability to qualify as a primary source of supply with our OEM customers. In order for our products to be considered by our customers for qualification, we must be among the leaders in time-to-market with those new products. Once a product is accepted for qualification testing, any failure or delay in the qualification process or a requirement that we requalify can result in our losing sales to that customer until new products are introduced. The limited number of high-volume OEMs magnifies the effect of missing a product qualification opportunity. These risks are further magnified because we expect competitive pressures to result in declining sales and declining gross margins on our current generation products. We cannot assure you that we will be among the leaders in time-to-market with new products or that we will be able to successfully qualify new products with our customers in the future.

 

Smaller Form Factor Disc Drives — If we do not continue to successfully market smaller form factor disc drives, our business may suffer.

 

The disc drive industry is experiencing significant increases in sales of smaller form factor disc drives for an expanding number of applications, in particular notebook computers and consumer electronics devices, but also including personal computers and enterprise storage applications. Much of our recent revenue growth is derived from the sale of drives for small form factor drives for notebook and enterprise applications.

 

We have experienced competition from other companies that produce alternative storage technologies like flash memory, where increased capacity, improving cost, lower power consumption and performance ruggedness have resulted in competition with our lower capacity, smaller form factor disc drives in handheld applications. This competition has largely replaced disc drive products smaller than 1.8-inch with flash memory. However, we believe that disc drives continue to be well suited in applications requiring capacities of 20 gigabytes or more and that the demand for additional storage to store, hold or back up related media content from such handheld devices using flash memory, continues to grow. While this competition has traditionally been in the markets for handheld consumer electronics applications like digital music players and personal media players, these competitors are also attempting to introduce SSD products for notebook and enterprise compute applications.

 

If we do not suitably adapt our product offerings to successfully introduce additional smaller form factor disc drives or alternative storage products based on flash storage technology, or if flash competitors are successful in achieving customer acceptance of SSD products for notebook and enterprise compute applications, customers may decrease the amounts of our products that they purchase which would adversely affect our results of operations.

Perpendicular Recording Technology — If products based on this technology suffer unanticipated or atypical reliability or operability problems, our operating results will be adversely impacted. In addition, products based on perpendicular technology require increased quantities of precious metals and scarce alloys like platinum and ruthenium which increases risk of higher costs and production delays that could adversely impact our operating results.

 

In fiscal year 2007, we converted more than half of our products to products using perpendicular technology and we expect that by the end of fiscal year 2008 that all of our products will be based on perpendicular technology. Perpendicular recording technology poses various technological challenges including a complex integration of the recording head, the disc, recording channel and drive firmware as a system.

 

If these perpendicular technology based products suffer unanticipated or atypical failures that were not anticipated in the design of those products, our service and warranty costs may materially increase which would adversely impact our operating results.

 

Perpendicular recording technology also requires recording media with more layers and the use of more precious metals and scarce alloys like platinum and ruthenium to create such layers. These precious metals and scarce alloys have recently become increasingly expensive and at times difficult to acquire. As our product offerings shift increasingly to perpendicular technology, we will be exposed to increased risks that higher costs or reduced availability of these precious metals and scarce alloys could adversely impact our operating results.

 

Seasonality — Because we experience seasonality in the sales of our products, our results of operations will generally be adversely impacted during our fourth fiscal quarter.

 

Because sales of computer systems, storage subsystems and consumer electronics tend to be seasonal, we expect to continue to experience seasonality in our business as we respond to variations in our customers’ demand for disc drives. In particular, we anticipate that sales of our products will continue to be lower during our fourth fiscal quarter than the rest of the year. In the desktop computer, notebook computer and consumer electronics sectors of our business, this seasonality is partially attributable to our customers’ increased sales of personal computers and consumer electronics during the winter holiday season. In the enterprise sector of our business, our sales are seasonal because of the capital budgeting and purchasing cycles of our end users. Because our working capital needs peak during periods in which we are increasing production in anticipation of orders that have not yet been received, our operating results will fluctuate seasonally even if the forecasted demand for our products proves accurate.

 

Furthermore, it is difficult for us to evaluate the degree to which this seasonality may affect our business in future periods because of the rate and unpredictability of product transitions and new product introductions, particularly in the consumer electronics market.

 

Difficulty in Predicting Quarterly Demand — If we fail to predict demand accurately for our products in any quarter, we may not be able to recapture the cost of our investments.

 

The disc drive industry operates on quarterly purchasing cycles, with much of the order flow in any given quarter coming at the end of that quarter. Our manufacturing process requires us to make significant product-specific investments in inventory in each quarter for that quarter’s production. Because we typically receive the bulk of our orders late in a quarter after we have made our investments, there is a risk that our orders will not be sufficient to allow us to recapture the costs of our investment before the products resulting from that investment have become obsolete. We cannot assure you that we will be able to accurately predict demand in the future.

 

Other factors that may negatively impact our ability to recapture the cost of investments in any given quarter include:

 

 

 

Dependence on Sales of Disc Drives in Consumer Electronics Applications — Our sales of disc drives for consumer electronics applications which have contributed significant revenues to our results, can experience significant volatility due to seasonal and other factors which could materially adversely impact our future results of operations.

 

Our sales of disc drives for consumer electronics applications have contributed significant revenues to our results for the past several years. The growth rate in consumer electronics products has recently begun to moderate and show more seasonal demand variability. The demand for consumer electronics products can be even more volatile and unpredictable than the demand for compute products. In some cases, our products manufactured for consumer electronics applications are uniquely configured for a single customer’s applications, which creates a risk of exposure if the anticipated volumes are not realized. This potential for unpredictable volatility is increased by the possibility of competing alternative storage technologies like flash memory, meeting the customers’ cost and capacity metrics, resulting in a rapid shift in demand from our products and disc drive technology, generally, to alternative storage technologies. Unpredictable fluctuations in demand for our products or rapid shifts in demand from our products to alternative storage technologies in new consumer electronics applications could materially adversely impact our future results of operations.

 

Dependence on Supply of Components, Equipment, and Raw Materials — If we experience shortages or delays in the receipt of critical components, equipment or raw materials necessary to manufacture our products, we may suffer lower operating margins, production delays and other material adverse effects.

 

The cost, quality and availability of components, certain equipment and raw materials used to manufacture disc drives and key components like recording media and heads are critical to our success. The equipment we use to manufacture our products and components is frequently custom made and comes from a few suppliers and the lead times required to obtain manufacturing equipment can be significant. Particularly important components for disc drives include read/write heads, aluminum or glass substrates for recording media, ASICs, spindle motors, printed circuit boards and suspension assemblies. We rely on sole suppliers or a limited number of suppliers for some of

these components, including recording media and aluminum and glass substrates that we do not manufacture, ASICs, spindle motors, printed circuit boards and suspension assemblies. Recently, substantially all of our purchases of recording media and a significant portion of our aluminum substrates from third-party suppliers have been sourced from Komag, which is in the process of being acquired by Western Digital. There can be no assurance that we will continue to be able to obtain alternative supply following the purchase of Komag by Western Digital.

 

In the past, we have experienced increased costs and production delays when we were unable to obtain the necessary equipment or sufficient quantities of some components and/or have been forced to pay higher prices or make volume purchase commitments or advance deposits for some components, equipment or raw materials, such as precious metals like platinum and ruthenium, that were in short supply in the industry in general.

 

Historically, the technology sector specifically, and the economy generally have experienced economic pressure, which has resulted in consolidation among component manufacturers and may result in some component manufacturers exiting the industry or not making sufficient investments in research to develop new components.

 

If there is a shortage of, or delay in supplying us with, critical components, equipment or raw materials, then:

 

 

We cannot assure you that we will be able to obtain critical components in a timely and economic manner, or at all.

 

Importance of Reducing Operating Costs — If we do not reduce our operating expenses, we will not be able to compete effectively in our industry.

 

Our strategy involves, to a substantial degree, increasing revenue and product volume while at the same time reducing operating expenses. In the past, these activities have included closures and transfers of facilities, significant personnel reductions and efforts to increase automation. Moreover, the reduction of personnel and closure of facilities may adversely affect our ability to manufacture our products in required volumes to meet customer demand and may result in other disruptions that affect our products and customer service. In addition, the transfer of manufacturing capacity of a product to a different facility frequently requires qualification of the new facility by some of our OEM customers. We cannot assure you that these activities and transfers will be implemented on a cost-effective basis without delays or disruption in our production and without adversely affecting our customer relationships and results of operations.

 

Industry Demand — Changes in demand for computer systems and storage subsystems has caused and may cause in the future a decline in demand for our products.

 

Our disc drives are components in computers, computer systems, storage subsystems and consumer electronics devices. The demand for these products has been volatile. In a weak economy, consumer spending tends to decline and retail demand for personal computers and consumer electronics devices tends to decrease, as does enterprise demand for computer systems and storage subsystems. Unexpected slowdowns in demand for computer systems and storage subsystems generally cause sharp declines in demand for disc drive products.

Additional causes of declines in demand for our products in the past have included announcements or introductions of major new operating systems or semiconductor improvements or changes in consumer preferences, such as the shift from desktop to notebook computers. We believe these announcements and introductions have from time to time caused consumers to defer their purchases and made inventory obsolete. Whenever an oversupply of disc drives causes participants in our industry to have higher than anticipated inventory levels, we experience even more intense price competition from other disc drive manufacturers than usual.

 

Dependence on Distributors — We are dependent on sales to distributors, which may increase price erosion and the volatility of our sales.

 

A substantial portion of our sales has been to distributors of desktop disc drive products. Product qualification programs in this distribution channel are limited, which increases the number of competing products that are available to satisfy demand, particularly in times of lengthening product cycles. As a result, purchasing decisions in this channel are based largely on price, terms and product availability. Sales volumes through this channel are also less predictable and subject to greater volatility than sales to our OEM customers.

 

To the extent that distributors reduce their purchases of our products or prices decline significantly in the distribution channel, and to the extent that our distributor relationships are terminated, our revenues and results of operations would be adversely affected.

 

Importance of Time-to-Market — Our operating results may depend on our being among the first-to-market and achieving sufficient production volume with our new products.

 

To achieve consistent success with our OEM customers, it is important that we be an early provider of new types of disc drives featuring leading, high-quality technology and lower per gigabyte storage cost. Historically, our operating results have substantially depended upon our ability to be among the first-to-market with new product offerings. Our market share and operating results in the future may be adversely affected if we fail to:

 

 

If delivery of our products is delayed, our OEM customers may use our competitors’ products to meet their production requirements. If the delay of our products causes delivery of those OEMs’ computer systems into which our products are integrated to be delayed, consumers and businesses may purchase comparable products from the OEMs’ competitors.

 

Moreover, we face the related risk that consumers and businesses may wait to make their purchases if they want to buy a new product that has been shipped or announced but not yet released. If this were to occur, we may be unable to sell our existing inventory of products that may have become less efficient and cost effective compared to new products. As a result, even if we are among the first-to-market with a given product, subsequent introductions or announcements by our competitors of new products could cause us to lose revenue and not achieve a positive return on our investment in existing products and inventory.

 

Accounting Charges and Pre-Acquisition Contingencies not Previously Identified Related to Acquisition of Maxtor — We expect the acquisition of Maxtor with Seagate will continue to result in additional accounting charges, that may continue to have an adverse effect on our fiscal year 2008 operating results.

 

We expect that, as a result of the acquisition of Maxtor, our fiscal year 2008 results of operations will continue to be adversely affected by non-cash accounting charges, the most significant of which relates to the amortization of acquired intangible assets. In addition, pre-acquisition contingencies not previously identified will adversely affect our results of operations.

Dependence on Key Customers — We may be adversely affected by the loss of, or reduced, delayed or cancelled purchases by, one or more of our larger customers.

 

Some of our key customers, including HP, Dell, Sony Corporation (“Sony”), EMC and IBM, account for a large portion of our disc drive revenue. Our recent acquisition of Maxtor may increase our business with certain of our larger customers. We have longstanding relationships with many of our customers, however, if any of our key customers were to significantly reduce their purchases from us, our results of operations would be adversely affected. While sales to major customers may vary from period to period, a major customer that permanently discontinues or significantly reduces its relationship with us could be difficult to replace. In line with industry practice, new customers usually require that we pass a lengthy and rigorous qualification process at the customer’s cost. Accordingly, it may be difficult or costly for us to attract new major customers. Additionally, mergers, acquisitions, consolidations or other significant transactions involving our customers generally entail risks to our business. If a significant transaction involving any of our key customers results in the loss of or reduction in purchases by these key customers, it could have a materially adverse effect on our business, results of operations, financial condition and prospects.

 

Impact of Technological Change — Increases in the areal density of disc drives may outpace customers’ demand for storage capacity.

 

The rate of increase in areal density, or storage capacity per square inch on a disc, may be greater than the increase in our customers’ demand for aggregate storage capacity, particularly in certain market applications like commercial desktop compute. As a result, our customers’ storage capacity needs may be satisfied with lower priced, low capacity disc drives. These factors could decrease our sales, especially when combined with continued price erosion, which could adversely affect our results of operations.

 

Changes in Information Storage Products — Future changes in the nature of information storage products may reduce demand for traditional disc drive products.

 

We expect that in the future, new personal computing devices and products will be developed, some of which, such as Internet appliances, may not contain a disc drive. While we are investing development resources in designing disc drives for new applications, it is too early to assess the impact of these new applications on future demand for disc drive products. Products using alternative technologies, such as flash memory, optical storage and other storage technologies could become a significant source of competition to particular applications of our products, which could adversely affect our results of operations.

 

New Product Development and Technological Change — If we do not develop products in time to keep pace with technological changes, our operating results will be adversely affected.

 

Our customers have demanded new generations of disc drive products as advances in computer hardware and software have created the need for improved storage products, with features such as increased storage capacity, improved performance and reliability and lower cost. We, and our competitors, have developed improved products, and we will need to continue to do so in the future. For the fiscal years 2007, 2006 and 2005, we had product development expenses of $904 million, $805 million and $645 million, respectively. We cannot assure you that we will be able to successfully complete the design or introduction of new products in a timely manner, that we will be able to manufacture new products in sufficient volumes with acceptable manufacturing yields, that we will be able to successfully market these new products or that these products will perform to specifications on a long-term basis. In addition, the impact of slowing areal density growth may adversely impact our ability to be successful.

 

When we develop new products with higher capacity and more advanced technology, our operating results may decline because the increased difficulty and complexity associated with producing these products increases the likelihood of reliability, quality or operability problems. If our products suffer increases in failures, are of low quality or are not reliable, customers may reduce their purchases of our products and our manufacturing rework and scrap costs and service and warranty costs may increase. In addition, a decline in the reliability of our products may make us less competitive as compared with other disc drive manufacturers.

Risks Associated with Future Acquisitions — We may not be able to identify suitable strategic alliance, acquisition or investment opportunities, or successfully acquire and integrate companies that provide complementary products or technologies.

 

Our growth strategy may involve pursuing strategic alliances with, and making acquisitions of or investments in, other companies that are complementary to our business. There is substantial competition for attractive strategic alliance, acquisition and investment candidates. We may not be able to identify suitable acquisition, investment or strategic partnership candidates. Even if we were able to identify them, we cannot assure you that we will be able to partner with, acquire or invest in suitable candidates, or integrate acquired technologies or operations successfully into our existing technologies and operations. Our ability to finance potential acquisitions will be limited by our high degree of leverage, the covenants contained in the indentures that govern our outstanding indebtedness, the credit agreement that governs our senior secured credit facilities and any agreements governing any other debt we may incur.

 

If we are successful in acquiring other companies, these acquisitions may have an adverse effect on our operating results, particularly while the operations of the acquired business are being integrated. It is also likely that integration of acquired companies would lead to the loss of key employees from those companies or the loss of customers of those companies. In addition, the integration of any acquired companies would require substantial attention from our senior management, which may limit the amount of time available to be devoted to our day-to-day operations or to the execution of our strategy. Growth by acquisition involves an even higher degree of risk to the extent we combine new product offerings and enter new markets in which we have limited experience, and no assurance can be given that acquisitions of entities with new or alternative business models, such as our recent acquisition of EVault, will be successfully integrated or achieve their stated objectives. Furthermore, the expansion of our business involves the risk that we might not manage our growth effectively, that we would incur additional debt to finance these acquisitions or investments and that we would incur substantial charges relating to the write-off of in-process research and development, similar to that which we incurred in connection with several of our prior acquisitions. Each of these items could have a material adverse effect on our financial position and results of operations.

 

In addition, we could issue additional common shares in connection with future acquisitions. For example, in May 2006, we issued approximately 97 million of our common shares in connection with our acquisition of Maxtor Corporation. Issuing shares in connection with acquisitions would have the effect of diluting your ownership percentage of the common shares and could cause the price of our common shares to decline.

 

Risk of Intellectual Property Litigation — Our products may infringe the intellectual property rights of others, which may cause us to incur unexpected costs or prevent us from selling our products.

 

We cannot be certain that our products do not and will not infringe issued patents or other intellectual property rights of others. Historically, patent applications in the United States and some foreign countries have not been publicly disclosed until the patent is issued, and we may not be aware of currently filed patent applications that relate to our products or technology. If patents are later issued on these applications, we may be liable for infringement. We may be subject to legal proceedings and claims, including claims of alleged infringement of the patents, trademarks and other intellectual property rights of third parties by us, or our licensees in connection with their use of our products.

 

We are currently subject to lawsuits involving intellectual property claims brought by Convolve, Inc. and the Massachusetts Institute of Technology in the United States, Shao Tong in Nanjing, China and Siemens AG and StorMedia Texas LLC in the United States which could cause us to incur significant additional costs or prevent us from selling our products; which could adversely effect our results of operations and financial condition.

 

Intellectual property litigation is expensive and time-consuming, regardless of the merits of any claim, and could divert our management’s attention from operating our business. In addition, intellectual property lawsuits are subject to inherent uncertainties due to the complexity of the technical issues involved, and we cannot assure you that we will be successful in defending ourselves against intellectual property claims. Moreover, patent litigation

has increased due to the current uncertainty of the law and the increasing competition and overlap of product functionality in the field. If we were to discover that our products infringe the intellectual property rights of others, we would need to obtain licenses from these parties or substantially reengineer our products in order to avoid infringement. We might not be able to obtain the necessary licenses on acceptable terms, or at all, or be able to reengineer our products successfully. Moreover, if we are sued for patent infringement and lose the suit, we could be required to pay substantial damages and/or be enjoined from using or selling the infringing products or technology. Any of the foregoing could cause us to incur significant costs and prevent us from selling our products which could adversely affect our results of operations and financial condition.

 

Dependence on Key Personnel — The loss of some key executive officers and employees could negatively impact our business prospects.

 

Our future performance depends to a significant degree upon the continued service of key members of management as well as marketing, sales and product development personnel. The loss of one or more of our key personnel would have a material adverse effect on our business, operating results and financial condition. We believe our future success will also depend in large part upon our ability to attract, retain and further motivate highly skilled management, marketing, sales and product development personnel. We have experienced intense competition for personnel, and we cannot assure you that we will be able to retain our key employees or that we will be successful in attracting, assimilating and retaining personnel in the future.

 

Substantial Leverage — Our substantial leverage may place us at a competitive disadvantage in our industry.

 

We are leveraged and have significant debt service obligations. Our significant debt and debt service requirements could adversely affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities. For example, our high level of debt presents the following risks:

 

 

Significant Debt Service Requirements — Servicing our debt requires a significant amount of cash and our ability to generate cash may be affected by factors beyond our control.

 

Our business may not generate cash flow in an amount sufficient to enable us to pay the principal of, or interest on, our indebtedness or to fund our other liquidity needs, including working capital, capital expenditures, product development efforts, strategic acquisitions, investments and alliances, and other general corporate requirements.

Our ability to generate cash is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We cannot assure you that:

 

 

If we cannot fund our liquidity needs, we will have to take actions such as reducing or delaying capital expenditures, product development efforts, strategic acquisitions, investments and alliances, selling assets, restructuring or refinancing our debt, or seeking additional equity capital. We cannot assure you that any of these remedies could, if necessary, be affected on commercially reasonable terms, or at all. In addition, our existing debt instruments permit us to incur a significant amount of additional debt. If we incur additional debt above the levels now in effect, the risks associated with our substantial leverage, including the risk that we will be unable to service our debt or generate enough cash flow to fund our liquidity needs, could intensify.

 

Restrictions Imposed by Debt Covenants — Restrictions imposed by our existing credit facility may limit our ability to finance future operations or capital needs or engage in other business activities that may be in our interest.

 

Our existing credit facility imposes, and the terms of any future debt may impose, operating and other restrictions on us. Our existing credit facility may also limit, among other things, our ability to:

 

 

These covenants are subject to a number of important qualifications and exceptions, including exceptions that permit us to make significant dividends.

 

Our credit facility also requires us to maintain compliance with specified financial ratios. Our ability to comply with these ratios may be affected by events beyond our control.

 

A breach of any of the covenants described above or our inability to comply with the required financial ratios could result in a default under our credit facility. If a default occurs, the Administrative Agent of the credit facility may elect to declare all of our outstanding obligations under the credit facility, together with accrued interest and other fees, to be immediately due and payable. If our outstanding indebtedness were to be accelerated, we cannot assure you that our assets would be sufficient to repay in full that debt and any potential future indebtedness, which would cause the market price of our common shares to decline significantly.

 

System Failures — System failures caused by events beyond our control could adversely affect computer equipment and electronic data on which our operations depend.

 

Our operations are dependent upon our ability to protect our computer equipment and the information stored in our databases from damage by, among other things, earthquake, fire, natural disaster, power loss, telecommunications failures, unauthorized intrusion and other catastrophic events. As our operations become more automated and increasingly interdependent, our exposure to the risks posed by these types of events will increase. We do not

have a contingency plan for addressing the kinds of events referred to in this paragraph that would be sufficient to prevent system failures and other interruptions in our operations that could have a material adverse effect on our business, results of operations and financial condition.

 

Economic Risks Associated with International Operations — Our international operations subject us to risks related to currency exchange fluctuations, longer payment cycles for sales in foreign countries, seasonality and disruptions in foreign markets, tariffs and duties, price controls, potential adverse tax consequences, increased costs, our customers’ credit and access to capital and health-related risks.

 

We have significant operations in foreign countries, including manufacturing facilities, sales personnel and customer support operations. We have manufacturing facilities in China, Malaysia, Northern Ireland, Singapore and Thailand, in addition to those in the United States. A substantial portion of our desktop disc drive assembly occurs in our facility in China.

 

Our international operations are subject to economic risks inherent in doing business in foreign countries, including the following:

 

 

Political Risks Associated with International Operations — Our international operations subject us to risks related to political unrest and terrorism.

 

We have manufacturing facilities in parts of the world that periodically experience political unrest. This could disrupt our ability to manufacture important components as well as cause interruptions and/or delays in our ability to ship components to other locations for continued manufacture and assembly. Any such delays or interruptions could result in delays in our ability to fill orders and have an adverse effect on our results of operation and financial condition. U.S. and international responses to the ongoing hostilities in Afghanistan and Iraq and the risk of terrorist attacks or hostilities elsewhere in the world could exacerbate these risks.

 

Legal and Operational Risks Associated with International Operations — Our international operations subject us to risks related to staffing and management, legal and regulatory requirements and the protection of intellectual property.

 

Operating outside of the United States creates difficulties associated with staffing and managing our international manufacturing facilities, complying with local legal and regulatory requirements and protecting our intellectual property. We cannot assure you that we will continue to be found to be operating in compliance with applicable customs, currency exchange control regulations, transfer pricing regulations or any other laws or regulations to which we may be subject. We also cannot assure you that these laws will not be modified.

 

SOX 404 Compliance — While we believe that we currently have adequate internal control procedures in place, we are still exposed to future risks of non-compliance and will continue to incur costs associated with Section 404 of the Sarbanes-Oxley Act of 2002.

 

We have completed the evaluation of our internal controls over financial reporting as required by Section 404 of the Sarbanes-Oxley Act of 2002. Although our assessment, testing, and evaluation resulted in our conclusion that as of June 29, 2007, our internal controls over financial reporting were effective, we cannot predict the outcome of our testing in future periods. If our internal controls are ineffective in future periods, our financial results or the market price of our shares could be adversely affected. We will incur additional expenses and commitment of management’s time in connection with further evaluations.

 

Volatile Public Markets — The price of our common shares may be volatile and could decline significantly.

 

The stock market in general, and the market for technology stocks in particular, has recently experienced volatility that has often been unrelated to the operating performance of companies. If these market or industry-based fluctuations continue, the trading price of our common shares could decline significantly independent of our actual operating performance, and you could lose all or a substantial part of your investment. The market price of our common shares could fluctuate significantly in response to several factors, including among others:

 

 

Failure to Pay Quarterly Dividends — Our failure to pay quarterly dividends to our common shareholders could cause the market price of our common shares to decline significantly.

 

We paid quarterly dividends aggregating $0.38 per share on September 1, 2006, November 17, 2006, February 16, 2007 and May 18, 2007 to our common shareholders of record as of August 18, 2006, November 3, 2006, February 2, 2007 and May 4, 2007, respectively. On July 19, 2007, we declared a quarterly dividend of $0.10 per share that was paid by August 17, 2007 to our common shareholders of record as of August 3, 2007.

 

Our ability to pay quarterly dividends will be subject to, among other things, general business conditions within the disc drive industry, our financial results, the impact of paying dividends on our credit ratings, and legal and contractual restrictions on the payment of dividends by our subsidiaries to us or by us to our common shareholders, including restrictions imposed by the credit agreement governing our revolving credit facility. Any reduction or discontinuation of quarterly dividends could cause the market price of our common shares to decline significantly. Our payment of dividends to holders of our common shares may in certain future quarters result in upward adjustments to the conversion rate of the 2.375% Convertible Senior Notes due 2012. Moreover, in the event our payment of quarterly dividends is reduced or discontinued, our failure or inability to resume paying dividends at historical levels could result in a persistently low market valuation of our common shares.

 

Potential Governmental Action — Governmental action against companies located in offshore jurisdictions may lead to a reduction in the demand for our common shares.

 

Recent federal and state legislation has been proposed, and additional legislation may be proposed in the future which, if enacted, could have an adverse tax impact on either Seagate or its shareholders. For example, the eligibility for favorable tax treatment of taxable distributions paid to U.S. shareholders of Seagate as qualified dividends could be eliminated.

 

Securities Litigation — Significant fluctuations in the market price of our common shares could result in securities class action claims against us.

 

Significant price and value fluctuations have occurred with respect to the publicly traded securities of disc drive companies and technology companies generally. The price of our common shares is likely to be volatile in the future. In the past, following periods of decline in the market price of a company’s securities, class action lawsuits have often been pursued against that company. If similar litigation were pursued against us, it could result in substantial costs and a diversion of management’s attention and resources, which could materially adversely affect our results of operations, financial condition and liquidity.

 

None.

 

Our company headquarters is located in the Cayman Islands, while our U.S. executive offices are in Scotts Valley, California. Our principal manufacturing facilities are located in China, Malaysia, Northern Ireland, Singapore and Thailand and, in the United States, in California and Minnesota. Our principal disc drive design and research and development facilities are located in Colorado, Minnesota, Pennsylvania, Massachusetts and Singapore. Portions of our facilities are occupied under leases that expire at various times through 2082. We occupy a total of 10.6 million square feet, of which, 6.0 million is for manufacturing and warehousing, 1.5 million is for product development, 1.3 million is for administrative purposes and 1.8 million is unoccupied.

 

See Item 8, Note 9, Legal, Environmental, and Other Contingencies.

 

None.

 

Our Chief Executive Officer has certified to the NYSE that he is unaware of any violation by the Company of the NYSE’s corporate governance listing standards. On November 15, 2006, we submitted our Annual CEO Certification as required by Section 303A.12(a) of the NYSE Listed Company Manual.

 

Market Information

 

Our common shares have traded on the New York Stock Exchange under the symbol “STX” since December 11, 2002. Prior to that time there was no public market for our common shares. The high and low sales prices of our common shares, as reported by the New York Stock Exchange, are set forth below for the periods indicated.

 

 

The closing price of our common shares as reported by the New York Stock Exchange on August 15, 2007 was $23.36 per share. As of August 15, 2007 there were approximately 2,243 holders of record of our common shares. We did not sell any of our equity securities during fiscal year 2007 that were not registered under the Securities Exchange Act of 1933, as amended.

Performance Graph

 

The performance graph below shows the cumulative total shareholder return on our common shares for the period starting on December 11, 2002, which was the initial trading date of the common shares, to June 29, 2007. This is compared with the cumulative total return of the Dow Jones US Computer Hardware Index and the Standard & Poor’s 500 Stock Index over the same period. The graph assumes that on December 11, 2002, $100 was invested in our common shares and $100 was invested in each of the other two indices, with dividends reinvested on the date of payment without payment of any commissions. Dollar amounts in the graph are rounded to the nearest whole dollar. The performance shown in the graph represents past performance and should not be considered an indication of future performance.

 

Seagate Technology operates on a 52 or 53 week fiscal year which ends on the Friday closest to June 30. Accordingly, the last trading day of Seagate Technology’s fiscal year may vary. Fiscal year 2005 was 52 weeks long and ended on July 1, 2005. Fiscal year 2006 was 52 weeks long and ended on June 30, 2006. Fiscal year 2007 was 52 weeks long and ended on June 29, 2007.

 

COMPARISON OF 54 MONTH CUMULATIVE TOTAL RETURN*
Among Seagate Technology, The S&P 500 Index
And The Dow Jones US Computer Hardware Index

 

 

 

  Indexes calculated on month-end basis.

 

  Copyright^© 2007, Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved.

  www.researchdatagroup.com/S&P.htm

 

Dividends

 

We are currently paying our shareholders a quarterly dividend of no more than $0.10 per share (up to $0.40 per share annually) so long as the aggregate amount of the dividend does not exceed 50% of our cumulative consolidated net income plus 100% of net cash proceeds received from the issuance of capital all of which are

measured from the period beginning June 30, 2001 and ending the most recent fiscal quarter in which financial statements are internally available.

 

We are restricted in our ability to pay dividends by the covenants contained in the revolving credit facility. Our declaration of dividends is also subject to Cayman Islands law and the discretion of our board of directors. Under the terms of the Seagate Technology shareholders agreement (which was amended on September 2, 2004) at least seven members of our board of directors must approve the payment of dividends in excess of 15% of our net income in the prior fiscal year (provided that such consent is not required to declare and pay our regular quarterly dividend of up to $0.10 per share). In deciding whether or not to declare quarterly dividends, our directors will take into account such factors as general business conditions within the disc drive industry, our financial results, our capital requirements, contractual and legal restrictions on the payment of dividends by our subsidiaries to us or by us to our shareholders, the impact of paying dividends on our credit ratings and such other factors as our board of directors may deem relevant.

 

Since the closing of our initial public offering in December 2002, we have paid dividends, pursuant to our quarterly dividend policy totaling approximately $604 million in the aggregate. The following are dividends paid in the last two fiscal years:

 

 

Because we had current earnings and profits in excess of distributions for our taxable year ended June 29, 2007, distributions on our common shares to U.S. shareholders during this period were treated as dividend income for U.S. federal income tax purposes. We anticipate that we will have earnings and profits in excess of distributions in fiscal year 2008. Therefore, distributions to U.S. shareholders in fiscal year 2008 are anticipated to be treated as dividend income for U.S. federal income tax purposes. Non-U.S. shareholders should consult with a tax advisor to determine appropriate tax treatment.

 

Furthermore, we believe that we were a foreign personal holding company for U.S. federal income tax purposes for our taxable years ended July 1, 2005 and July 2, 2004. Pursuant to the American Jobs Creation Act of 2004, foreign corporations will be excluded from the application of the personal holding company rules of the Internal Revenue Code of 1986, as amended (the “Code”), effective for taxable years of foreign corporations beginning after December 31, 2004. For us, the effective date was our fiscal year beginning July 2, 2005. As a result, if taxable distributions on our common shares are made after July 1, 2005, U.S. shareholders who are individuals may be eligible for reduced rates of taxation applicable to certain dividend income (currently a maximum rate of 15%) on distributions made after the effective date.

 

Repurchases of Our Equity Securities

 

On August 8, 2006, we announced that our board of directors had authorized the use of up to $2.5 billion for the repurchase of our outstanding common shares over a two-year period. From the authorization of this repurchase program and through the fiscal year ended June 29, 2007, we repurchased approximately 62.0 million shares at an average price of $24.62, all of which were considered cancelled and are no longer outstanding. We repurchased these shares through a combination of open market purchases and prepaid forward agreements with large financial institutions, according to which we prepaid the financial institutions a fixed amount to deliver a variable number of shares at future dates. We entered into these agreements in order to take advantage of repurchasing shares at a guaranteed discount to the Volume Weighted Average Price (“VWAP”) of our common shares. Our policy to date

has been to enter into such transactions only when the discount that we receive is higher than the foregone return on our cash prepayment to the financial institution. There were no explicit commissions or fees on these prepaid forward agreements. Under the terms of these agreements, there was no requirement for the financial institutions to return any portion of the prepayment to us. These prepaid forward agreements were not derivatives because the Company had prepaid all amounts and had no remaining obligation. The agreements do not contain an embedded derivative. The prepayments were recorded as a reduction to shareholders’ equity when paid and the shares were deducted from shares outstanding. The agreements require the physical delivery of shares; there were no settlement alternatives, except in the case of certain defined extraordinary events which are outside the control of Seagate and the financial institutions. The parameters used to calculate the final number of shares deliverable are the total notional amount of the contract and the average VWAP of our common shares during the contract period less the agreed upon discount. The contracts are indexed solely to the price of Seagate’s common shares.

 

During fiscal year 2007, we repurchased 24.3 million shares through open market repurchases. In addition, we made payments totaling $950 million under prepaid forward agreements and took delivery of 37.7 million shares using prepaid forward agreements. Shares physically delivered to us were cancelled and are no longer outstanding. At June 29, 2007, there were no outstanding prepaid forward agreements to repurchase our common shares.

 

As of June 29, 2007, we had approximately $974 million remaining under the authorized $2.5 billion stock repurchase program. Share repurchases during fiscal year 2007 were as follows:

 

 

During the fourth quarter of fiscal year 2006, we repurchased 16.7 million shares under a previously authorized stock repurchase program. The program authorizing repurchases in the fourth quarter of fiscal year 2006 was completed and there is no outstanding authority for further shares to be purchased under that program.

 

We list in the table below selected historical consolidated and combined financial information relating to us for the periods indicated.

 

 

 

 

 

Year Ended June 29, 2007

 

Includes a $359 million tax benefit resulting from a favorable adjustment to the valuation allowance related to our deferred tax assets, $101 million of stock-based compensation expense as a result of our adoption of Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), Share-Based Payment (“SFAS No. 123(R)”), a $40 million increase in the provision for doubtful accounts receivable related to the termination of our distributor relationship with eSys Technologies Pte. Ltd. and its related affiliate entities (“eSys”), a $29 million restructuring charge, a $19 million charge related to the redemption of our $400 million 8% Senior Notes previously due 2009 (“8% Notes”) and charges related to our acquisition of Maxtor which include $42 million in integration and retention costs, net of related tax effects, $150 million in amortization of acquired intangibles, $27 million in stock-based compensation charges related to Maxtor options assumed and nonvested shares exchanged and the settlement of $18 million in customer compensatory claims related to legacy Maxtor products.

 

Year Ended June 30, 2006

 

Includes $74 million of stock-based compensation expense as a result of our adoption of SFAS No. 123(R), Maxtor’s operating losses from May 19, 2006 through June 30, 2006 and charges related to our acquisition of Maxtor which include $38 million in integration and retention costs, net of related tax effects, $24 million in amortization of acquired intangibles and $16 million in stock-based compensation charges.

Year Ended July 1, 2005

 

Includes a $14 million reduction in operating expenses related to the reduction in accrued benefit obligations associated with our post-retirement medical plan and approximately $10 million in income from the settlement of a litigation matter.

 

Year Ended July 2, 2004

 

Includes a $125 million income tax benefit from the reversal of accrued income taxes relating to tax indemnification amounts and a $59 million restructuring charge.

 

Year Ended June 27, 2003

 

Includes a $10 million write-down in our investment in a private company and a $9 million net restructuring charge.

 

The following is a discussion of the financial condition and results of operations for the fiscal years ended June 29, 2007, June 30, 2006 and July 1, 2005. Unless the context indicates otherwise, as used herein, the terms “we,” “us” and “our” refer to Seagate Technology, an exempted company incorporated with limited liability under the laws of the Cayman Islands, and its subsidiaries.

 

You should read this discussion in conjunction with “Item 6. Selected Financial Data” and “Item 8. Financial Statements and Supplementary Data” included elsewhere in this report. Except as noted, references to any fiscal year mean the twelve-month period ending on the Friday closest to June 30 of that year.

 

Our Company

 

We are the leader in the design, manufacture and marketing of rigid disc drives. Rigid disc drives, which are commonly referred to as disc drives or hard drives, are used as the primary medium for storing electronic information in systems ranging from desktop and notebook computers, and consumer electronics devices to data centers delivering information over corporate networks and the Internet. We produce a broad range of disc drive products addressing enterprise applications, where our products are used in enterprise servers, mainframes and workstations; desktop applications, where our products are used in desktop computers; mobile computing applications, where our products are used in notebook computers; and consumer electronics applications, where our products are used in a wide variety of devices such as digital video recorders (DVRs), gaming devices and other consumer electronic devices that require storage. We also sell under the Seagate and Maxtor brands storage products containing our disc drives.

 

We sell our disc drives primarily to major original equipment manufacturers (OEMs), and also market to distributors under our globally recognized brand names. For the fiscal years 2007, 2006 and 2005, approximately 64%, 72% and 72%, respectively, of our disc drive revenue was from sales to OEMs, of which Hewlett-Packard was the only customer exceeding 10% of our disc drive revenue in all of these respective periods while Dell exceeded 10% of our disc drive revenue in fiscal years 2006 and 2005. We have longstanding relationships with many of our OEM customers. We also have key relationships with major distributors, who sell our disc drive products to small OEMs, dealers, system integrators and retailers throughout most of the world. Shipments to distributors were approximately 30%, 25% and 26% of our disc drive revenue in fiscal years 2007, 2006 and 2005, respectively. Retail sales in fiscal year 2007, as a percentage of our disc drive revenue, was 6%, compared to 3% and 2% in fiscal years 2006 and 2005, respectively. For fiscal years 2007, 2006 and 2005, approximately 30%, 30% and 31%, respectively, of our disc drive revenue came from customers located in North America, approximately 27%, 27% and 28%, respectively, came from customers located in Europe and approximately 43%, 43% and 41%, respectively, came from customers located in the Far East. Substantially all of our revenue is denominated in U.S. dollars.

In addition to manufacturing and selling disc drives and branded storage products, we provide data storage services for small to medium size businesses, including online backup, data protection and recovery solutions through EVault, Inc. (“EVault”), which we acquired in fiscal year 2007.

 

Industry Overview

 

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

 

Disc Drive Industry Consolidation

 

Due to the significant challenges posed by the need to continually innovate and improve manufacturing efficiency and because of the increasing amounts of capital and research and development expenditure required, the disc drive industry has undergone significant consolidation as disc drive manufacturers and component suppliers merged with other companies or exited the industry. Through such combinations, disc drive manufacturers have also become increasingly vertically integrated. Our recent acquisition of Maxtor Corporation (“Maxtor”) in May 2006 is an example of such industry consolidation. In March 2007, TDK, a disc drive head manufacturer, announced its pending acquisition of Alps, also a disc drive head manufacturer, while in June 2007, Western Digital announced that it is acquiring Komag. We believe industry consolidation is likely to continue in the disc drive industry through combinations of disc drive manufacturers, component manufacturers, or both, as the technological challenges and the associated levels of required investment grow, increasing the competitive necessity of larger-scale operations.

 

Price Erosion

 

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

 

 

Disc drive manufacturers typically attempt to off-set price erosion with an improved mix of disc drive products characterized by higher capacity, better performance and additional feature sets and/or product cost reductions.

 

We expect that price erosion in our industry will continue for the foreseeable future. To remain competitive, we believe it will be necessary to continue to reduce our prices as well as introduce new product offerings that utilize advanced technologies prior to that of our competitors to take advantage of potentially higher initial profit margins and reduced cost structure on these new products. We have established production facilities in China, Malaysia, Singapore and Thailand to achieve cost reductions.

 

Disc Drive Industry Demand Trends

 

We believe that the disc drive industry is experiencing the following growth trends relative to overall unit demand, including:

 

 

 

 

 

 

 

We believe that for some of the fastest growing applications described above, the demand is focused on higher capacity disc drive products.

Product Life Cycles and Changing Technology

 

Our industry has been characterized by significant advances in technology, which have contributed to rapid product life cycles, the importance of either being first to market with new products or quickly achieving product cost effectiveness as well as difficulty in recovering research and development expenses. Also, there is a continued need to successfully execute product transitions and new product introductions, as factors such as quality, reliability and manufacturing yields become of increasing competitive importance.

 

To address the growing demand for higher capacity products, the industry is undergoing a transition to perpendicular recording technology, which is necessary to achieve continued growth in areal density. Perpendicular recording technology poses various technological challenges, including a complex integration of the recording head, the disc, recording channel and drive firmware as a system, and involves the use of certain precious metals, such as ruthenium, which has been in limited supply and increasingly expensive.

 

Seasonality

 

The disc drive industry traditionally experiences seasonal variability in demand with higher levels of demand in the second half of the calendar year. This seasonality is driven by consumer spending in the back-to-school season from late summer to fall and the traditional holiday shopping season from fall to winter. In addition, corporate demand is higher during the second half of the calendar year when IT budget calendars typically provide for more spending. We expect normal industry seasonal patterns of increased demand for the September quarter.

 

Recording Media

 

Consistent with our expectations that the disc drive industry will continue to consolidate and integrate, Western Digital is in the process of acquiring Komag, a third-party supplier of recording media. Although this transaction may limit Komag’s supply of media to the disc drive industry in the long-term, we believe that there is adequate supply to meet currently identified industry demand, and that there is enough time to readjust supply chains if needed.

 

Raw Material Constraints

 

Perpendicular recording technology requires more layers and the use of more precious metals and scarce alloys in the sputtering process required to create such layers. As a result, products utilizing perpendicular recording technology are more sensitive to fluctuations in prices and availability of precious metals and scarce alloys such as platinum and ruthenium. As product offerings transition to perpendicular recording technology, companies will be required to maintain an increased inventory of these precious metals and scarce alloys.

 

Industry Supply Balance

 

Finally, to the extent that the disc drive industry builds product based on expectations of demand that do not materialize, the distribution channel may experience an oversupply of products that could lead to increased price erosion. The industry, excluding Seagate, exited the June 2007 quarter with what we believe to be less than five weeks of distribution inventory in the desktop channel, which is consistent with historical seasonal patterns.

 

Seagate Overview

 

We are the leader in the disc drive industry with products that address the enterprise, desktop, mobile computing and consumer electronics and branded solutions storage markets. The Seagate 3.5-inch and 2.5-inch disc drive units used in our branded storage products are reported in the desktop and mobile market information, respectively. We maintain a highly integrated approach to our business by designing and manufacturing a significant portion of the components we view as critical to our products, such as read/write heads and recording media. We believe that our control of these key technologies, combined with our platform design and manufacturing, enable us to achieve product performance, time-to-market leadership and manufacturing flexibility, which allows us to respond to customers and market opportunities. Our technology ownership, combined with our

integrated design and manufacturing approach, have allowed us to effectively leverage our leadership in traditional computing to enter new markets with only incremental product development and manufacturing costs.

 

Maxtor acquisition

 

During fiscal year 2007, we completed our integration of Maxtor, including customer and product transitions where we replaced Maxtor designed disc drive products with Seagate designed disc drive products, allowing us to improve our capacity utilization and further lower our cost structure. We achieved our goals of retaining a substantial portion of the market share held by Maxtor prior to the acquisition. We also continued to advance what we believe to be our technology and cost leadership positions, maintaining our position in key markets and introducing new products in core markets while developing additional value streams in new and emerging markets.

 

Our fiscal year 2007 included Maxtor’s operating losses largely recognized during the first half of the fiscal year as we transitioned Maxtor products to Seagate products and acquisition and integration related charges recognized over the entire fiscal year. Although we substantially completed the Maxtor restructuring and integration activities during the December 2006 quarter, certain operating expenses and acquisition related charges continued during the last half of the fiscal year, the most significant of which related to the amortization of acquired intangible assets. We expect to continue to incur charges, the most significant of which are expected to be the amortization of acquired intangible assets.

 

Operating performance

 

 

 

Other factors affecting income — In fiscal year 2007, our operating results were favorably impacted by the elimination of variable performance-based compensation compared to an expense of $163 million recorded in fiscal year 2006. We expect that we will incur expenses related to variable performance-based compensation in fiscal year 2008. Our operating results were also favorably impacted by a $359 million tax adjustment that reflected a change to our valuation allowance for deferred tax assets (see Note 4 to the Consolidated Financial Statements elsewhere in this report). Additionally, the proceeds of our $1.5 billion in new long-term debt was used to retire our 8% Senior Notes previously due 2009 (“8% Notes”) and to buy back shares of our common stock, thereby decreasing our outstanding common shares by over 40 million shares. Interest expense in fiscal year 2007, excluding $19 million in expenses related to the retirement of the 8% Notes, was approximately $80 million more than in fiscal year 2006 because of additional interest expense related to the $1.5 billion in new long-term debt and because the debt assumed from the Maxtor acquisition represented less than two months of interest in fiscal year 2006. Interest expense, based on the debt outstanding at the end of fiscal year 2007, will be over $30 million per quarter in fiscal year 2008.

 

Seasonality

 

Historically, we have exhibited seasonally lower unit demand during the second half of each fiscal year, however, there were some recent quarters in fiscal year 2005 and fiscal year 2006 in which these seasonal trends were moderated. We saw a return to traditional seasonality in fiscal year 2007. For the September 2007 quarter, we expect to see demand in the desktop, mobile and consumer electronics markets to be seasonally higher than the June 2007 quarter, while we expect demand in the enterprise market to be flat to slightly up compared to the June 2007 quarter.

 

Recording Media

 

The percentage of our requirements for recording media that we produce internally varies from quarter to quarter. We are continuing to expand our media production facilities in Singapore, and have relocated certain of the acquired Maxtor media manufacturing equipment to Asia. We do not expect our new media facility in Singapore to be fully operational until towards the end of fiscal year 2008. Our long-term strategy is to externally purchase no more than 15% of total recording media requirements.

 

We purchase approximately 70% of our aluminum substrates for recording media production from third parties. We are in the process of adding an aluminum substrate manufacturing facility in Johor, Malaysia which will allow us to decrease our purchases of aluminum substrates from third parties. We also purchase all of our glass substrates from third parties (mainly in Japan), which are used to manufacture our disc drives for mobile and small form factor consumer electronics products.

 

Recently, substantially all of our purchases of recording media and a significant portion of our aluminum substrates from third-party suppliers have been sourced from Komag, which is in the process of being acquired by Western Digital. We are engaged in discussions with other suppliers to ensure supply continuity should Komag decrease its supply to us after the closing of the acquisition by Western Digital.

Raw Materials

 

We believe Seagate is leading the transition to perpendicular recording technology. We are currently shipping perpendicular technology based products for all four major markets, and during the June 2007 quarter, we shipped over 28 million disc drives that use perpendicular recording technology compared to 17 million disc drives shipped in the immediately preceding quarter. We expect that by the end of fiscal year 2008, all of our drive shipments will utilize perpendicular recording technology. Our products based on perpendicular technology require increased quantities of precious metals like ruthenium, which has led to an increase (that is likely to continue) in the inventory levels for these raw materials. The price of ruthenium has increased significantly over the last year and may continue to be volatile. In addition, ruthenium has at times been difficult to acquire. We believe we have adequate supply plans in place to support our expected perpendicular product ramp requirements.

 

Investments

 

In fiscal year 2007, we made $906 million of capital investments, $218 million of which occurred in the June 2007 quarter. For fiscal year 2008, we expect approximately $900 million in capital investment will be required to continue to proceed with our planned media and substrate capacity expansions in Asia and to align capacity additions with current levels of customer demand, while we continue to improve our utilization of capital equipment.

 

In January 2007, we completed our acquisition of EVault in an all cash transaction valued at approximately $186 million, which includes approximately $2 million in acquisition costs as part of our effort to extend our storage solutions offerings.

 

Results of Operations

 

We list in the tables below the historical consolidated statements of operations in dollars and as a percentage of revenue for the fiscal years indicated.

 

 

 

Fiscal Year 2007 Compared to Fiscal Year 2006

 

The fiscal year 2007 results include the results of Maxtor for the entire year, while fiscal year 2006 include the results of Maxtor from May 19, 2006 to June 30, 2006. In connection with the Maxtor acquisition, we incurred a number of accounting charges and other costs, which impacted our earnings for the entire fiscal year 2007 and during the fourth quarter of fiscal year 2006.

 

Revenue.  Revenue for fiscal year 2007 was approximately $11.4 billion, up 23% from approximately $9.2 billion in fiscal year 2006. The increase in revenue from fiscal year 2006 was driven by a 34% increase in the unit volume of disc drives shipped from 118.7 million units to 159.2 million units principally as a result of the retention of a portion of Maxtor’s market share, offset by a 9% reduction in our average sales price from $78 to $71 per unit and a weaker than anticipated demand for large capacity 3.5-inch ATA disc drives. The comparative decrease in average sales price per unit in the period resulted from price erosion that more than offset improved product mix.

 

Unit shipments for our products in fiscal year 2007 were as follows:

 

 

We maintain various sales programs aimed at increasing customer demand. We exercise judgment in formulating the underlying estimates related to distributor and retail inventory levels, sales program participation and customer claims submittals in determining the provision for such programs. During fiscal year 2007, sales programs recorded as contra revenue, were approximately 9% of our gross revenue, compared to 7% of our gross revenue for fiscal year 2006. The increase in sales programs as a percentage of gross revenue from fiscal year 2006 was primarily the result of a higher mix of sales to distributors and retail customers which generally require higher program support than OEM sales and to a more aggressive pricing environment. Point-of-sale rebates, sales price adjustments and price protection accounted for a substantial portion of the increase in sales programs.

 

Cost of Revenue.  Cost of revenue for fiscal year 2007 was approximately $9.2 billion, up 30% from approximately $7.1 billion in fiscal year 2006, principally as a result of the acquisition of Maxtor. Gross margin as a percentage of revenue for fiscal year 2007 was 19% as compared with 23% for fiscal year 2006.

The gross margin percentage decrease from fiscal year 2006 was due to the sale of lower margin Maxtor designed products during the first six months of fiscal year 2007; costs and charges related to our acquisition of Maxtor during fiscal year 2007 (including integration and retention costs of $54 million, stock-based compensation of $27 million, amortization of existing technology of $150 million, and an $18 million accrual for the settlement of customer compensatory claims associated with quality issues related to legacy Maxtor products shipped prior to the closing of the Maxtor acquisition); and an aggressive pricing environment in fiscal year 2007, particularly in the high capacity 3.5-inch and mobile markets in the first half of the year, and the low end OEM desktop and mobile markets in the second half. These effects were partially offset by the elimination of variable performance-based compensation for fiscal year 2007, compared to an expense of $76 million recorded in Cost of revenue in fiscal year 2006.

 

Product Development Expense.  Product development expense increased by $99 million, or 12%, for fiscal year 2007 when compared with fiscal year 2006. The increase in product development expense from fiscal year 2006 was primarily due to increases of $115 million in salaries and benefits resulting from increased staffing levels due in part to the retention of certain Maxtor employees, and $10 million in stock-based compensation related to the Maxtor acquisition, $7 million in non-Maxtor stock-based compensation and $4 million in the write-off of in-process research and development related to our acquisition of EVault, partially offset by the elimination of variable performance-based compensation for fiscal year 2007, compared to an expense of $46 million in fiscal year 2006.

 

Marketing and Administrative Expense.  Marketing and administrative expense increased by $142 million, or 32%, for fiscal year 2007 when compared with fiscal year 2006. The increase in marketing and administrative expense from fiscal year 2006 was primarily due to the recording in our first quarter of a $40 million increase in the provision for doubtful accounts receivable related to eSys Technologies Pte. Ltd. and its related affiliate entities (“eSys”), previously our largest distributor, an increase of $86 million in salaries and benefits resulting from increased staffing levels due in part to the retention of certain Maxtor employees, an increase of $5 million in integration and retention costs related to the Maxtor acquisition, an increase of $11 million in advertising expense and an increase of $11 million in non-Maxtor stock-based compensation. These increases were partially offset by the elimination of variable performance-based compensation for fiscal year 2007, compared to an expense of $41 million in fiscal year 2006.

 

Amortization of Intangibles.  Amortization of intangibles increased by $42 million primarily due to the amortization of intangibles acquired in the Maxtor and EVault acquisitions.

 

Restructuring and Other.  During fiscal year 2007, we recorded restructuring costs of approximately $33 million in connection with our ongoing restructuring activities. These costs were primarily a result of a restructuring plan established to continue the alignment of our global workforce with existing and anticipated business requirements, primarily in our U.S. and Far East operations and asset impairments. The restructuring costs were comprised of employee termination costs of approximately $14 million relating to a reduction in our workforce, approximately $11 million in charges related to impaired facility improvements and equipment as a result of the alignment plan, and approximately $8 million in charges related to impaired other intangibles. These restructuring activities are expected to be completed by the end of fiscal year 2008. Additionally, we reversed $4 million of restructuring accruals relating to the sale of a surplus building impaired in a prior restructuring.

 

Net Other Income (Expense).  Net other income changed by $103 million from net other income of $50 million in fiscal year 2006 to net other expense of $53 million in fiscal year 2007. The change from fiscal year 2006 was primarily due to an increase in interest expense of $81 million related to our new $1.5 billion long-term debt issued in September 2006, as well as debt acquired in the Maxtor acquisition, and expenses of $19 million incurred in October 2006 related to the early retirement of our 8% Notes. The $1.5 billion in new long-term debt was used to retire the 8% Notes and to buy back shares of our common stock. Interest expense in fiscal year 2007, excluding the expenses related to the early retirement of the 8% Notes, was approximately $80 million more than in fiscal year 2006 because of additional interest expense related to the $1.5 billion in new long-term debt and because the debt assumed from the Maxtor acquisition represented less than two months of interest in fiscal year 2006.

 

Income Taxes.  We recorded a benefit from income taxes of $352 million for the fiscal year ended June 29, 2007 compared to a provision for income taxes of $84 million for the fiscal year ended June 30, 2006. We are a foreign holding company incorporated in the Cayman Islands with foreign and U.S. subsidiaries that operate in multiple taxing jurisdictions. As a result, our worldwide operating income is either subject to varying rates of tax or

is exempt from tax due to tax holidays or tax incentive programs we operate under in China, Malaysia, Singapore, Switzerland and Thailand. These tax holidays or incentives are scheduled to expire in whole or in part at various dates through 2020. Our provision for income taxes recorded for the fiscal year ended June 29, 2007 differs from the provision for income taxes that would be derived by applying a notional U.S. 35% rate to income before income taxes primarily due to the net effect of (i) a decrease in our valuation allowance for certain deferred tax assets and (ii) the tax benefit related to the aforementioned tax holidays and tax incentive programs. Our provision for income taxes recorded for the fiscal year ended June 30, 2006 differed from the provision for income taxes that would be derived by applying a notional U.S. 35% rate to income before income taxes primarily due to the net effect of (i) the tax benefit related to the aforementioned tax holidays and tax incentive programs, (ii) an increase in our valuation allowance for certain deferred tax assets, and (iii) utilization of research tax credits generated in the current year.

 

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

 

During fiscal year ended June 29, 2007, we reduced our valuation allowance recorded in prior years for our deferred tax assets by $641 million. This release of valuation allowance was largely due to the completion during fiscal 2007 of the restructuring of our intercompany arrangements, which enabled us to forecast our U.S. profits with greater certainty and the recording of a U.S. taxable gain in connection with the intercompany sale of certain Maxtor intangible assets as described below. As a result of the valuation allowance release, we recorded a U.S. deferred tax benefit of $319 million and a $322 million reduction in the goodwill originally recorded in connection with the Maxtor acquisition. The reduction in goodwill was required in accordance with Financial Accounting Standards Board (“FASB”) Statement (“SFAS”) No. 109, Accounting for Income Taxes (“SFAS No. 109”) as a result of the reversal of valuation allowance that had been previously recorded as of the date of acquisition against Maxtor related deferred tax assets primarily for tax net operating loss carryovers. The valuation allowance was reduced primarily to reflect the realization of acquired Maxtor net operating loss carryforwards due to increased forecasts of future U.S. taxable income and a $296 million gain for U.S. tax purposes from the intercompany sale of certain intellectual property rights to a foreign subsidiary. Approximately $120 million of tax expense associated with the gain on the intercompany sale of intangibles has been capitalized in accordance with Accounting Research Bulletin No. 51, Consolidated Financial Statements (“ARB No. 51”) and is being amortized to income tax expense over a sixty-month period, which approximates the expected useful life of the intangibles sold in the intercompany transaction.

 

As of June 29, 2007, we recorded net deferred tax assets of $768 million, the realization of $663 million of which is primarily dependent on our ability to generate sufficient taxable income in future periods. Although realization is not assured, we believe that it is more likely than not that these deferred tax assets will be realized. The amount of deferred tax assets considered realizable, however, may increase or decrease in subsequent quarters, when we reevaluate our estimates of future taxable income.

 

As a result of the Maxtor acquisition, Maxtor underwent a change in ownership within the meaning of IRC Section 382 on May 19, 2006. In general, IRC Section 382 places annual limitations on the use of certain tax attributes such as net operating losses and tax credit carryovers in existence at the ownership change date. As of June 29, 2007, $1.4 billion and $337 million of U.S. federal and state net operating losses, respectively, and $47 million of tax credit carryovers acquired from Maxtor are generally subject to an annual limitation of approximately $110 million. Certain amounts may be accelerated into the first five years following the acquisition pursuant to IRC Section 382 and published notices.

 

On January 3, 2005, we underwent a change in ownership under IRC Section 382 due to the sale of common shares to the public by our then largest shareholder, New SAC. Based on an independent valuation as of January 3, 2005, the annual limitation for this change is $44.8 million. As of June 29, 2007, there were $447 million of U.S. net operating loss carryforwards and $111 million of U.S. tax credit carryforwards subject to IRC Section 382

limitation associated with the January 3, 2005 change. To the extent we believe it is more likely than not that the deferred tax assets associated with tax attributes subject to this IRC Section 382 limitation will not be realized, a valuation allowance has been provided.

 

The Internal Revenue Service (“IRS”) is currently examining our federal income tax returns for fiscal years ending in 2001 through 2004. The timing of the settlement of these examinations is uncertain. We believe that adequate amounts of tax have been provided for any final assessments that may result.

 

Fiscal Year 2006 Compared to Fiscal Year 2005

 

The fiscal year 2006 results include the results of Maxtor for the six weeks from the closing date of the acquisition of May 19, 2006 through June 30, 2006. In connection with the Maxtor acquisition, we incurred a number of accounting charges and other costs, which impacted our earnings for the last quarter of and the entire fiscal year 2006.

 

Revenue.  Revenue for fiscal year 2006 was approximately $9.2 billion, up 22% from approximately $7.6 billion in fiscal year 2005. The increase in revenue was primarily due to record disc drive shipments of 118.7 million units in fiscal year 2006 compared to 98.1 million units in fiscal year 2005, as well as an improved product mix of our new products, offset by price erosion. Our overall average sales price per unit (ASP) for our products was $78 for fiscal year 2006, up from $77 in fiscal year 2005.

 

Unit shipments for our products in fiscal year 2006 were as follows:

 

 

We maintained various sales programs aimed at increasing customer demand. We exercise judgment in formulating the underlying estimates related to distributor inventory levels, sales program participation and customer claims submittals in determining the provision for such programs. During fiscal year 2006, sales programs recorded as contra revenue were approximately 7% of our gross revenue, compared to 5% of our gross revenue for fiscal year 2005. The increase in sales programs as a percentage of gross revenue was primarily the result of higher price erosion in the distribution channel and growth in retail sales, which typically require higher point-of-sale rebates.

 

Cost of Revenue.  Cost of revenue for fiscal year 2006 was approximately $7.1 billion, up 20% from approximately $5.9 billion in fiscal year 2005. Gross margin as a percentage of revenue for fiscal year 2006 was 23% as compared with 22% for fiscal year 2005. The increase in gross margin as a percentage of revenue from fiscal year 2005 was primarily due to higher overall unit shipments and an increase mix of new higher-margin products partially offset by higher costs associated with new product transitions, increased warranty cost and customer service inventory write-downs, stock-based compensation costs, price erosion, and in connection with the Maxtor acquisition, an increasingly under-utilized manufacturing infrastructure required to build Maxtor-designed disc drive products and purchase accounting related costs including integration and retention costs, stock-based compensation and amortization of existing technology.

 

Product Development Expense.  Product development expense increased by $160 million, or 25%, for fiscal year 2006 when compared with fiscal year 2005. The increase in product development expense from fiscal year 2005 was primarily due to increases of $65 million in salaries resulting and benefits from increased staffing levels and variable performance-based compensation, $38 million in product development support costs, $24 million in stock-based compensation and $28 million in costs related to the Maxtor acquisition, including integration and retention costs and stock-based compensation.

 

Marketing and Administrative Expense.  Marketing and administrative expense increased by $141 million, or 46%, for fiscal year 2006 when compared with fiscal year 2005. The increase in marketing and administrative expense from fiscal year 2005 was primarily due to increases of $54 million in salaries and benefits resulting from

increased staffing levels and variable performance-based compensation, $24 million in stock-based compensation, $13 million in advertising and promotion, and $18 million in costs related to the Maxtor acquisition, including integration and retention costs and stock-based compensation.

 

Amortization of Intangibles.  Amortization of intangibles increased by $7 million due to intangibles acquired in the Maxtor acquisition.

 

Restructuring.  During fiscal year 2006, we recorded restructuring costs of approximately $4 million in connection with our ongoing restructuring activities. These costs were related to a restructuring plan established to continue the alignment of our global workforce with existing and anticipated business requirements in our Far East operations. The restructuring costs were comprised of employee termination costs relating to a continuing effort to optimize our production around the world. We have substantially completed these restructuring activities.

 

In connection with the Maxtor acquisition, we accrued certain exit costs aggregating $251 million, all of which increased goodwill and did not impact our operating results. See Note 10 of the Notes to Consolidated Financial Statements elsewhere in this report.

 

Net Other Income (Expense).  Net other income increased by $40 million for fiscal year 2006 when compared with fiscal year 2005. The change from fiscal year 2005 was primarily due to an increase in interest income of $33 million resulting from higher average interest rates and higher average balances in our interest bearing accounts and a decrease in interest expense of $7 million resulting from the pay off of a term loan in fiscal year 2006.

 

Income Taxes.  We recorded a provision for income taxes of $84 million for the fiscal year ended June 30, 2006 compared to a provision for income taxes of $25 million for the fiscal year ended July 1, 2005. We are a foreign holding company incorporated in the Cayman Islands with foreign and U.S. subsidiaries that operate in multiple taxing jurisdictions. As a result, our worldwide operating income is either subject to varying rates of tax or is exempt from tax due to tax holidays or tax incentive programs we operate under in China, Malaysia, Singapore, Switzerland and Thailand. These tax holidays or incentives are scheduled to expire in whole or in part at various dates through 2015. Our provision for income taxes recorded for the fiscal year ended June 30, 2006 differed from the provision for income taxes that would be derived by applying a notional U.S. 35% rate to income before income taxes primarily due to the net effect of (i) the tax benefit related to the aforementioned tax holidays and tax incentive programs, (ii) an increase in our valuation allowance for certain deferred tax assets, and (iii) utilization of research tax credits generated in the current year. Our provision for income taxes for the fiscal year ended July 1, 2005 differed from the provision for income taxes that would be derived by applying a notional U.S. 35% rate to income before income taxes primarily due to the net effect of (i) the tax benefit related to the aforementioned tax holidays and tax incentive programs, (ii) an increase in our valuation allowance for certain foreign deferred income tax assets, (iii) a tax benefit related to a reduction in previously accrued foreign income taxes, and (iv) utilization of research tax credits generated in that year. Based on our foreign ownership structure and subject to (i) potential future increases in our valuation allowance for deferred tax assets, (ii) limitations imposed by Internal Revenue Code Section 382 on usage of certain tax attributes (further described below), and (iii) use of tax attributes acquired from Maxtor and other acquisitions for which a valuation allowance has initially been recognized that, if reversed, will be reversed to goodwill, we anticipate that our effective tax rate in future periods will generally be less than the U.S. federal statutory rate. Dividend distributions received from our U.S. subsidiaries may be subject to U.S. withholding taxes when and if distributed. Deferred tax liabilities were not recorded on unremitted earnings of certain foreign subsidiaries, as these earnings will not be subject to tax in the Cayman Islands or U.S. federal income tax if remitted to our foreign parent holding company.

 

As of June 30, 2006, we had recorded net deferred tax assets of $78 million, the realization of which was primarily dependent on our ability to generate sufficient taxable income in fiscal years 2007 and 2008. Although realization is not assured, we believe that it is more likely than not that these deferred tax assets will be realized. The amount of deferred tax assets considered realizable, however, may increase or decrease in subsequent quarters, when we reevaluate our estimates of future taxable income.

 

Liquidity and Capital Resources

 

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

We had approximately $1.1 billion in cash, cash equivalents and short-term investments at June 29, 2007, which includes $988 million of cash and cash equivalents. Cash and cash equivalents increased by $78 million during fiscal year 2007. This increase in cash and cash equivalents during fiscal year 2007 was primarily attributable to net proceeds received from the issuance of long-term debt totaling approximately $1.5 billion, cash provided by operating activities and maturities and sales of short-term investments in excess of purchases of short-term investments, substantially offset by capital expenditures, the redemption of our 8% Notes, the repurchase of our common shares and the acquisition of EVault.

 

In September 2006, Seagate Technology HDD Holdings (“HDD”), our wholly-owned direct subsidiary issued senior notes totaling $1.5 billion comprised of $300 million aggregate principal amount of Floating Rate Senior Notes due October 2009 (the “2009 Notes”), $600 million aggregate principal amount of 6.375% Senior Notes due October 2011 (the “2011 Notes”) and $600 million aggregate principal amount of 6.800% Senior Notes due October 2016 (the “2016 Notes”). The notes are guaranteed by Seagate Technology on a full and unconditional basis.

 

Until required for other purposes, our cash and cash equivalents are maintained in highly liquid investments with remaining maturities of 90 days or less at the time of purchase. Our short-term investments consist primarily of readily marketable debt securities with remaining maturities of more than 90 days at the time of purchase.

 

Cash Provided by Operating Activities

 

Cash provided by operating activities for fiscal year 2007 was approximately $943 million and consisted primarily of net income adjusted for non-cash items including depreciation, amortization, stock-based compensation and tax benefits related to a change in our valuation allowance for deferred tax assets, combined with a decrease in accounts payable, variable performance-based compensation earned during fiscal year 2006 and paid in fiscal year 2007 and the payment of accrued exit costs and retention bonuses related to the Maxtor acquisition, partially offset by a reduction in inventories.

 

Cash provided by operating activities for fiscal year 2006 was approximately $1.5 billion and consisted primarily of net income adjusted for non-cash items including depreciation, amortization and stock-based compensation, combined with an increase in accounts receivable and inventories, partially offset by increases in accounts payable and accrued expenses.

 

Cash provided by operating activities for fiscal year 2005 was approximately $1.4 billion and consisted primarily of net income adjusted for non-cash items including depreciation and amortization, combined with an increase in accounts payable and accrued expenses offset by an increase in accounts receivable.

 

Cash Used in Investing Activities

 

During fiscal year 2007, we used $402 million for net cash investing activities, which was primarily attributable to expenditures for property, equipment and leasehold improvements of approximately $906 million and $178 million (net of cash acquired) for the acquisition of EVault, partially offset by $675 million of maturities and sales of short-term investments in excess of purchases of short-term investments. The approximately $906 million we invested in property, equipment and leasehold improvements was comprised of:

 

 

Net cash used in investing activities was approximately $561 million for fiscal year 2006 and was primarily attributable to expenditures for property, equipment and leasehold improvements partially offset by the maturities

and sales of short-term investments in excess of purchases thereof as well as net cash acquired from Maxtor. Specifically, during fiscal year 2006, we invested approximately $1.0 billion in property, equipment and leasehold improvements comprised of:

 

 

Net cash used in investing activities was approximately $1.1 billion for fiscal year 2005 and was primarily attributable to expenditures for property, equipment and leasehold improvements and the purchases of short-term investments in excess of maturities and sales thereof.

 

The increase in the investment in property, equipment and leasehold improvements during fiscal years 2007 and 2006 as compared with fiscal year 2005 was for increased capacity to support increased unit shipments and additional capacity for the ramp-up and production of Seagate-designed disc drive products to replace legacy Maxtor-designed products. For fiscal year 2008, we expect approximately $900 million in capital investment will be required to continue to proceed with our planned media and substrate capacity expansions in Asia and to align capacity additions with current levels of customer demand, while we continue to improve our utilization of capital equipment.

 

Cash Used in Financing Activities

 

Net cash used in financing activities of $463 million for fiscal year 2007 was primarily attributable to approximately $1.5 billion used for the repurchases of our common shares, $416 million used in the redemption of our 8% Notes and $212 million of dividends paid to our shareholders, largely offset by approximately $1.5 billion received from the issuance of long-term debt and $219 million cash provided by employee stock option exercises and employee stock purchases.

 

Net cash used in financing activities of $732 million for fiscal year 2006 was primarily attributable to $399 million used in the repurchases of common shares, the repayment of a $340 million term loan and $155 million of dividends paid to our shareholders, partially offset by $118 million cash provided by employee stock option exercises and employee stock purchases.

 

Net cash used in financing activities of $35 million for fiscal year 2005 was primarily attributable to dividends of $122 million paid to our shareholders and principal payments on our senior secured credit facilities offset by $90 million in cash provided by employee stock option exercises and employee stock purchases.

 

Liquidity Sources and Cash Requirements and Commitments

 

Our principal sources of liquidity as of June 29, 2007, consisted of: (1) approximately $1.1 billion in cash, cash equivalents, and short-term investments, (2) cash we expect to generate from operations and (3) a $500 million revolving credit facility.

 

Our $500 million revolving credit facility matures in September 2011. The $500 million revolving facility, which we entered into in September 2006, replaced our previous $100 million revolving credit facility. The $500 million revolving credit facility is available for cash borrowings and for the issuance of letters of credit up to a sub-limit of $100 million. Although no borrowings have been drawn under this revolving credit facility to date, we had utilized $47 million for outstanding letters of credit and bankers’ guarantees as of June 29, 2007, leaving $453 million for additional borrowings, subject to compliance with financial covenants and other customary conditions to borrowing.

The credit agreement that governs our revolving credit facility contains covenants that we must satisfy in order to remain in compliance with the agreement. This credit agreement contains three financial covenants: (1) minimum cash, cash equivalents and marketable securities; (2) a fixed charge coverage ratio; and (3) a net leverage ratio. As of June 29, 2007, we are in compliance with all covenants, including the financial ratios that we are required to maintain.

 

In October 2006, we used $416 million of the net proceeds from the September 2006 issuance of $1.5 billion debt to redeem the $400 million principal amount of our 8% Notes and pay a $16 million redemption premium.

 

Our principal liquidity requirements are primarily to meet our working capital, research and development, capital expenditure needs, and to service our debt. In addition, since the second half of fiscal year 2002 and through the June 2007 quarter, we have paid dividends to our shareholders.

 

On September 1, 2006, November 17, 2006, February 16, 2007 and May 18, 2007, we paid dividends aggregating approximately $212 million, or $0.38 per share, to our common shareholders of record as of August 18, 2006, November 3, 2006, February 2, 2007 and May 4, 2007. On July 19, 2007, we declared a quarterly dividend of $0.10 per share that will be paid on or before August 17, 2007 to our common shareholders of record as of August 3, 2007. In deciding whether or not to declare quarterly dividends, our directors will take into account such factors as general business conditions within the disc drive industry, our financial results, our capital requirements, contractual and legal restrictions on the payment of dividends by our subsidiaries to us or by us to our shareholders, the impact of paying dividends on our credit ratings and such other factors as our board of directors may deem relevant.

 

Because we had current earnings and profits in excess of distributions for our taxable year ended June 29, 2007, distributions on our common shares to U.S. shareholders during this period were treated as dividend income for U.S. federal income tax purposes. We anticipate that we will have earnings and profits in excess of distributions in fiscal year 2008. Therefore, distributions to U.S. shareholders in fiscal year 2008 are anticipated to be treated as dividend income for U.S. federal income tax purposes. Non-U.S. shareholders should consult with a tax advisor to determine appropriate tax treatment.

 

As a result of the acquisition of Maxtor, we assumed all of Maxtor’s outstanding debts, including, without limitation, its outstanding convertible senior notes. Maxtor’s 2.375% Convertible Senior Notes due August 2012 (the “2.375% Notes), of which $326 million were outstanding as of June 29, 2007, contain a cash conversion feature that will require Seagate to deliver the holders, upon any conversion of these notes, cash in an amount equal to the lesser of (a) the principal amount of the notes converted and (b) the as-converted value of the notes. To the extent holders of the Maxtor notes choose to convert their notes, Seagate will require additional amounts of cash to meet this obligation. The payment of dividends to holders of our common shares may in certain future quarters result in upward adjustments to the conversion rate of the 2.375% Notes.

 

On January 26, 2007, we completed our acquisition of EVault, a privately held provider of online backup services in an all cash transaction valued at approximately $178 million (net of cash acquired).

 

On August 8, 2006, we announced that our board of directors had authorized the use of up to $2.5 billion for the repurchase of our outstanding common shares over a two-year period. From the authorization of this repurchase program and through the fiscal year ended June 29, 2007, we repurchased approximately 62.0 million shares at an average price of $24.62, all of which were considered cancelled and are no longer outstanding. We repurchased these shares through a combination of open market purchases and prepaid forward agreements with large financial institutions, according to which we prepaid the financial institutions a fixed amount to deliver a variable number of shares at future dates. We entered into these agreements in order to take advantage of repurchasing shares at a guaranteed discount to the Volume Weighted Average Price (“VWAP”) of our common shares. Our policy to date has been to enter into such transactions only when the discount that we receive is higher than the foregone return on our cash prepayment to the financial institution. There were no explicit commissions or fees on these prepaid forward agreements. Under the terms of these agreements, there was no requirement for the financial institutions to return any portion of the prepayment to us. These prepaid forward agreements were not derivatives because the Company had prepaid all amounts and had no remaining obligation. The agreements do not contain an embedded derivative. The prepayments were recorded as a reduction to shareholders’ equity when paid and the shares were

deducted from shares outstanding. The agreements require the physical delivery of shares; there were no settlement alternatives, except in the case of certain defined extraordinary events which are outside the control of Seagate and the financial institutions. The parameters used to calculate the final number of shares deliverable are the total notional amount of the contract and the average VWAP of our common shares during the contract period less the agreed upon discount. The contracts are indexed solely to the price of Seagate’s common shares.

 

During fiscal year 2007, we repurchased 24.3 million shares through open market repurchases. In addition, we made payments totaling $950 million under prepaid forward agreements and took delivery of 37.7 million shares using prepaid forward agreements. Shares physically delivered to us were cancelled and are no longer outstanding. At June 29, 2007, there were no outstanding prepaid forward agreements to repurchase our common shares.

 

During the fourth quarter of fiscal year 2006, we repurchased 16.7 million shares under a previously authorized stock repurchase program. The program authorizing repurchases in the fourth quarter of fiscal year 2006 was completed and there is no outstanding authority for further shares to be purchased under that program.

 

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

 

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

 

Contractual Obligations and Commitments

 

Our contractual cash obligations and commitments as of June 29, 2007 have been summarized in the table below (in millions):

 

 

 

 

 

Off-Balance Sheet Arrangements

 

As of June 29, 2007, we did not have any material off-balance sheet arrangements (as defined in Item 303(a)(4)(ii) of Regulation S-K).

 

Critical Accounting Policies

 

The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our consolidated financial statements. The SEC has defined the most critical accounting policies as the ones that are most important to the portrayal of our financial condition and operating results, and require us to make our 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, our 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. Below, we discuss these policies further, as well as the estimates and judgments involved. We also have other key accounting policies and accounting estimates relating to uncollectible customer accounts, valuation of inventory, valuation of share-based payments and acquisition related restructuring. We believe that these other accounting policies and accounting estimates either do not generally require us 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 our reported results of operations for a given period.

 

Establishment of Sales Program Accruals.  We establish certain distributor and OEM sales programs aimed at increasing customer demand. For the distribution channel, these programs typically involve rebates related to a distributor’s level of sales, order size, advertising or point of sale activity and price protection adjustments. For OEM sales, rebates are typically based on an OEM customer’s volume of purchases from Seagate or other agreed upon rebate programs. We provide for these obligations at the time that revenue is recorded based on estimated requirements. We estimate these contra-revenue rebates and adjustments based on various factors, including price reductions during the period reported, estimated future price erosion, customer orders, distributor sell-through and inventory levels, program participation, customer claim submittals and sales returns. Our estimates reflect contractual arrangements but also our judgment relating to variables such as customer claim rates and attainment of program goals, and inventory and sell-through levels reported by our distribution customers.

 

While we believe we have sufficient experience and knowledge of the market and customer buying patterns to reasonably estimate such rebates and adjustments, actual market conditions or customer behavior could differ from our expectations. As a result, actual payments under these programs, which may spread over several months after the related sale, may vary from the amount accrued. Accordingly, revenues and margins in the period in which the adjustment occurs may be affected. For example, if the pricing environment is more favorable than we anticipated, as it was in the quarter ended December 2006, accruals for forward price protection may be higher than needed. Conversely, in the more severely price-competitive second half of fiscal year 2007, utilization of special price adjustments was higher than expected. In addition, during periods in which our distributors’ inventories of our products are at higher than historical levels, our contra-revenue estimates are subject to a greater degree of subjectivity and the potential for actual results to vary is accordingly higher. Currently, our distributors’ inventories are within the historical range.

 

Significant actual variations in any of the factors upon which we base our contra-revenue estimates could have a material effect on our operating results. Since fiscal year 2005, total sales programs have ranged from 5% to 9% of gross revenues. Due to the competitive pricing environment in our industry, sales programs as a percentage of gross revenue may increase from the current range. If such rebates and incentives trend upwards, revenues and margins will be reduced. Adjustments to revenues due to under or over accruals for sales programs related to revenues reported in prior periods have averaged 0.3% of quarterly gross revenue throughout fiscal years 2006 and 2007.

In addition, our failure to accurately predict the level of future sales returns by our distribution customers could have a material impact on our financial condition and results of operations.

 

Establishment of Warranty Accruals.  We estimate probable product warranty costs at the time revenue is recognized. We generally warrant our products for a period of one to five years. Our warranty provision considers estimated product failure rates and trends (including the timing of product returns during the warranty periods), estimated repair or replacement costs and estimated costs for customer compensatory claims related to product quality issues, if any. We use a statistical model to help with our estimates and we exercise considerable judgment in determining the underlying estimates. Should actual experience in any future period differ significantly from our estimates, or should the rate of future product technological advancements fail to keep pace with the past, our future results of operations could be materially affected. Our judgment is subject to a greater degree of subjectivity with respect to newly introduced products and legacy Maxtor designed products because of limited experience with those products upon which to base our warranty estimates. We continually introduce new products and have recently begun a shift to disc drive products that utilize perpendicular recording technology.

 

The actual results with regard to warranty expenditures could have a material adverse effect on our results of operations if the actual rate of unit failure, the cost to repair a unit, or the actual cost required to satisfy customer compensatory claims are greater than that which we have used in estimating the warranty accrual. Since we typically outsource our warranty repairs, our repair cost is subject to periodic negotiations with vendors and may vary from our estimates. We also exercise judgment in estimating our ability to sell certain repaired disc drives. To the extent such sales fall below our forecast, warranty cost will be adversely impacted.

 

Our warranty cost has ranged from approximately 2 to 3% of revenue over the last three years. We review our warranty accrual quarterly for products shipped in prior periods and which are still under warranty. Any changes in the estimates underlying the accrual may result in adjustments that will impact the current period gross margins and income. Re-estimates of prior warranty accruals have been approximately 1% of revenue or less in fiscal years 2005, 2006 and 2007. Higher than anticipated failures of specific products (as we had in fiscal years 2004 and 2005) and significant increases in repair or replacement costs driven by reduced sales for refurbished products (as during the fiscal years 2006 and 2007) have historically been the major reasons for significant re-estimates.

 

Valuation of Deferred Tax Assets.  The recording of our deferred tax assets each period depends primarily on our ability to generate current and future taxable income in the United States and certain foreign jurisdictions. Each period we evaluate the need for a valuation allowance for our deferred tax assets and we adjust the valuation allowance so that we record net deferred tax assets only to the extent that we conclude it is more likely than not that these deferred tax assets will be realized. Significant decreases in projections of taxable income, particularly in the United States, would likely result in significant increases in our valuation allowance which in turn could adversely impact our effective tax rate. With the acquisition of Maxtor, the realizability of U.S. deferred tax assets was determined on a consolidated return basis. As a result, Maxtor’s deferred tax assets that were determined to be realizable were recorded as a reduction of goodwill and Seagate deferred tax assets that were determined to be no longer realizable were written off with a charge to income tax expense at the date of acquisition.

 

Valuation of Intangible Assets and Goodwill.  In accordance with the provisions of SFAS No. 141, Business Combinations (“SFAS No. 141”), the purchase price of an acquired company is allocated between tangible and intangible assets acquired and liabilities assumed from the acquired business based on their estimated fair values, with the residual of the purchase price recorded as goodwill. We engage third-party appraisal firms to assist management in determining the fair values of certain assets acquired and liabilities assumed. Such valuations require management to make significant judgments, estimates and assumptions, especially with respect to intangible assets. Management makes estimates of fair value based upon assumptions we believe to be reasonable. These estimates are based on historical experience and information obtained from the management of the acquired companies, and are inherently uncertain. Critical estimates in valuing certain of the intangible assets include but are not limited to: future expected cash flows from existing technology, customer relationships, trade names, and other intangible assets; the acquired company’s brand awareness and market position, as well as assumptions about the period of time the acquired brand will continue to be used in the combined company’s product portfolio; and discount rates. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results.

We are required to periodically evaluate the carrying values of our intangible assets for impairment. If any of our intangible assets are determined to be impaired, we may have to write down the impaired asset and our earnings would be adversely impacted in the period that occurs.

 

At June 29, 2007, our goodwill totaled approximately $2.3 billion and our identifiable other intangible assets totaled $188 million. In accordance with the provisions of SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”), we assess the impairment of goodwill at least annually, or more often if warranted by events or changes in circumstances indicating that the carrying value may exceed its fair value. This assessment may require the projection and discounting of cash flows, analysis of our market capitalization and estimating the fair values of tangible and intangible assets and liabilities. Estimates of cash flow are based upon, among other things, certain assumptions about expected future operating performance; judgment is also exercised in determining an appropriate discount rate. Our estimates of discounted cash flows may differ from actual cash flows due to, among other things, economic conditions, changes to the business model, or changes in operating performance. Significant differences between these estimates and actual cash flows could materially affect our future financial results.

 

Recent Accounting Pronouncements

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115 (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating the impact that the adoption of SFAS No. 159 will have on our consolidated results of operations and financial condition.

 

In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — An Amendment of FASB No. 87, 88, 106 and 132(R) (“SFAS No. 158”). SFAS No. 158 requires that the funded status of defined benefit postretirement plans be recognized on a company’s balance sheet, and changes in the funded status be reflected in comprehensive income, effective fiscal years ending after December 15, 2006, which we adopted in our fiscal year ended June 29, 2007 and did not have a material impact on our consolidated results of operations or financial condition. SFAS No. 158 also requires companies to measure the funded status of the plan as of the date of its fiscal year-end, effective for fiscal years ending after December 15, 2008. We expect to adopt the measurement provisions of SFAS No. 158 in our fiscal year 2010, effective June 30, 2009. We do not expect the adoption of SFAS No. 158 to have a material impact on our consolidated results of operations or financial condition.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”) which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. However, for some entities, the application of this Statement will change current practice. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating the effect that the adoption of SFAS No. 157 will have on our consolidated results of operations and financial condition.

 

In June 2006, the FASB issued FASB Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109 (“FIN No. 48”). This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation is effective for fiscal years beginning after December 15, 2006 and will be adopted by us in the first quarter of fiscal year 2008. We are currently evaluating the effect that the adoption of FIN No. 48 will have on our consolidated results of operations and financial condition.

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments (“SFAS No. 155”), which amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”), and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“SFAS No. 140”). SFAS No. 155 simplifies the accounting for certain derivatives embedded in other financial instruments by allowing them to be accounted for as a whole if the holder elects to account for the entire instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140. SFAS No. 155 is effective for all financial instruments acquired, issued, or subject to a remeasurement event occurring in fiscal years beginning after September 15, 2006. Earlier adoption is permitted, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. We do not expect the adoption of SFAS No. 155 to have a material impact on our consolidated financial position, results of operations, or cash flows.

 

In July 2007, the FASB agreed to issue for comment a proposed FASB Staff Position (FSP) addressing convertible instruments that may be settled in cash upon conversion, including those that may require partial cash settlement. The proposed FSP would require the issuer to separately account for the liability and equity components of the instrument in a manner that reflects the issuer’s economics interests. The proposed FSP would require bifurcation of a component of the debt, classification of that component in equity, with the accretion of the discount on the debt resulting in the “economic interest cost” being reflected in the statement of operations through higher interest expense. The proposed FSP if issued would be effective for fiscal years beginning after December 15, 2007, and would be applied retrospectively to all periods presented pursuant to the guidance of SFAS No. 154, Accounting Changes and Error Corrections (“SFAS No. 154”). Our accounting for the 2.375% Notes acquired from Maxtor and therefore our financial position and results of operations may be impacted by the proposed FSP. We will evaluate the impact of the final FSP on our financial position and results of operations when issued.

 

Interest Rate Risk.  Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio and long-term debt. We currently do not use derivative financial instruments in either our investment portfolio or to hedge debt.

 

As stated in our investment policy, we are averse to principal loss and ensure the safety and preservation of our invested funds by limiting default risk and market risk. We mitigate default risk by maintaining portfolio investments in diversified, high-quality investment grade securities with limited time to maturity. We constantly monitor our investment portfolio and position our portfolio to respond appropriately to a reduction in credit rating of any investment issuer, guarantor or depository. We maintain a highly liquid portfolio by investing only in marketable securities with active secondary or resale markets.

 

We have both fixed and variable rate debt obligations. We enter into debt obligations to support general corporate purposes including capital expenditures and working capital needs. We currently do not use interest rate derivatives to hedge our interest rate exposure.

 

At June 29, 2007, we had $23 million in marketable securities that had been in a continuous unrealized loss position for a period greater than twelve months. The unrealized loss on these marketable securities was immaterial.

 

The table below presents principal (or notional) amounts and related weighted average interest rates by year of maturity for our investment portfolio and debt obligations as of June 29, 2007. All investments mature in three years or less. Included in long term debt for fiscal year 2008, is the principal amount of $326 million related to our 2.375% Notes which is payable upon the conversion of the 2.375% Notes, which are currently convertible as the Company’s share price was in excess of 110% of the conversion price for at least 20 consecutive trading days during the last 30 trading days of the fourth quarter of fiscal year 2007. Unless earlier converted, the 2.375% Notes must be redeemed in August 2012.

 

 

Foreign Currency Exchange Risk.  We transact business in various foreign countries. Our primary foreign currency cash flows are in countries where we have a manufacturing presence. We have established a foreign currency hedging program to protect against the increase in value of foreign currency cash flows resulting from operating and capital expenditures over the next year. We hedge portions of our forecasted expenses denominated in foreign currencies with forward exchange contracts. When the U.S. dollar weakens significantly against the foreign currencies, the increase in the value of the future foreign currency expenditure is offset by gains in the value of the forward contracts designated as hedges. Conversely, as the U.S. dollar strengthens, the decrease in value of the future foreign currency cash flows is offset by losses in the value of the forward contracts. These forward foreign exchange contracts, carried at fair value, may have maturities of up to twelve months. Additionally, in the fourth quarter of fiscal year 2007, we entered into forward contracts to hedge the capital expense costs associated with a new manufacturing facility under construction in Malaysia.

 

We evaluate hedging effectiveness prospectively and retrospectively and record any ineffective portion of the hedging instruments in other income (expense) on the statement of operations. We did not have any net gains (losses) recognized in other income (expense) for cash flow hedges due to hedge ineffectiveness in fiscal years 2007, 2006 and 2005.

 

As of June 29, 2007, our notional fair values of foreign exchange forward contracts totaled $148 million. We do not believe that these derivatives present significant credit risks, because the counterparties to the derivatives consist of major financial institutions, and we manage the notional amount of contracts entered into with any one counterparty. We maintain limits on maximum tenor of contracts based on the credit rating of the financial institutions. We do not enter derivative financial instruments for speculative or trading purposes. The table below provides information as of June 29, 2007 about our derivative financial instruments, comprised of foreign currency forward exchange contracts. The table is provided in U.S. dollar equivalent amounts and presents the notional amounts (at the contract exchange rates) and the weighted average contractual foreign currency exchange rates.

 

 

SEAGATE TECHNOLOGY

 

CONSOLIDATED BALANCE SHEETS

 

 

See notes to consolidated financial statements.

SEAGATE TECHNOLOGY

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

See notes to consolidated financial statements.

SEAGATE TECHNOLOGY

 

CONSOLIDATED STATEMENTS OF CASH FLOWS