Capital Commitments

The following is a Fundamental Change (as defined in the Debenture documents), at the issue price plus accrued original issue discount to the date of redemption. The payment on those dates, with the exception of a Fundamental Change, can be in cash, stock or any combination, at the Company’s option. The Debentures are convertible into sharessummary of the Company’s common stocksignificant contractual cash obligations and commercial commitments at the rate of 14.935 shares per $1,000 principal amount at maturity. Since issuance of the Debentures in 1998, the Company has redeemed Debentures with a book value of $435.9 million and an aggregate principal amount at maturity of $1.1 billion through the issuance of cash and/ or common stock. These redemptions were private, individually negotiated transactions with certain institutional investors. As of June 28, 2002, the remaining book value of the Debentures was $86.2 million, the aggregate principal amount at maturity was $193.5 million and the market value was $83.0 million. Based on current forecasts that show the Company continuing to generate positive cash flow from operations, the Company now intends to satisfy the majority, if not all, of its put obligations in cash instead of common stock. Accordingly, the Debentures have been classified as a current liability at June 28, 2002. Debentures not put to the Company in February 2003, if any, will be reclassified as long-term debt.July 2, 2004 (in millions):

     During 2001,On September 19, 2003, the Company entered into a three-year new $125 million five-year credit facility (“Senior Credit Facility,Facility”) replacing a previousthe facility that had matured on March 31, 2000.September 20, 2003. The new Senior Credit Facility provides up to $125$75 million in revolving credit (subject to outstanding letters of credit and a borrowing base calculation), matures in revolving credit and a term loan of $50 million. Both the term loan and revolving credit facility mature on September 20, 200319, 2008, and isare secured by the Company’s accounts receivable, inventory, 65% of theits stock in its foreign subsidiaries and other assets. At the option of the Company, borrowings bear interest at either LIBOR (with option periods of one to three months) or a base rate, plus a margin determined by the borrowing base.margin. The Senior Credit Facility requires the Company to maintain certain amountslevels of tangible net worth,income, prohibits the payment of cash dividends on common stock, and contains a number of other covenants. AsThe Company was in compliance with all such covenants at July 2, 2004. The $50 million term loan was funded on September 22, 2003 and requires quarterly principal payments of $3 million beginning in October 2004. The Company used the proceeds from the term loan to repay obligations incurred as a result of the date hereof,Read-Rite asset acquisition (see Note 3, “Read-Rite Asset Acquisition” included in the Company’s Consolidated Financial Statements). At July 2, 2004 there were no borrowings under the facility. However,revolving credit facility and $71 million was available.

In the normal course of business to reduce the risk of component shortages, the Company enters into purchase orders with suppliers for the purchase of hard disk drive components used to manufacture the Company’s products. These purchase orders generally cover forecasted component supplies needed for production during the next quarter, become payable upon receipt of the components, and generally may be changed or canceled at any time prior to shipment of the components. In some cases we may be obligated to pay for certain costs related to changes to, or cancellation of, a purchase order, such as costs incurred for raw materials or work in process. The Company has issued a $25 million standby letterentered into long-term purchase agreements for components with certain vendors such as Komag, IBM, and Marvell. Future purchases under these agreements are not fixed and determinable as they depend on the Company’s overall unit volume requirements and are contingent upon the prices, technology and quality of creditthe supplier’s products remaining competitive. These arrangements are not included under “Purchase Obligations” in the table above. See below under the facilityheading “Risk Factors That May Affect Future Results” for a discussion of these commitments.

The Company purchases short-term, forward exchange contracts to Cirrus Logic, Inc. (“Cirrus”) concerning $25 millionhedge the impact of foreign currency fluctuations on certain underlying assets, liabilities and commitments for operating expenses and product costs denominated in disputed accounts payable. These disputed accounts payable have been recorded inforeign currencies. See Part II, Item 7A, under the heading “Disclosure About Foreign Currency Risk,” for the Company’s financial statements, butcurrent forward exchange contract commitments.

     The Company announced a stock repurchase program on May 5, 2004. Under the program, the Company may purchase on the open market up to $100 million of its common stock depending on market conditions and other

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     At June 28, 2002, the Company had cash and cash equivalents of $223.7 million, working capital of $34.8 million (net of the Debentures) and shareholders’ equity of $102.9 million. In addition, the Company has a Senior Credit Facility providing up to $125 million in revolving credit (subject to outstanding letters of credit and a borrowing base calculation).     The Company believes its current cash and cash equivalents and its existing credit facility will be sufficient to meet its working capital needs through the foreseeable future. There can be no assurance that the Senior Credit Facility or lease financing will continue to be available to the Company. Also, the Company’s ability to sustain its working capital position is dependent upon a number of factors that are discussed below under the headingsheading “Risk factors related to the hard drive industry in which we operate” and “Risk factors relating to Western Digital particularly.Factors That May Affect Future Results.”

Commitments

     The following is a summary of the Company’s significant contractual cash obligations and commercial commitments at June 28, 2002:

     Convertible Debentures

The Company has zero coupon convertible subordinated debentures due February 18, 2018 (the “Debentures”). For a descriptioncurrently anticipates that it will continue to utilize its liquidity and cash flows to improve the efficiency and capability of the Debentures, see the discussion under “Liquidityits existing hard disk drive and Capital Resources”.

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     Operating Leases

The Company leases certain facilities and equipment under long-term, non-cancelable operating leases which expire at various dates through 2010. The following table summarizes the future payments of these leases (in thousands):

     Purchase Orders

     In the normal course of business, to reduce the risk of component shortages, the Company enters into purchase commitments with suppliers for the purchase of hard drive components used to manufacture the Company’s products. These commitments generally cover forecasted component supplies needed for production during the next quarter, become payable upon receipt of the components and may be non-cancelable (cancellation charges may be significant). The Company’s relationship with suppliers allows for some flexibility within these commitments and quantities are subject to change as a quarter progresses and the Company’s needs change.

     Forward Exchange Contracts

     Although the majority of the Company’s transactions are in U.S. Dollars, some transactions are based in various foreign currencies. The Company purchases short-term, forward exchange contracts to hedge the impact of foreign currency fluctuations on certain underlying assets, liabilities and commitments for operating expenses denominated in foreign currencies. The Company does not purchase short-term forward exchange contracts for trading purposes. As of June 28, 2002, the Company had $5.0 million outstanding of purchased foreign currency forward exchange contracts. The contracts have maturity dates that do not exceed three months. At June 28, 2002, the carrying value of the contracts approximates fair value.head manufacturing operations.

Critical Accounting Policies

     The preceding discussion and analysis ofCompany has prepared the Company’s results of operations is based on itsaccompanying consolidated financial statements which have been prepared in accordanceconformity with GAAP.accounting principles generally accepted in the United States. The preparation of the financial statements requires estimationthe use of judgment and judgmentestimates that affect the reported amounts of revenues, expenses, assets and liabilities. The Company has adopted accounting policies and practices that are generally accepted in the industry in which it operates. FollowingThe Company believes the following are the Company’sits most critical accounting policies that affect significant areas and involve management’s judgment and estimates. If these estimates differ materiallysignificantly from actual results, the impact to the consolidated financial statements may be material.

     In accordance with standard industry practice, the Company has agreements with resellers that provide price protection for inventories held by resellers at the time of published list price reductions. In addition, the Company may have agreements with resellers that provide for stock rotation on slow-moving items and other incentive programs. In accordance with current accounting standards, the Company recognizes revenue upon shipment or delivery to resellers and records a corresponding adjustmentreduction to revenue for estimated price protection and other programs in effect until the resellers sell such inventory to their customers. Adjustments are based on

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     The Company establishes an allowance for doubtful accounts by analyzing specific customer accounts and assessing the risk of uncollectibilityloss based on insolvency, disputes or other collection issues. In addition, the Company routinely analyzes the different receivable aging categories and its bad debt loss history and establishes reserves based on a combination of past due receivables and expected future losses. If the lengthfinancial condition of time receivables are past due.a significant customer deteriorates resulting in their inability to pay their accounts when due, an increase in the Company’s allowance for doubtful accounts would be required, which could negatively affect operating results.

     The Company records provisions against revenue and cost of revenuesrevenue for estimated sales returns in the same period that the related revenues arerevenue is recognized. The Company bases these provisions on existing product return notifications as well as historical returns by product type (see “Warranty”).

If actual sales returns exceed expectations, an increase in the sales return provision would be required, which could negatively affect operating results.

     The Company records an accrual for estimated warranty costs when revenue is recognized. Warranty covers costcosts of repair or replacement of the hard disk drive andover the warranty periods rangeperiod, which generally ranges from one to threefive years. The Company has comprehensive processes with which to estimate accruals for warranty, which include specific detail on hard disk drives in the field by product type, historical field return rates and costs to repair. If actual product return rates or costs to repair returned products increase above expectations, an increase in the warranty provision would be required, which could negatively affect operating results.

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     Inventories are valued at the lower of cost (first-in, first-out basis) or net realizable value. Inventory write-downs are recorded for the valuation of inventory at the lower of cost or net realizable value by analyzing market conditions and estimates of future sales prices as compared to inventory costs and inventory balances.

     The Company evaluates inventory balances for excess quantities and obsolescence on a regular basis by analyzing backlog, estimated demand, inventory on hand, sales levels and other information. The Companyinformation, and writes down inventory balances for excess and obsolete inventory based on the analysis.

Unanticipated changes in technology or customer demand could result in a decrease in demand for one or more of the Company’s products, which may require an increase in inventory write-downs that could negatively affect operating results.

     The Company applies Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies”Contingencies,” to determine when and how much to accrue for and disclose related to legal and other contingencies. Accordingly, the Company accrues loss contingencies when management, in consultation with its legal advisors, concludes that a loss is probable and reasonably estimable.

(Refer to Part II, Item 8, Notes to Consolidated Financial Statements, Note 6 “Legal Proceedings” included in this Annual Report on Form 10-K). The ability to predict the ultimate outcome of such matters involves judgments, estimates and inherent uncertainties. The actual outcome of such matters could differ materially from management’s estimates.

     The Company’s deferred tax assets, which consist primarily of net operating loss and tax credit carryforwards, are fully reserved due to management’s determination that it is “moremore likely than not”not that these assets will not be realized. This determination is based on the weight of available evidence, the most significant of which is the Company’s loss history in the related tax jurisdictions. Should this determination change in the future, some amount of deferred tax assets could be recognized, resulting in a tax benefit or a reduction of future tax expense.

New Accounting PronouncementsRisk Factors That May Affect Future Results

     During April 2002,The hard disk drive industry has experienced declining ASP’s. Although the FASB issued Statementrate of Financial Accounting Standards No. 145, “Rescissiondecline has moderated in recent years, there can be no assurance that this trend will continue. In fact, during the fourth quarter of FASB Statements No. 4, 44,2004, ASPs decreased significantly. Increases in areal density mean that the average drive we sell has fewer heads and 64, Amendment of FASB Statement No. 13,disks for the same capacity and, Technical Corrections” (“SFAS 145”). SFAS 145 rescinds SFAS 4, “Reporting Gains and Losses from Extinguishment of Debt”, which required all gains and losses from extinguishment of debt to be classified as an extraordinary item. The Company will adopt SFAS 145 on June 29, 2002 at which time it will begin classifying gains and losses resulting from the extinguishment of debt as other income and expense, instead of extraordinary items. The adoption will not havetherefore, a net impact on the Company’s results of operations or liquidity.

     On September 11, 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 02-15, “Determining Whether Certain Conversions of Convertible Debt to Equity Securities are within

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Risk factors related to the hard disk drive industry, lower costs generally mean lower prices. This is true even for those products that are competitive and introduced into the market in which we operatea timely manner. Our ASPs decline even further when competitors lower prices as a result of decreased costs or to absorb excess capacity, liquidate excess inventories, restructure or attempt to gain market share.

     To achieve consistent success with computerour customers who manufacturer customers,computers, systems and consumer electronic devices, we must be an early provider of next generation hard drives featuring leading technologybalance several key attributes: time-to-market, time-to-volume, quality, cost, service, price and high quality.a broad product portfolio. If we fail to:

	•	consistently maintain or improve our time-to-market performance with ouroverall quality of products on new and established programs,
	•	maintain competitive cost structures on new and established products,
	•	produce thesesufficient quantities of products in sufficient volume withinat the capacities our rapid product cycle,customers demand while managing the integration of new and established technologies,
	•	develop and qualify new products that have changes in overall specifications or features that our customers may require for their business needs,

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	•	qualify these products with key customers on a timely basis by meeting all of our customers’ needs for performance, quality and quality specifications,
	•	achieve acceptable manufacturing yields and costs with these products,features, or
	•	consistently meet stated quality requirements on delivered products,

our operating results would be adversely affected.

     New products in the desktop hard disk drive market may require higher areal densities (the gigabyte of storage per disk) than previous product generations, posing formidable technical and manufacturing challenges. Higher areal densities require fewer heads and disks to achieve a given drive capacity, which means that existing head technology mustto be improved or new technology developed to accommodate more data on a single disk. In addition, our introduction of new products during a technology transition increases the likelihood of unexpected quality concerns. Our failure to bring thesehigh quality new products to market on time and at acceptable costs wouldmay put us at a competitive disadvantage to companies that achieve these results. In addition, technology improvements may require us to reduce the price on existing products to remain competitive.

     OverThe rate of increase in areal density may be greater than the past few years,increase in our customers’ demand for aggregate storage capacity. This could lead to our customers’ storage capacity needs being satisfied with more lower-cost single-surface drives, thereby decreasing our revenue. As a result, even with increasing aggregate demand for storage capacity, our ASPs could decline, which could adversely affect our results of operations.

Product life cycles have been extending since the middle of calendar year 2002 due in large part to a decrease in the rate of hard disk drive areal density has increased at a much more rapid pace than previously experienced. This has significantly shortenedgrowth. However, there can be no assurance that this trend will continue. If longer product life cycles since each generationcontinue, we may need to develop new technologies or programs to reduce our costs on any particular product in order to maintain competitive pricing for such product. This may result in an increase in our overall expenses and a decrease in our gross margins, both of drives is more cost effective than the previous one. Shorterwhich could adversely affect our operating results. If product life cycles makeshorten, it may be more difficult to recover the cost of product development.development before the product becomes obsolete. Although we believe that the current rate of growth in areal density is lower than in the past several years and will continue to decrease in the near term, we expect that areal density will continue to increase. Our failure to recover the cost of product development in the future could adversely affect our operating results.

     Due to short product life cycles and continuously changing products, we mustWe regularly engage in new product qualification with our customers. To be considered for qualification, we must be among the leaders in time-to-market with our new products. Once a product is accepted for qualification testing, any failurefailures or

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     If one of our competitors were able to implement a significant advance in head or hard disk drive technology that enables a “step-change” increase in areal density that permits greater storage of data on a disk, it could put us at a competitive disadvantage and harm our operating results.

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     Advances in magnetic, optical, semiconductor or other data storage technologies could result in competitive products that have better performance or lower cost per unit of capacity than our products. If these products prove to be superior in performance or cost per unit of capacity, we could be at a competitive disadvantage to the companies offering those products.

     We expect that our average selling prices for hard drives will continue to decline. Increases in areal density mean that the average drive we sell has fewer heads and disks, and therefore lower component cost. Because of the competitiveness ofCurrently the hard disk drive industry loweruses giant magnetoresistive head technology, which allows significantly higher storage capacities than the previously utilized thin-film head technology. However, the industry is developing new recording technologies that may enable greater recording densities than currently available using magnetoresistive head technology, including perpendicular, current perpendicular-to-plane, and tunneling junction technology. If the industry experiences a fundamental shift in recording technology, hard disk drive manufacturers would need to timely adjust their designs and processes to accommodate the new technology in order to remain competitive. As a result, we could incur substantial costs generally mean lower prices. This is true even for those productsin developing new technologies, media, and tools to remain competitive. We may also become more dependent on suppliers to ensure our access to components that are competitive and introduced intoaccommodate the market in a timely manner. Our average selling prices decline even further when competitors lower prices to absorb excess capacity, liquidate excess inventories, restructure or attempt to gain market share.new technology. These results would increase our operating costs, which may negatively impact our operating results.

     The price of hard disk drives has fallen over time due to increases in supply, cost reductions, technological advances and price reductions by competitors seeking to liquidate excess inventories or attempting to gain market share. In addition, rapid technological changes often reduce the volume and profitability of sales of existing products and increase the risk of inventory obsolescence. These factors, taken together, result in significant and rapid shifts in market share among the industry’s major participants. For example, during the first quarterIn addition, product recalls can lead to a loss of 2000, the Company lost market share, as a result of a product recall. Similar losses in market sharewhich could adversely affect our operating results.

     Demand for our hard disk drives depends on the demand for systems manufactured by our customers and on storage upgrades to existing systems. The demand for systems has been volatile in the past and often has had an exaggerated effect on the demand for hard disk drives in any given period. As a result, the hard disk drive market tends to experiencehas experienced periods of excess capacity, which typically leadhas led to intense price competition. During calendar year 2001 and the first half of calendar year 2002, the industry experienced weak PC demand in the U.S. and other markets. If intense price competition occurs, as a result of weak demand, we may be forced to lower prices sooner and more than expected, which could result in lower revenuesrevenue and gross profits.margins.

     Over the past few years the consumer market for desktop computers has shifted significantly towards lower priced systems, especially thosesystems. According to data released by TrendFOCUS in November 2003, systems priced below $1,000. Although we were late to market with a value line hard drive to serve$600 comprised the low-cost PC market, we are now offering such value line products at prices that we view as competitive. However, iffastest growing segment of the desktop computer market. If we are not able to continue to offer a competitively priced value line hard disk drive for the low-cost PC market, our share of that market will likely fall, which could harm our operating results.

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The PC market for hard disk drives is also fragmenting into a variety of computing devices and products. Some of these products, such as Internet appliances, may not contain a hard drive. On the other hand, manyMany industry analysts expect, as do we, that as broadcasting and communications are increasingly converted to digital technology from the older, analog technology, the technology of computers and consumer electronics and communication devices will continue to converge, and hard disk drives will be found in many consumer products other than computers. For 2002, more than 10%example, although general market acceptance remains in its early stages, the use of hard disk drives has expanded into the game console market. Microsoft and Sony currently incorporate a hard disk drive into their video game systems. However, there can be no assurance that these companies will continue incorporating a hard disk drive into their game consoles, or that the market for these products will grow.

     In addition, we expect that the consumer market for audio-video products incorporating a hard disk drive will continue to grow. However, because this market remains relatively new, although overall growth has been strong, accurate forecasts for future growth remain challenging. Moreover, some of the devices, such as personal video recorders and digital video recorders, may require attributes not currently offered in our unit sales were for consumer products, other than computers, primarily gaming devices.which may result in a need to expend capital, increasing our overall operational expense. If we are not successful in using our hard disk drive technology and

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     The useTo remain a significant supplier of hard disk drives, in the game console market iswe will need to offer a fairly recent trend. Due to the price competitive naturebroad range of the hard disk drive industry, with selling pricesproducts to our customers. We currently offer a variety of personal computers being substantially higher than game consoles, game manufacturers may not have the ability to either incorporate or continue to incorporate3.5-inch form factor hard disk drives into their overall architecture.for the desktop computer market. However, demand for hard disk drives may shift to products in smaller form factors, which we do not currently offer, but which some of our competitors offer. In addition, current price reduction demands from either currentthe enterprise and desktop PC industries are transitioning to higher speed interfaces such as SATA to handle higher data transfer rates. We currently offer SATA products; however, the transition of technology and the introduction of new products is challenging and creates risks. While we continue to develop new products and look to expand into non-desktop applications such as consumer electronics and mobile products, the success of our new product introductions is dependent on a number of factors, including difficulties faced in manufacturing ramp, market acceptance, effective management of inventory levels in line with anticipated product demand, and the risk that our new products will have quality problems or future game consoleother defects in the early stages of introduction that were not anticipated in the design of those products. If we fail to successfully develop and manufacture new products, customers may not makedecrease the amount of our products that they purchase, and we may lose business to our competitors who offer these products or who use their dominance in the enterprise or mobile market to encourage sales of desktop hard disk drive integration an attractive market for us or other hard drive manufacturers.drives.

     Our success depends upon the continued contributions of our key personnel and skilled employees, many of whom would be extremely difficult to replace. Worldwide competition for skilled employees in the hard disk drive industry is intense. WeVolatility or lack of positive performance in our stock price may adversely affect our ability to retain key personnel or skilled employees who have lost a number of experienced hard drive engineers over the past two years as a result of the loss of retention value of their employeebeen granted stock options (because of the decrease in price of our common stock) and aggressive recruiting of our employees.options. If we are unable to retain our existing key personnel or skilled employees, or hire and integrate new key personnel or skilled employees, our operating results would likely be harmed.

Risk factors relating to Western Digital particularly

     A majority of our revenue comes from a few customers. For example, during 2002,2004, sales to our top 10 customers accounted for approximately 58%51% of revenue.revenue, as compared to 55% of revenue for 2003. These customers have a variety of suppliers to choose from and therefore can make substantial demands on us. Even if we successfully qualify a product with a customer, the customer generally is not obligated to purchase any minimum volume of products from us and is able to terminate its relationship with us at any time. Our ability to maintain strong relationships with our principal customers is essential to our future performance. If we lose a key customer, or if any of our key customers reduce their orders of our products or require us to reduce our prices before we are able to reduce costs, our operating results would likely be harmed. For example, this occurred withIn addition, if customer pressures require us to reduce our enterprise hard drive product line earlypricing such that our gross margins are diminished, we could decide not to sell our products to a particular customer, which could result in the third quarter of 2000 and is one of the factors which led toa decrease in our decision to exit the enterprise hard drive market.revenue.

     Because we do not manufacture anydepend on a limited number of suppliers for certain hard disk drive components and manufacturing equipment, an increase in the basiccost of such components in our hard drives,or equipment, an extended shortage of required components or equipment, or the failure of key suppliers to remain in business, adjust to market conditions, or to meet our quality, yield or production requirements could harm us more severely than our competitors, some of whom manufacture certain of the components for their hard drives, and could significantly harm our operating results. A number of the components used by us are available from only a single or limited number of qualified outside suppliers.suppliers, and there is continued attrition and consolidation in our supplier base. In addition, some of the components (or component types) used in our products are used in other devices, such as mobile telephones and digital cameras. If there is a significant simultaneous upswing in demand for such a component (or component type) from several high volume industries, resulting in a supply reduction, or a component is otherwise in short supply, or if a supplier fails to qualify or has a quality issue with a component, we may experience delays or increased costs in obtaining that component. In addition, if a component becomes unavailable, we could suffer significant loss of revenue. For example, we lost revenue in

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     To reduce the risk of component shortages, we attempt to provide significant lead times when buying these components. As a result, we may havebe subject to pay significant cancellation charges to suppliers if we cancel orders, as we did in 1998which may occur when we accelerated our transition to magnetoresistive recording headmake technology and astransitions.

     In some cases, not only are we did in 2000 asdependent on a resultlimited number of our decision to exit the enterprise hard drive market.

In April 1999,suppliers, but we also have entered into contractual commitments that require us to buy a three-yearsubstantial number of components from certain suppliers. For example, we have entered into a volume purchase agreement with Komag under which we buy a substantial portionfor the purchase of our media components, from Komag. In October 2001, we amended the Komagand volume purchase agreement to extend the initial term to six years. Similarly, in February 2001, we entered into a two-year volume purchase agreementagreements with IBM under which we buy a substantial portionand Marvell for the purchase of our read channel chips from IBM. Effective June 2002, we amended the IBM volume purchase agreement to extend the initial term through December 31, 2003. These strategic relationships have increased our dependence on each of Komag and IBM as a supplier.devices. Our future operating results may depend substantially on Komag’s ability to timely qualify its mediatheir components in our new development programs, and each of Komag’s, IBM’s, and IBM’sMarvell’s ability to supply us with these components or chips, as the case may be, in sufficient volume to meet our production requirements. A significant disruption in Komag’sany of these suppliers’ ability to manufacture and supply us with mediathe components could harm our operating results.

In addition, certain equipment we use in our manufacturing or IBM’stesting processes is available only from a limited number of suppliers. Some of this equipment uses materials that at times could be in short supply. If these materials are not available, or are not available in the quantities we require for our manufacturing and testing processes, our ability to manufacture our products could be impacted, and we could suffer significant loss of revenue.

As a result of our head manufacturing operations, we are developing and manufacturing a substantial portion of the heads used in the hard disk drives we manufacture. Consequently, we are more dependent upon our own development and execution efforts and less able to take advantage of head technologies developed by other head manufacturers. There can be no assurance, however, that we will be successful in timely and cost-effectively developing and manufacturing heads for products using perpendicular recording technology, or other future technologies. We also may not achieve acceptable manufacturing yields using such technologies necessary to satisfy our customers’ product needs, or we may encounter quality problems with the heads we manufacture. In addition, we may not have access to external sources of supply uswithout incurring substantial costs. If we fail to develop new technologies in a timely manner, or if we encounter quality problems with read channel chipsthe heads we manufacture, and if we do not have access to external sources of supply that incorporate new technologies, we would have a competitive disadvantage to companies that are successful in this regard, and our business and financial results could harmsuffer.

     Our acquisition of head manufacturing assets represented a fundamental change in our operating structure, as we are now manufacturing heads for use in the hard disk drives we manufacture. Consequently, we carry a higher percentage of fixed costs than assumed in our prior financial business model. If the overall level of production decreases for any reason, our head manufacturing assets may face under-utilization that may impact our results of operations. We are therefore subject to additional risks related to overall asset utilization, including the need to operate at high levels of utilization to drive competitive costs, and the need for assured supply of components, especially hard disk drive media, that is optimized to work with our heads.

     Moreover, capital expenditures and working capital investments required to support the head manufacturing operations, including research and development expenses and expenses necessary to investigate new recording technologies to extend technology, will increase.

     In addition, we may incur additional costs, expenses and risks, including:

	•	we may not have sufficient head sources in the event that we are unable to manufacture a sufficient supply of heads to satisfy our needs;
	•	third party head suppliers may not deal with us or may not deal with us on the same terms and conditions we have previously enjoyed;

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	•	the costs of operating head manufacturing assets may exceed the prices we have historically paid for heads or the prices that might be otherwise available to us from other vendors;
	•	we may be subject to claims that our manufacturing of heads may infringe certain intellectual property rights of other companies;
	•	we could incur substantial costs, including clean up costs, fines and civil or criminal sanctions, as a result of violations of or liabilities under environmental laws applicable to our Fremont, California facility, including those governing the discharge of pollutants into the air and water; and
	•	it may be difficult and time-consuming for us to locate suitable manufacturing equipment for our head manufacturing processes and replacement parts for such equipment.

If we do not adequately address the challenges related to our head manufacturing operations, our ongoing operations could be disrupted, resulting in a decrease in our revenue or profit margins and negatively impacting our operating results.

     Under our business model, we do not manufacture any of the component parts used in our hard drives.disk drives, other than heads as a result of our acquisition of head manufacturing assets in July 2003. As a result, the success of our products depends on our ability to gain access to and integrate parts that are “best in class” from reliable component suppliers. To do so, we must effectively manage our relationships with our strategicmajor component suppliers. We must also effectively integrate different products from a variety of suppliers, each of which employs variations on technology, which can impact, for example, feasible combinations of heads and media components. We are currentlyIn August 2003 we settled litigation we were engaged in litigation with Cirrus which until this yearLogic, Inc., a supplier who previously was the sole source of read channel chipsdevices for our hard disk drives. As a result of the disputes that gave rise to the litigation, our business operations wereprofitability was at risk until another supplier’s read channel chipsdevices could be designed into our products. Similar disputes with other strategic component suppliers could adversely affect our operating results.

We use enterprise resource planning software in the operation of our business and maintenance of business and financial data related to our daily operations. We are in the process of upgrading this software and we anticipate transitioning to new enterprise resource planning software during the next year. We may experience unexpected difficulties in transitioning to the new software, including difficulties related to the failure or inefficient operation of the new software. Such difficulties or failures could result in our inability to access business and financial information stored on the system or the loss of such information. Any inability to access, or loss of, such information could affect our daily operations, including our ability to ship products and invoice our customers, which could have a significant adverse impact on our business, financial condition and results of operations.

Some of our computer manufacturer customers (also referred to as OEMs) have adopted a subcontractor model that requires us to contract directly with companies that provide manufacturing services to our OEM customers. Because these subcontractors are generally not as well capitalized as our direct OEM customers, this subcontractor model exposes us to increased credit risks. Our agreements with our OEM customers may not permit us to increase our product prices to alleviate this increased credit risk. Any credit losses we may suffer as a result of this increased risk would increase our operating costs, which may negatively impact our operating results.

     The majorityOur hard disk drives are manufactured in facilities in Malaysia and in Thailand. In addition, following our acquisition of ourhead manufacturing volume comes from oneassets in July 2003, we are operating a head wafer fabrication and research and

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     The terrorist attacks on the United States on September 11, 2001, the United States-led military response to counter terrorism and the continued threat of terrorist activity and other acts of war or hostility, including the war in Iraq, have created uncertainty in the financial and insurance markets and have significantly increased the political, economic and social instability in some of the geographic areas in which the Company operates. It is possible that furtherwe operate. Further acts of terrorism, may be directed against the United Stateseither domestically or abroad, could create further uncertainties and such actsinstability. To the extent this results in disruption or delays of terrorismour manufacturing capabilities or shipments of our products, our business, operating results and financial condition could be directed against properties and personnel of U.S.-owned companies such as ours.

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adversely affected.

     We are subject to risks associated with our foreign manufacturing operations, including:

	•	obtaining requisite United States and foreign governmental permits and approvals;
	•	currency exchange rate fluctuations or restrictions;
	•	political instability and civil unrest;
	•	transportation delays or higher freight rates;
	•	labor problems;
	•	trade restrictions or higher tariffs;
	•	exchange, currency and tax controls and reallocations;
	•	increasing labor and overhead costs; and
	•	loss or non-renewal of favorable tax treatment under agreements or treaties with foreign tax authorities.

     Because we manufacture our products abroad, our operating costs are subject to fluctuations in foreign currency exchange rates. Further fluctuations in the exchange rate of the Thai Baht, a floating currency, or a determination by the Malaysian government to repeg the Malaysian Ringgit or convert it to a floating currency, could result in an increase in our operating costs, which may negatively impact our operating results.

We have attempted to manage the impact of foreign currency exchange rate changes by, among other things, entering into short-term, forward exchange contracts. However, those contracts do not cover our full exposure and can be canceled by the issuer if currency controls are put in place, which occurred in Malaysia during the first quarter of 1999.place. As a result of the Malaysian currency controls, we are no longer hedging the Malaysian currency risk. Currently, we hedge the Thai Baht, and British Pound Sterling.Sterling and the Euro.

There has been a trend toward a weakening U.S. dollar relative to most foreign currencies. If this trend continues the U.S. dollar equivalents of unhedged manufacturing costs could increase because a significant portion of our production costs are foreign-currency denominated. Conversely, there would not be an offsetting impact to revenues since revenues are substantially U.S. dollar denominated.

     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 and making producers of those products financially responsible for the collection, treatment, recycling and disposal of certain products. Such laws and regulations have been passed in several jurisdictions in which we operate, including various European Union member countries. Similar legislation may be enacted in other locations where we manufacture or sell our products.

     We could incur substantial costs in connection with our compliance with such environmental laws and regulations, and we could also be subject to governmental fines and liability to our customers if we were to violate these laws. If we

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     The hard disk drive industry has been characterized by significant litigation. This includes litigation relating to patent and other intellectual property rights, product liability claims and other types of litigation. Litigation can be expensive, lengthy, and disruptive to normal business operations. Moreover, the results of litigation are inherently uncertain and may result in adverse rulings or decisions. We may enter into settlements or be subject to judgments that may, individually or in the aggregate, have a material adverse effect on our business, financial condition or results of operations.

We are currently evaluating notices of alleged patent infringement or notices of patents from patent holders. We also are a party to several judicial and other proceedings relating to patent and other intellectual property rights. If we conclude that a claim of infringement is valid,claims or actions are asserted against us, we may be required to obtain a license or cross-license, modify our existing technology or design a new non-infringing technology. Such licenses or design modifications can be extremely costly. We may also be liable for any past infringement. If there is an adverse ruling against us in an infringement lawsuit, an injunction could be issued barring production or sale of any infringing product. It could also result in a damage award equal to a reasonable royalty or lost profits or, if there is a finding of willful infringement, treble damages. Any of these results would likely increase our costs and harm our operating results.

     Our success depends, in significant part, on the proprietary nature of our technology, including non-patentable intellectual property such as our process technology. Despite safeguards, to the extent that a competitor is able to reproduce or otherwise capitalize on our technology, it may be difficult, expensive or impossible for us to obtain necessary legal protection. Also, the laws of some foreign countries may not protect our intellectual property to the same extent as do the laws of the United States. In addition to patent protection of intellectual property rights, we consider elements of our product designs and processes to be proprietary and confidential. We rely upon employee, consultant and vendor non-disclosure agreements and contractual provisions and a system of internal safeguards to protect our proprietary information. However, any of our registered or unregistered intellectual property rights may be challenged or exploited by others in the industry, which might harm our operating results.

27     We generally warrant our products for one to five years. We test our hard disk drives in our manufacturing facilities through a variety of means. However, there can be no assurance that our testing will reveal latent defects in our products, which may not become apparent until after the products have been sold into the market. Accordingly, there is a risk that product defects will occur, which could require a product recall. Product recalls can be expensive to implement and, if a product recall occurs during the product’s warranty period, we may be required to replace the defective product. In addition, a product recall may damage our relationship with our customers, and we may lose market share with our customers, including our OEM customers.

     The standard warranties used by us contain limits on damages and exclusions of liability for consequential damages and for negligent or improper use of the products. We record an accrual for estimated warranty costs at the time revenue is recognized. We may incur additional operating expenses if our warranty provision does not reflect the actual cost of resolving issues related to defects in our products. If these additional expenses are significant, it could adversely affect our business, financial condition and results of operations.

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     If we do not forecast total quarterly demand accurately, it can have a material adverse effect on our quarterly results. We typically book andoften ship a high percentage (at times up to 58%in excess of 50%) of our total quarterly sales in the third month of the quarter, which makes it difficult for us to matchforecast our production plansfinancial results prior to customer demands.the end of the quarter. In addition, our quarterly projections and results may be subject to significant fluctuations as a result of a number of other factors including:

	•	the timing of orders from and shipment of products to major customers;
	•	our product mix;
	•	changes in the prices of our products;
	•	manufacturing delays or interruptions;
	•	acceptance by customers of competing products in lieu of our products;
	•	variations in the cost of components for our products;
	•	limited access to components that we obtain from a single or a limited number of suppliers, such as Komag, IBM, Marvell, ALPS Electric Co., Ltd., STMicroelectronics, and IBM;SAE Magnetics Ltd., a subsidiary of TDK Corporation;
	•	competition and consolidation in the data storage industry; and
	•	seasonal and other fluctuations in demand for computersPCs often due to technological advances.advances; and
	•	availability and rates of transportation.

     We have made and continue to make a number of estimates and assumptions relating to our consolidated financial reporting. The rapidly changing market conditions with which we deal means that actual results may differ significantly from our estimates and assumptions. Key estimates and assumptions for us include:

	•	accruals for warranty costs related to product defects;
	•	price protection adjustments and other sales promotions and allowances on products sold to retailers, resellers and distributors;
	•	inventory adjustments for write-down of inventories to lower of cost or market value (net realizable value);
	•	reserves for doubtful accounts;
	•	accruals for product returns;
	•	accruals for litigation and other contingencies; and
	•	reserves for deferred tax assets.

     The market price of our common stock has been, and may continue to be, extremely volatile. Factors such as the following may significantly affect the market price of our common stock:

	•	actual or anticipated fluctuations in our operating results;
	•	announcements of technological innovations by us or our competitors which may decrease the volume and profitability of sales of our existing products and increase the risk of inventory obsolescence;
	•	new products introduced by us or our competitors;
	•	periods of severe pricing pressures due to oversupply or price erosion resulting from competitive pressures;

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	•	developments with respect to patents or proprietary rights;

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	•	conditions and trends in the hard disk drive, data and content management, storage and communication industries; and
	•	changes in financial estimates by securities analysts relating specifically to us or the hard disk drive industry in general.

     In addition, general economic conditions may cause the stock market to experience extreme price and volume fluctuations from time to time that particularly affect the stock prices of many high technology companies. These fluctuations often appear to be unrelated to the operating performance of the companies.

     Securities class action lawsuits are often brought against companies after periods of volatility in the market price of their securities. A number of such suits have been filed against us in the past, and should any new lawsuits be filed, such matters could result in substantial costs and a diversion of resources and management’s attention.

     Due to the risks described herein, in the future we may be unable to maintain adequate financial resources for capital expenditures, expansion or acquisition activity, working capital and research and development. We have a credit facility, which matures on September 20, 2003.19, 2008, and planned capital lease facilities. If we decide to increase or accelerate our capital expenditures or research and development efforts, or if results of operations do not meet our expectations, we could require additional debt or equity financing. However, we cannot ensure that additional financing will be available to us or available on acceptable terms. An equity financing could also be dilutive to our existing stockholders.

Item 7A.     Quantitative and Qualitative Disclosures About Market Risk

Disclosure About Foreign Currency Risk

     Although the majority of the Company’s transactions are in U.S. Dollars, some transactions are based in various foreign currencies. The Company purchases short-term, forward exchange contracts to hedge the impact of foreign currency fluctuations on certain underlying assets, liabilities and commitments for operating expenses and product costs denominated in foreign currencies. The purpose forof entering into these hedge transactions is to minimize the impact of foreign currency fluctuations on the results of operations. AThe resulting impact from these hedge contracts is to offset a majority of the increases or decreasescurrency gains and losses in the Company’s local currency operating expenses are offset by gains and losses on the hedges.expenses. The contracts havecontract maturity dates that do not exceed threesix months. The Company does not purchase short-term forward exchange contracts for trading purposes.

     Historically, Currently, the Company has focusedfocuses on hedging its foreign currency risk related to the Singapore Dollar,Thai Baht, the British Pound Sterling, and the Malaysian Ringgit. With the establishment of currency controls and the prohibition of purchases or sales of the Malaysian Ringgit by offshore companies, the Company discontinued hedging its Malaysian Ringgit currency risk in 1999. Future hedging of this currency will depend on currency conditions in Malaysia. As a result of the closure of the Company’s Singapore operations in 2000, the Company has also discontinued its hedging program related to the Singapore Dollar. During the third quarter of 2002, the Company purchased a manufacturing facility in Thailand and began hedging the Thai Baht.

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Euro.

     As of June 28, 2002,July 2, 2004, the Company had outstanding the following purchased foreign currency forward exchange contracts (in millions, except weighted average contract rate):

*	Expressed in units of foreign currency per dollar.

     In 2002, 20012004, 2003 and 2000,2002, total realized transaction and forward exchange contract currency gains and losses were not material to the consolidated financial statements and the carrying value of the contracts approximated fair value. Based on historical experience, the Company does not expect that a significant change in foreign exchange rates would materially affect the Company’s consolidated financial statements.

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Disclosure About Other Market Risks

Fixed Interest Rate Risk

     At June 28, 2002, the market value of the Company’s 5.25% zero coupon convertible subordinated debentures due in 2018 was approximately $83.0 million, compared to the related book value of $86.2 million. The convertible debentures will be repurchased by the Company, at the option of the holder, as of February 18, 2003, February 18, 2008, or February 18, 2013, or if there is a Fundamental Change (as defined in the Debenture documents), at the issue price plus accrued original issue discount to the date of redemption. The payment on those dates, with the exception of a Fundamental Change, can be in cash, stock or any combination, at the Company’s option.

     At the option of the Company, borrowings under the Senior Credit Facility would bear interest at either LIBOR (with option periods of one to three months) or a base rate, plus a margin determined bymargin. If LIBOR or the borrowing base. This isbase rate increases, the only debt which does not haveCompany’s interest payments could also increase. At July 2, 2004 the Company had a fixed-rate of interest. At June 28, 2002, there were no borrowings$50 million term loan outstanding under the Senior Credit Facility.

Fair Value Risk

     The Company owns approximately 1.0 million shares of Vixel common stock. As of June 28, 2002, the market value of the Vixel shares was $2.6 million. Changes A one percent increase in the market valuevariable rate of the Vixel shares are recorded as unrealized gains or losses in other comprehensive income (shareholders’ equity). As of June 28, 2002, a $2.6 million total accumulated unrealized gain has been recorded in accumulated other comprehensive income. If the Company sells any portion of this common stock, the related unrealized gain or lossinterest on the date of sale will become realized and reflected as a gain or loss in the Company’s income statement. As a result of market conditions, the market value of the shares had declined from $2.6Senior Credit Facility would increase interest expense by approximately $0.5 million as of June 28, 2002 to $1.5 million as of September 20, 2002. Due to market fluctuations, an additional decline in the stock’s fair market value could occur.annually.

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Index to Financial Statements and Financial Statement Schedule