The following discussion and analysis contains forward-looking statements within the meaning of the federal securities laws, and should be read in conjunction with the disclosures we make concerning risks and other factors that may affect our business and operating results. You should read this information in conjunction with the unaudited Condensed Consolidated Financial Statements and the notes thereto included in this Quarterly Report on Form 10-Q, and the audited Consolidated Financial Statements and notes thereto included in Part II, Item 8 of our Annual Report on Form 10K for the fiscal year endedJuly 2, 2021 . See also "Forward-Looking Statements" immediately prior to Part I, Item 1 in this Quarterly Report on Form 10-Q. Unless otherwise indicated, references herein to specific years and quarters are to our fiscal years and fiscal quarters. As used herein, the terms "we," "us," "our," and the "Company" refer toWestern Digital Corporation and its subsidiaries.
Our Company
We are on a mission to unlock the potential of data by harnessing the possibility to use it. With both Flash and HDD franchises, underpinned by advancements in memory technologies, we create breakthrough innovations and powerful data storage solutions that enable the world to actualize its aspirations.
Our fiscal year ends on the Friday nearest toJune 30 and typically consists of 52 weeks. Approximately every five to six years, we report a 53-week fiscal year to align the fiscal year with the foregoing policy. Fiscal years 2022, which ends onJuly 1, 2022 , and 2021, which ended onJuly 2, 2021 , are each comprised of 52 weeks, with all quarters presented consisting of 13 weeks.
Key Developments
Joint Venture Contamination Incident
InFebruary 2022 , contamination of certain material used in manufacturing processes occurred atFlash Ventures' fabrication facilities in both Yokkaichi and Kitakami,Japan which resulted in damage to inventory units in production, a temporary disruption to production operations and a reduction in our flash wafer availability. During the three and nine months endedApril 1, 2022 , we incurred charges of$203 million related to this contamination incident that were recorded in Cost of revenue and primarily consisted of scrapped inventory and rework costs, decontamination and other costs needed to restore the facilities to normal capacity, and under absorption of overhead costs. We are evaluating potential options for recovery.
Tax Resolution
As previously disclosed, we have received statutory notices of deficiency and notices of proposed adjustments from theIRS with respect to fiscal years 2008 through 2015. During the three months endedApril 1, 2022 , new information became available which required us to re-measure our unrecognized tax benefits for thisIRS matter. Subsequent toApril 1, 2022 , we and theIRS tentatively reached a basis for resolving this matter. Additional information is provided in our discussion of Income tax expense in our results of operations below, as well as in Part I, Item 1, Note 13, Income Tax Expense, of the Notes to the Condensed Consolidated Financial Statements, and in the "Short- and Long-Term Liquidity--Unrecognized Tax Benefits" section below.
Financing Activities
In fiscal 2022, we continued to execute on our commitment to reduce our overall debt levels andFitch Ratings, Inc. raised our Company credit rating to investment grade inDecember 2021 . We fully repaid our Term Loan B-4 inOctober 2021 and shortly thereafter initiated a series of transactions to further reduce our debt levels and better stagger the maturities of our debt. InDecember 2021 , we issued$500 million aggregate principal amount of 2.850% senior unsecured notes dueFebruary 1, 2029 (the "2029 Notes") and issued$500 million aggregate principal amount of 3.100% senior unsecured notes dueFebruary 1, 2032 (the "2032 Notes"). We used the proceeds from these notes offerings and available cash to voluntarily repay$1.21 billion of our Term Loan A-1 and reduce its principal amount to$3.0 billion as ofDecember 31, 2021 . InJanuary 2022 , we amended and restated our existing loan agreement to provide for, among other things: (i) the issuance of a new$3.0 billion Term Loan A-2 maturing inJanuary 2027 to replace our previously existing Term Loan A-1; (ii) the availability of a new$2.25 billion revolving credit facility maturing inJanuary 2027 to replace our previously existing$2.25 billion revolving credit facility; and (iii) additional covenant flexibility and other modifications. Upon completion of these transactions, over 85% of the principal 37 -------------------------------------------------------------------------------- Table of Contents amount of our debt is now due in 2026 or later. We believe this new debt structure gives us greater financial stability and flexibility to manage our business over the longer term. Additional information regarding our indebtedness, including the principal repayment terms, interest rates, covenants and other key terms of our outstanding indebtedness, is included in Part I, Item 1, Note 8, Debt, of the Notes to Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q and in Part II, Item 8, Note 6, Debt, of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year endedJuly 2, 2021 .Flash Ventures InJanuary 2022 , we entered into additional agreements with Kioxia regardingFlash Ventures' investment in a new wafer fabrication facility, known as "Y7 ", located in Yokkaichi,Japan . The primary purpose ofY7 is to provide clean room space to continue the transition of existing flash-based wafer capacity to newer technology nodes. Output fromY7 is expected to begin in the first half of fiscal year 2023. Our share of the initial commitment forY7 is expected to result in equipment investments and start-up costs totaling approximately$140 million , to be incurred primarily through the second half of fiscal year 2022. We also agreed to pay, among other items, future building depreciation payments of$482 million as follows:$142 million in fiscal year 2022,$314 million in fiscal year 2023 and$26 million in fiscal year 2024, to be credited against future wafer charges. Business Structure Historically, our company had been managed and reported under a single operating segment. Late in the first quarter of fiscal 2021, the Chief Executive Officer, who is our Chief Operating Decision Maker, announced a decision to reorganize our business by forming two separate product business units: flash-based products ("Flash") and hard disk drives ("HDD"). The new structure is intended to provide each business unit with focus and responsibility for identifying current and future customer requirements while driving the strategy, roadmap, pricing and overall profitability for their respective product areas. To align with the new operating model and business structure, we made management organizational changes and implemented new reporting modules and processes to provide discrete information to manage the business. EffectiveJuly 3, 2021 , management finalized its assessment of our operating segments and concluded that we now have two reportable segments: Flash and HDD. Our broad portfolio of technology and products address multiple end markets. In the fiscal first quarter of 2022, we refined the end markets we report to be "Cloud", "Client" and "Consumer". Cloud represents a large and growing end market comprised primarily of products for public or private cloud environments and end customers, which we believe we are uniquely positioned to address as the only provider of both flash and hard drive products. Through the Client end market, we provide our original equipment manufacturer ("OEM") and channel customers a broad array of high-performance flash and hard drive solutions across personal computer, mobile, gaming, automotive, virtual reality headsets, at-home entertainment, and industrial spaces. The Consumer end market is highlighted by our broad range of retail and other end-user products, which capitalize on the strength of our product brand recognition and vast points of presence around the world.
The discussion and analysis included under Results of Operations below reflects our new business unit structure and end markets discussed above.
COVID-19 Pandemic and Operational Update
As the ongoing COVID-19 pandemic has evolved, we have implemented and maintained more thorough sanitation practices as outlined by health organizations and supported vaccination efforts. We continually monitor and update our practices based on recommendations from health organizations to ensure the continued safety of our employees and business partners as we continue to return to site. In addition, the responses to COVID-19 taken by others in the supply chain have increased the costs of their services which have in turn impacted our operations. We incurred incremental charges primarily related to logistics, absorption and other factory-related costs of approximately$59 million and$185 million , and$33 million and$94 million during the three and nine months endedApril 1, 2022 andApril 2, 2021 , respectively, which were recorded in Cost of revenue. The technology hardware and semiconductor industries continued to face supply chain disruptions and component shortages during the quarter that negatively impacted both our customers' ability to ship products, and our ability to build products. In order to meet our end customers' demand, we are incurring increased component costs in addition to COVID-related expenses, which we expect to weigh primarily on our hard drive gross margins through the first half of calendar year 2022. While these supply disruptions may continue for the near term, we ultimately expect that they will be transitory as demand for our products remained solid during the COVID-19 pandemic, with work-from-home, distance learning, and at home entertainment driving demand for cloud environments, new devices, and retail products. 38
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The COVID-19 environment remains dynamic with outbreaks in various geographies includingChina , where we experienced a temporary lockdown. We will continue to actively monitor the situation and may take further actions altering our business operations that we determine are in the best interests of our employees, customers, partners, suppliers, and stakeholders, or as required by federal, state, or local authorities. See "The COVID-19 pandemic could negatively affect our business" and "We are dependent on a limited number of qualified suppliers who provide critical services, materials or components, and a disruption in our supply chain could negatively affect our business" in Part I, Item 1A, Risk Factors, of our Annual Report on Form 10-K for the fiscal year endedJuly 2, 2021 for more information regarding the risks we face as a result of the COVID-19 pandemic and supply chain disruptions.
Russia Sanctions
InFebruary 2022 , theU.S. and other countries imposed sanctions onRussia . In accordance with these sanctions, we have ceased shipments to distributors for customers located inRussia . Our revenue from distributors for customers inRussia have not been significant. We have no material assets or operations inRussia . Results of Operations
Third Quarter and Nine Month Overview
The following table sets forth, for the periods presented, selected summary information from our Condensed Consolidated Statements of Operations by dollars and percentage of net revenue(1):
Three Months Ended April 1, April 2, 2022 2021 $ Change % Change ($ in millions) Revenue, net$ 4,381 100.0 %$ 4,137 100.0 %$ 244 6 % Cost of revenue 3,200 73.0 3,046 73.6 154 5 Gross profit 1,181 27.0 1,091 26.4 90 8 Operating Expenses: Research and development 572 13.1 555 13.4 17 3 Selling, general and administrative 281 6.4 287 6.9 (6) (2) Employee termination, asset impairment, and other charges 4 0.1 (68) (1.6) 72 (106) Total operating expenses 857 19.6 774 18.7 83 11 Operating income 324 7.4 317 7.7 7 2 Interest and other income (expense): Interest income 1 - 2 - (1) (50) Interest expense (75) (1.7) (81) (2.0) 6 (7) Other income (loss), net 12 0.3 11 0.3 1 9 Total interest and other expense, net (62) (1.4) (68) (1.6) 6 (9) Income before taxes 262 6.0 249 6.0 13 5 Income tax expense 237 5.4 52 1.3 185 356 Net income$ 25 0.6$ 197 4.8 (172) (87)
(1) Percentages may not total due to rounding.
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Table of Contents Nine Months Ended April 1, April 2, 2022 2021 $ Change % Change ($ in millions) Revenue, net$ 14,265 100.0 %$ 12,002 100.0 %$ 2,263 19 % Cost of revenue 9,836 69.0 9,047 75.4 789 9 Gross profit 4,429 31.0 2,955 24.6 1,474 50 Operating Expenses: Research and development 1,725 12.1 1,645 13.7 80 5 Selling, general and administrative 851 6.0 808 6.7 43 5 Employee termination, asset impairment, and other charges 24 0.2 (43) (0.4) 67 (156) Total operating expenses 2,600 18.2 2,410 20.1 190 8 Operating income 1,829 12.8 545 4.5 1,284 236 Interest and other income (expense): Interest income 4 - 6 - (2) (33) Interest expense (229) (1.6) (246) (2.0) 17 (7) Other income (expense), net 8 0.1 26 0.2 (18) (69) Total interest and other expense, net (217) (1.5) (214) (1.8) (3) 1 Income before taxes 1,612 11.3 331 2.8 1,281 387 Income tax expense 413 2.9 132 1.1 281 213 Net income$ 1,199 8.4$ 199 1.7 1,000 503
(1) Percentages may not total due to rounding.
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Table of Contents The following table sets forth, for the periods presented, a summary of our segment information: Three Months Ended Nine Months Ended April 1, April 2, April 1, April 2, 2022 2021 2022 2021 ($ in millions) Net revenue: Flash$ 2,243 $ 2,175 $ 7,353 $ 6,287 HDD 2,138 1,962 6,912 5,715 Total net revenue$ 4,381 $ 4,137 $ 14,265 $ 12,002 Gross profit: Flash$ 798 $ 653 $ 2,665 $ 1,752 HDD 592 491 2,061 1,462 Unallocated corporate items: Contamination related charges (203) - (203) - Amortization of acquired intangible assets - (39) (65) (293) Stock-based compensation expense (13) (14) (36) (41) Recoveries from a power outage incident 7 - 7 75 Total unallocated corporate items (209) (53) (297) (259) Consolidated gross profit$ 1,181 $ 1,091 $ 4,429 $ 2,955 Gross margin: Flash 35.6 % 30.0 % 36.2 % 27.9 % HDD 27.7 % 25.0 % 29.8 % 25.6 % Consolidated gross margin 27.0 % 26.4 % 31.0 % 24.6 %
Our disaggregated revenue information is as follows:
Three Months Ended Nine Months Ended April 1, April 2, April 1, April 2, 2022 2021 2022 2021 (in millions) Revenue by End Market Cloud$ 1,774 $ 1,423 $ 5,919 $ 3,728 Client 1,732 1,767 5,439 5,386 Consumer 875 947 2,907 2,888 Total Revenue$ 4,381 $ 4,137 $ 14,265 $ 12,002 Revenue by Geography Asia$ 2,400 $ 2,215 $ 7,685 $ 6,702 Americas 1,377 1,009 4,398 3,033 Europe, Middle East and Africa 604 913 2,182 2,267 Total Revenue$ 4,381 $ 4,137 $ 14,265 $ 12,002 41
-------------------------------------------------------------------------------- Table of Contents Net Revenue The increases in consolidated net revenue for the three and nine months endedApril 1, 2022 from the comparable periods in the prior year reflect increases in exabytes of Flash and HDD sold as further discussed below. The revenue increases driven by exabyte growth were partially offset by declines in the average price per gigabyte of storage for both Flash and HDD as product mix shifted. Despite the disruption to our Flash production from the contamination event atFlash Ventures' fabrication facilities in both Yokkaichi and Kitakami,Japan , Flash revenue increased 3% for the three months endedApril 1, 2022 from the comparable period in the prior year, primarily driven by a 9% increase in exabytes sold, partially offset by a decline in the average price per gigabyte. The higher exabytes sold primarily reflected the ramp of our latest BiCS5 flash solutions. Higher volume was also driven by strong demand in gaming along with a growing brand recognition of WD_Black based products in our Consumer market. Flash revenue increased 17% for the nine months endedApril 1, 2022 from the comparable period in the prior year, primarily driven by a 24% increase in exabytes sold, partially offset by a decline in the average price per gigabyte. The increase in exabytes for the nine-month period was largely attributable to the same factors noted above for the three-month period. HDD revenue increased 9% for the three months endedApril 1, 2022 from the comparable period in the prior year, primarily driven by a 20% increase in exabytes sold, partially offset by a decline in the average price per gigabyte as noted above. The increase in exabytes sold was due to continued demand for our latest generation energy assisted drives among our public and private cloud customers. The strong demand in Cloud was partly offset by a decline in HDD exabytes sold in our Client and Consumer end markets due to continued pressure in the commercial channel related to component issues impacting our customers' ability to ship product and greater component sourcing constraints within our own operations, and customers transitioning to client SSD. HDD revenue increased 21% for the nine months endedApril 1, 2022 from the comparable period in the prior year, primarily driven by a 33% increase in exabytes sold, partially offset by a decline in the average price per gigabyte as noted above. The increase in exabytes for the nine-month period was largely attributable to the same factors noted above for the three-month period. The increase in Cloud revenue for the three months endedApril 1, 2022 from the comparable period in the prior year was led by demand for HDD capacity enterprise drives, including growth in our 18-terabyte capacity drives and ramp of our 20-terabyte capacity drives. The growth was partially offset by lower revenues from enterprise SSDs primarily caused by the supply impact as a result of the contamination event mentioned above and lower revenues from smart video hard drives. In Client, the slight decrease in revenues for the three months endedApril 1, 2022 from the comparable period in the prior year reflected declines in both client SSD and client HDD revenue, as a result of the supply chain disruptions noted previously, partially offset by the ramp of 5G phones. In Consumer, the slight decrease in revenues for the three months endedApril 1, 2022 from the comparable period in the prior year reflected declines in both Flash and HDD as a result of short term demand weakness outside theU.S. tied to geopolitical events inEurope , as well as COVID-related lockdowns inChina . The increase in Cloud revenue for the nine months endedApril 1, 2022 from the comparable period in the prior year primarily reflects the same drivers noted above for the three-month period. Client revenue was relatively flat for the nine months endedApril 1, 2022 compared to the prior year, with growth in mobile (led by 5G growth), gaming, automotive, IOT, and industrial applications in the first quarter of fiscal 2022, partially offset by declines in both client SSD and client HDD revenue, as a result of the supply chain disruptions noted previously. Consumer revenue was relatively flat for the nine months endedApril 1, 2022 from the comparable period in the prior year with growth in gaming along with a growing brand recognition of WD_Black tempered by the slightly weaker demand in the third quarter noted above.
The changes in net revenue by geography for both the three and nine months ended
Our top 10 customers accounted for 44% and 43% of our net revenue for the three and nine months endedApril 1, 2022 , respectively, compared to 42% and 40% of our net revenue for the three and nine months endedApril 2, 2021 , respectively. For each of the three and nine months endedApril 1, 2022 andApril 2, 2021 , no single customer accounted for 10% or more of our net revenue. Consistent with standard industry practice, we have sales incentive and marketing programs that provide customers with price protection and other incentives or reimbursements that are recorded as a reduction to gross revenue. These programs represented 17% and 18% of gross revenues for both the three and nine months endedApril 1, 2022 , and 18% and 19% of gross revenues for the three and nine months endedApril 2, 2021 , respectively. Adjustments due to changes in accruals for these programs have generally averaged less than 1% of gross revenue year over year. The amounts attributed to our sales incentive and marketing programs generally vary according to several factors including industry conditions, list pricing strategies, 42 -------------------------------------------------------------------------------- Table of Contents seasonal demand, competitor actions, channel mix and overall availability of products. Changes in future customer demand and market conditions may require us to adjust our incentive programs as a percentage of gross revenue. We believe we have made significant progress in strengthening our product portfolio to meet our customers' growing and evolving storage needs. We have largely completed qualification of BiCS5 based product for client and consumer end markets. Additionally, qualification of OptiNAND-based hard drives progress as planned across multiple cloud and OEM customers and we continue to see an increase in customer interest in adopting shingled magnetic recording ("SMR") technology. Combining OptiNAND with our SMR leadership positions us to drive business results in our capacity enterprise business. For our next generation 3D-flash, we continued commercial shipment of consumer flash devices based on our 162-layer BiCs6. We expect these developments to contribute to further revenue growth when supply chain disruptions begin to abate.
Gross Profit and Gross Margin
Consolidated gross profit increased by$90 million for the three months endedApril 1, 2022 from the comparable period in the prior year, which reflects the increase in revenue in both Flash and HDD and reduced costs as we ramped production on newer products, partially offset by charges of$203 million related to the contamination event in theFlash Ventures' fabrication facilities. Consolidated gross margin increased 0.6 percentage points for the three months endedApril 1, 2022 from the comparable period in the prior year, which reflects cost reductions as we ramped production on newer products and a shift in product mix to higher-margin flash drives, partially offset by the impact of the contamination related charges which represented approximately 4.6 percentage points of gross margin. Flash and HDD gross margin increased by 5.6 and 2.7 percentage points year over year, respectively, reflecting cost reductions as we ramped production on newer products. Consolidated gross profit increased by$1.47 billion for the nine months endedApril 1, 2022 from the comparable period in the prior year, which reflects the increase in revenue in both Flash and HDD, as well as a$228 million decrease in charges in the current period related to amortization expense on acquired intangible assets, some of which became fully amortized, partially offset by the contamination related charges of$203 million noted above. Consolidated gross margin increased 6.4 percentage points for the nine months endedApril 1, 2022 from the comparable period in the prior year, which reflects higher gross margin in both Flash and HDD as a result of cost reductions as we ramped production on newer products and a shift in product mix to higher-margin flash drives, as well as the lower charges for amortization of acquired intangible assets noted above. Flash and HDD gross margin increased by 8.3 and 4.2 percentage points year over year, respectively, reflecting cost reductions as we ramped production on newer products. Operating Expenses Research and development ("R&D") expense increased$17 million and$80 million for the three and nine months endedApril 1, 2022 , respectively, from the comparable period in the prior year. The primary increase was due to increased headcount. Selling, general and administrative ("SG&A") expense decreased$6 million for the three months endedApril 1, 2022 from the comparable period in the prior year, primarily reflecting slightly lower variable compensation expense. SG&A expense increased$43 million for the nine months endedApril 1, 2022 from the comparable period in the prior year and primarily reflected higher outside professional services. Employee termination, asset impairment and other charges for both the three and nine months endedApril 1, 2022 reflect minor actions taken in each period, while the prior year periods primarily reflected gains related to the disposition of assets associated with actions taken in earlier periods. For information regarding Employee termination, asset impairment and other charges, see Part I, Item 1, Note 15, Employee Termination, Asset Impairment, and Other Charges of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.
Interest and Other Income (Expense)
Total interest and other expense, net for the three months endedApril 1, 2022 slightly decreased compared to the prior year, mainly reflecting lower interest expense primarily resulting from the pay-down of principal on our debt. Total interest and other expense, net for the nine months endedApril 1, 2022 increased slightly compared to the prior year, mainly reflecting unfavorable exchange rates in the current period mostly offset by lower interest expense resulting from the pay-down of principal on our debt. 43 -------------------------------------------------------------------------------- Table of Contents Income Tax Expense The Tax Cuts and Jobs Act (the "2017 Act") includes a broad range of tax reform proposals affecting businesses. We completed our accounting for the tax effects of the enactment of the 2017 Act during the second quarter of fiscal 2019. However, theU.S. Treasury and the Internal Revenue Service ("IRS") have issued tax guidance on certain provisions of the 2017 Act since the enactment date, and we anticipate the issuance of additional regulatory and interpretive guidance. We applied a reasonable interpretation of the 2017 Act along with the then-available guidance in finalizing our accounting for the tax effects of the 2017 Act. Any additional regulatory or interpretive guidance would constitute new information, which may require further refinements to our estimates in future periods.
The following table sets forth income tax information from our Condensed Consolidated Statements of Operations by dollar and effective tax rate:
Three Months Ended Nine Months Ended April 1, April 2, April 1, April 2, 2022 2021 2022 2021 ($ in millions) Income before taxes$ 262 $ 249 $ 1,612 $ 331 Income tax expense 237 52 413 132 Effective tax rate 90 % 21 % 26 % 40 % The primary drivers of the difference between the effective tax rate for the three and nine months endedApril 1, 2022 and theU.S. Federal statutory rate of 21%, are the relative mix of earnings and losses by jurisdiction, the deduction for foreign derived intangible income, credits, and tax holidays inMalaysia ,the Philippines andThailand that will expire at various dates during fiscal years 2024 through 2031. In addition, the effective tax rate for the three and nine months endedApril 1, 2022 includes the discrete effect of a net increase to the liability for unrecognized tax benefits, which includes interest and offsetting tax benefits, as a result of ongoing discussions with various taxing authorities of$194 million and$219 million , respectively. The primary drivers of the difference between the effective tax rate for the three and nine months endedApril 2, 2021 and theU.S. Federal statutory rate of 21% are the relative mix of earnings and losses by jurisdiction, the deduction for foreign derived intangible income, credits, and tax holidays inMalaysia ,Philippines andThailand . In addition, the effective tax rate for the three and nine months endedApril 2, 2021 includes discrete effects for increases to the liability for unrecognized tax benefits of$35 million as a result of ongoing discussions with various taxing authorities that are offset in part by a release of certain unrecognized tax benefits of$22 million as a result of business realignment activities. The effective tax rate for the nine months endedApril 2, 2021 also includes the discrete effects of net tax deficiencies from shortfalls of$11 million related to the vesting of stock-based awards and additional tax expense of$10 million from the re-measurement of deferred tax liabilities due to restructuring activities, which have no impact on the amount of income taxes that we paid. Subsequent toApril 1, 2022 , we and theIRS tentatively reached a basis for resolving the statutory notices of deficiency and notices of proposed adjustments with respect to fiscal years 2008 through 2015. See the "--Short- and Long-Term Liquidity--Unrecognized Tax Benefits" section below for additional information related to this matter. Our future effective tax rate is subject to future regulatory developments and changes in the mix of ourU.S. earnings compared to foreign earnings. Our total tax expense in future fiscal years may also vary as a result of discrete items such as excess tax benefits or deficiencies. For additional information regarding Income tax expense, see Part I, Item 1, Note 13, Income Tax Expense, of the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. 44
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