Good afternoon, and thank you for standing by. Welcome to Western Digital's Second Quarter Financial Results for Fiscal Year 2014. [Operator Instructions] As a reminder, this call is being recorded. .

Now, I will turn the call over to Bob Blair. You may begin, sir. .

Thank you.

As we begin, I want to mention that we will be making forward-looking statements in our comments and in response to your questions concerning, among others, our participation in the growth and our role in the future of digital data, our position in the storage ecosystem, customer response to our product offerings, trends in the global economy and PC market, investments in the enterprise markets and our financial performance, including our financial results expectations for the March quarter.

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These forward-looking statements are based on management's current expectations and are subject to risks and uncertainties that could cause actual results to differ materially, including those listed in our 10-Q filed with the SEC on October 29, 2013, and in our registration Form S-3 filed with the SEC on October 30, 2013.

We undertake no obligation to update our forward-looking statements to reflect new information or events..

In addition, references will be made during this call to non-GAAP financial measures. Reconciliations of the differences between the historical non-GAAP measures we provide during this call to the comparable GAAP financial measures are included in the quarterly fact sheet posted in the Investor Relations section of our website.

The forward-looking guidance we provide during this call excludes amortization of intangibles related to the acquisitions of HGST, VeloBit, sTec and Virident; employee termination benefits and other charges; and charges related to litigation.

Because of the amount of these items -- because the amount of these items is not fully known to us at this time, we are unable to provide guidance for, or a reconciliation to, the most directly comparable GAAP financial measures.

The impact of these excluded items may cause the estimated non-GAAP financial measures to differ materially from the comparable GAAP financial measures. .

I also want to mention that we're aware that there's been some technical issue with accessing our investor summary posted on our investor website. And that's in the process right now of being addressed and taken care of. [Operator Instructions].

I also want to note that copies of remarks from today's call will be available on the Investor Section of Western Digital's website immediately following the conclusion of this call. .

I will now turn the call over to President and Chief Executive Officer, Steve Milligan. .

Good afternoon, and thank you for joining us. After my opening remarks, Tim Leyden will provide additional commentary on our December quarter results and our outlook for the March quarter..

We executed well in the December quarter, as we continued to participate in the ongoing growth of data in all of our served markets. The industry TAM was slightly higher than anticipated, driven by seasonal demand. We saw strength in gaming and branded products.

We exceeded our expectations on revenue, gross margin and earnings per share in the December quarter, and our cash generation remains strong. The consistency in our financial performance reflects the reduced volatility in our business. .

We continue to be very excited about our unique position in the storage ecosystem, enabling a broad-based perspective on the dramatic changes that are underway. We serve very large markets, underpinned by strong data growth prospects.

It is clear to us that most of the world's data will be stored on hard drives and enterprise-class, solid-state drives in tiered architectures, as companies and consumers seek to optimize performance. .

Strategically, we are well-positioned to play a leadership role by innovating and collaborating with our customers to define the future digital data landscape. Total exabytes shipped and average gigabytes per drive continue to grow, reflecting strong customer response to our enterprise and branded products.

These are 2 growing businesses where we have established leadership positions. Continued success in these markets offers us the opportunity to achieve even better financial results over time as we add more and more value to our solutions.

As data becomes more strategic in the enterprise, companies are investing differently in IT infrastructure, looking to achieve optimal total cost of ownership. This is resulting in more fragmented solutions, allowing for more customization and value creation by storage providers.

These trends are helping to drive the upward trajectory in our cloud-related revenue..

Over the last few months, customers have responded positively to 2 of our newest products addressing the demand for innovative solutions in the personal, public and private clouds.

Specifically, we launched the WD My Cloud, a comprehensive personal cloud solution for users to organize, centralize and secure their digital content and access it from anywhere in the world. This is an important element of our Connected Life initiative to improve the connectivity of the home.

We launched our 6 terabyte helium-based sealed drive, which leverages our proprietary technology platform called HelioSeal. Select strategic customers have already qualified the drive, and we are shipping the product. .

We have also seen continued customer preference for our portfolio of enterprise-class, solid-state drives. In the December quarter, our SSD enterprise revenue outpaced the growth rate in the overall SSD enterprise market, as we continue to integrate our recently acquired talent and technology into the HGST SSD organization. .

We are excited about the year ahead, tempered by the industry's usual seasonality in the first half of the year. We see several potential drivers for a better demand environment, including prospects for an improving global economy, a stabilizing PC market and ongoing investment in both the traditional and capacity enterprise markets. .

I will now turn the call over to Tim Leyden. .

Thank you, Steve. Our strong December quarter performance benefited from solid market demand, favorable channel and business mix, and continuing good execution.

The hard drive industry shipped approximately 142 million units during the December quarter, up from the September quarter and the year-ago period, and the TAM came in slightly higher than the guidance we gave on our October call.

In our business, we saw strength in gaming, consistent quarter-over-quarter performance in client and enterprise, and the anticipated seasonal pickup in branded products..

Our distribution and retail channel inventory remains lean. Our revenue for the December quarter was $4 billion, including $155 million from Enterprise SSDs.

While we expect our Enterprise SSD revenue growth rate to continue to exceed that of the industry, the upward trajectory in the December quarter was especially strong, given a single-source opportunity. Overall, 54% of our revenue came from non-PC applications. We shipped a total of 63.1 million hard drives at an average selling price of $60.

The quarter-over-quarter increase in overall ASP was primarily driven by the seasonal uptick in branded products and strength in distribution. .

Our gross margin for the quarter was 28.7%. Non-GAAP gross margin was 30.1%, excluding $40 million of amortization expense for acquired intangible assets, as well as $15 million of restructuring charges. We exceeded our implied guidance from non-GAAP gross margin by 30 basis points, primarily due to favorable business mix..

$12 million of charges related to certain litigation; $11 million of amortization expense for acquired intangible assets; and $6 million of restructuring and other charges. R&D included $5 million of restructuring charges. As a reminder, the previous period included a flood-related insurance recovery of $65 million..

We accrued interest charges of $13 million in the December quarter relating to the Seagate arbitration matter. Tax expense for the December quarter was $37 million or 8% of pretax income. Our net income for the December quarter totaled $430 million or $1.77 per share. On a non-GAAP basis, net income was $532 million or $2.19 per share..

Turning to the balance sheet. We generated $727 million in cash from operations, and our free cash flow totaled $557 million. Our CapEx for the December quarter totaled $170 million or 4% of revenue. As part of our capital allocation program, we repurchased 2 million shares for $150 million during the December quarter.

We also declared a dividend in the amount of $0.30 per share. We exited Q2 with total cash and cash equivalents of $4.7 billion, of which approximately $700 million was in the U.S..

I will now provide our guidance for the March quarter.

We expect revenue to be seasonally down and in the range of $3.65 billion to $3.75 billion, reflecting the seasonally lower TAM; gross margin approximately at the midpoint of our 27% to 32% model, excluding the amortization of intangibles, reflecting the impact of lower factory utilization due to lower volumes; r&D and SG&A spending of approximately $600 million, excluding the amortization of intangibles; a tax rate of approximately 8%; and a share count of approximately 243 million.

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Accordingly, we estimate non-GAAP earnings per share of between $1.80 and $1.90 for the March quarter, which includes a dilution impact of $0.10 from the sTec and Virident acquisitions. As a reminder, we expect the sTec, VeloBit and Virident acquisitions to be accretive early in calendar year 2015. .

Overall we are pleased with our continued strong performance. We are enthusiastic about our prospects to play an increasingly strategic role in the evolving storage market. .

Operator, we are now ready to open the call for questions. .

[Operator Instructions] And our first question comes from Katy Huberty with Morgan Stanley. .

How would you characterize the compute in enterprise markets versus your original expectations in December? And then can you just talk about, in each of those segments, what you think seasonality will look like in the first quarter? And you mentioned potential upticks as the economies improve.

When would you expect to see the better seasonality off of the macro recovery?.

Sure, Katy. A couple of comments, in terms of the quarter, the past quarter, so calendar Q4, for the most part, it really kind of played out to the way that we expected it. Enterprise really sort of came in, both in terms of performance enterprise and capacity enterprise, more or less turned out the way that we expected it.

Where we saw a little bit more strength was the notebook business, or 2.5-inch client business was maybe a bit stronger than what we expected it to be. The -- also, the gaming market, gaming business was certainly stronger than what we expected. The new gaming consoles appear to be -- consumers appear to be responding to them very favorably.

That's encouraging to us. We're glad to see that. And again, I think the branded products business was seasonally stronger. And so, really, things played out very consistently to our expectation, with a bit more strength in gaming and a bit more strength in the notebook business.

Now, in terms of how things are going to play out in 2014, a little bit hard to say, frankly. One of the things that we're seeing right now, because we haven't seen it frankly for several years, is we're seeing seasonality return a bit. If you go back in time, we've had various things that have impacted seasonality.

We've had earthquake in Japan, we've had floods in Thailand, we've had other kinds of situations that have maybe masked, from our perspective, traditional seasonality in our business. So if you look at this quarter, the March quarter, PCs traditionally are down about 10%. So we're looking at a TAM reduction probably in the 5% to 7%, maybe 8% level.

One of the things that is making things a little bit difficult from a clarity perspective is that Chinese New Year is a bit earlier this year. So what we're seeing some of our customers do in the PC space is do a bit of build ahead in anticipation of the Chinese New Year shutdown, and then we'll have to see how demand picks up after that.

So that's just a bit of color in terms of what we're seeing from a demand environment perspective. .

And then just as a follow-up, there was margin upside this quarter, even without enterprise upside.

What would it take to get margins up into the 30% to 32% sustainably? What do you need to see over the next 4 quarters for that type of margin upside?.

To answer that question in kind of a generic way, what we're going to have to continue to do, which is really what we're really trying to do all the time, is continue to add more value from a customer perspective. And we do think that as we do that, there's an opportunity for us to see our margins creep up a bit.

I mean, that's really what we've been doing. Obviously, we're going to continue to do the things that historically we've done, which I'll call it the normal blocking -- blocking and tackling, managing our mix, managing our costs effectively. And so -- but really what we've got to do is continue to add more value from a product perspective.

The other thing is, is that specifically as it relates to our Enterprise SSD business and some of the acquisitions that we made there, we need to continue to ramp those, which is coming along nicely.

And as we do that and as we see that become a more material part of our business, that should contribute favorably to our gross margin structure going forward. .

Next question comes, from Rich Kugele with Needham. .

Just a few questions for me. I guess, first, let's talk about the SSD side a little bit.

Do you see the operating structure of the now combined entity appropriately sized and the accretion that's in early calendar '15 is driven by just revenue growth? Or do you have some operational changes that you're trying to make as well? Just trying to understand the puts and takes that get you from here, with $0.10 dilution, to the accretion. .

Rich, I think there's a couple of different factors. I mean one, we're still in the process of making sure that we optimize the organization, both from a pure headcount perspective, as well as making sure that we've got the right mix of employees. And so that process is ongoing. We'll continue to do that.

But the main thing that we need to do in order to realize that accretion in 2015, is continue to ramp our revenue appropriately with the appropriate product set. .

Okay. And then secondly, just looking at, obviously, Xyratex is taken out by Seagate.

Can you just comment on your view of testers and your relationship with Teradyne?.

Yes. So, really, a couple of things. It's a little bit hard to respond to that specifically at this point, Rich, because Seagate has, to my knowledge, made no specific comments externally in terms of what their plans are with the Xyratex organization, and more specifically, as it relates to their tester business.

That being said, we're obviously looking at various different ways that we can manage any potential impact that might occur related to that transaction, and part of it has to do with our relationship with Teradyne. .

Certainty, I guess then, from your manufacturing footprint today, you feel comfortable you have enough flexibility in your testing capacity?.

Yes. .

And then lastly, because I've been asked the question, any disruptions from the unrest in Thailand? I know you guys have been there a very, very long time and have seen these things from time to time. But, just because I've been asked. .

Yes. And no disruption. And we're obviously monitoring the situation very, very closely. Our -- one of our primary things is to continue to make sure that our facilities and employees are safe, and the disruptions have been occurring in, call it, the center of Bangkok.

Our facilities, we have 2 primary facilities in Thailand that are pretty well outside of the Bangkok area, but we do have employees that are located, and so we're making sure that we've got appropriate transportation for them and that sort of thing, so that our facilities and our employees are protected.

And we certainly, to your point, Rich, we've seen this before. We don't -- we continue to take it seriously because it could become more volatile.

So we've got to keep a close eye on it, but we clearly have a number of different contingency plans in place to make sure that we can work through various different situations to ensure appropriate supply to our customers and protection of our employees. .

Next question comes from Aaron Rakers with Stifel. .

I guess, first question from me is just to go into the free cash flow generation. You've been very consistently north of $2 billion in free cash flow, but one of the things that's interesting is your cash conversion cycle is notably above your 4- to 8-day target range, which is reiterated in the material today.

So just curious to how you're thinking about free cash flow generation as we look forward, and kind of tying that back to how do we get from a 19-day cash conversion cycle down to that 4- to 8-day range that's your stated target?.

Yes, this is Tim. We've got opportunity in inventory, definitely, and we've actually been in transition a little bit because we've got a higher percentage of our total business which is now enterprise driven. So consequently, that does place a little bit of pressure on inventory.

In addition to that, we have been utilizing finished goods for 2 purposes. First of all, in order to smooth out some of the linearity challenges, because we're making choices to take spikes out of the production and to build ahead where necessary and be able to carry a little bit extra inventory. That's one particular item from an inventory viewpoint.

Secondly, we've also been making choices to put more inventory on the ocean in order to help our cost of goods sold. So, we are working the inventory pretty much in order to get to optimum positions. And I think we've got some room there.

In terms of DSOs, we got worse in DSOs quarter-on-quarter, and that's driven a little bit by the peculiar linearity in the December quarter. Because, as Steve already mentioned, that the timing of Chinese New Year in the current quarter, the early timing of it, was driving some different behavior by customers.

But the timing of the Christmas period was also an issue. So consequently, what we saw was a little lighter linearity in the October timeframe and a bit stronger linearity in the November timeframe. So consequently, we had to carry a couple of more days DSOs as a result of that.

And our 4 to 8, we're going to reevaluate it, because I do think that there are some differences in our business that now have to be dealt with, and we're going to have to reevaluate whether the 4 to 8 is really appropriate. But we've certainly got an opportunity there in order to be able to generate more cash.

And of course, we've got to keep the profitability, and Steve talked a little bit also about driving higher gross margin, higher ROC, and that will generate -- that will help us also to continue to generate the -- to generate the strong cash generation that we've been seeing for 8 quarters now in excess of $500 million. .

Just to add one comment to that, just quickly. Absent Tim's comment in terms of, call it reevaluating whether or not the 4 and 8 -- 4 to 8 makes sense, given different dynamics in our business, which I think is obviously appropriate.

The other thing is, is that there's no way that we're going to get within that range under the hold-separate arrangement. The hold-separate arrangement continues to drive inefficiencies in our business from a financial perspective, which we obviously believe translates to value that we can provide to our customers.

And so, we'll be looking for an opportunity to request that, that be lifted in March. And that should help us address some of this as well. .

Great, as the quick follow-up I'd just like to understand, as you think about the SSD business growing and kind of flowing through your model, so first of all, what was the dilutive impact that we recognize in the December quarter? Do you still see a $0.20 dilution in total for fiscal '15? And how do we think about that business ramping in the context of gross margin flowing on the consolidated P&L?.

On a quarterly basis, it's a dilution of about $0.10 per quarter. And from a gross margin viewpoint, we measure that business on basis of ROIC and it's at the high end of our ROIC range. .

Next question comes from Keith Bachman with Bank of Montréal. .

I wanted to go back to the TAM for a second. Last year in the March quarter, at the same conference call, you guided revenues for the March quarter to be down 4% to 6%, I believe it was. Revenues end up coming down sequentially about 2%, and the TAM was relatively flattish.

So as you -- to Katy's question, I think you intimated that the TAM would be in the low 130 million range, 133 million, 135 million. I understand Chinese New Year is a few weeks earlier this year than last. But what's really the difference on how you're thinking about the TAM this year versus last year? Because it seems like a pretty big drop off.

Or is there certainly some element of conservatism in there?.

Keith, let me comment on that. Really, the dynamics that we're seeing, just to kind of oversimplify it, is it's primarily related to the PC market. And I know there's been a lot of commentary or speculation in terms of what's happening with the PC market. Let me give you our perspective on that.

We have seen the PC market, I will call it, begin to stabilize. Obviously, the PC market still shrunk in calendar Q4. And so it's less bad than what it used to be. However, there is still a fair amount of cautiousness on behalf of our customers in terms of what the demand environment is going to look like, in terms of the first half of calendar 2014.

That cautiousness is factored into the guidance that we've provided. .

And not only that, the visibility that our customers have is a bit -- it isn't that -- I mean, in terms of the demand environment, they're just very cautious.

Now that being said, I think one very important point is that our customers, in my view of -- in our visibility or knowledge of the PC channel inventory as best we know it, it's in very, very healthy shape. In other words, what I mean by that is [indiscernible]. And so that's very good.

And so if there does happen to be, at this point, an unanticipated pickup in PC demand that's not reflected in our numbers, obviously, that will translate to upside to our numbers in the March quarter. But there's still a fair amount of cautiousness out there, Keith. .

Okay.

And then my follow-up, perhaps if you can lay out as best as you can a framework or a schedule with milestones as you think about your discussions with MOFCOM and the Chinese? How should we be thinking about the sequence of events, the timing of the events and the impact of both, number one, your OpEx, and then number two, the opportunities with cost of goods sold?.

Sure. I'll comment on the process as best I can. Just to remind everybody, in March, we have the opportunity, I will call it, reapply or submit a request to MOFCOM for them to lift the hold-separate restriction. In terms of how the process plays out from there, I'm sorry to say I don't know how that's going to play out.

We don't have a lot of visibility to that. It's a new process. In other words, we are either the first or one of the first companies to actually reapply for that to be lifted. So we're going to have to see how that goes.

In the meantime, our working relationship, more from the standpoint of us complying with the hold-separate, continues with MOFCOM and continues to be constructive.

And we'll continue a dialogue with them as we get closer to March to aid us in having more transparency in terms of how the process will unfold, and we'll inform the investment community as we learn more as to how that's going to play out.

In terms of the impact on our financial results, what we have said is that we believe that it will allow us to realize OpEx synergies of about $100 million a quarter. We have not quantified the impact from a gross margin perspective, but obviously, it will be beneficial to our gross margin profile as well. .

Next question is from Mark Miller with Noble Financial Capital Markets. .

IBM reported and I think Intel also reported that the server business was somewhat softer. And there are some specifics there for both firms. For example, Intel, I think had some problems ramping its motherboard shipments with its new Xenon chip. And I'm just wondering about the enterprise market.

You've been flat there for the last couple of quarters on units where there are some industry-specific things that are impacting the market, and how does that look?.

We were not affected by any of that and had no visibility to that. So as I indicated earlier, the performance enterprise business, which would be directly applicable to server-related activity, pretty much came in along our expectations. .

Okay.

And just as a follow-up, did you see any strengthening, or have you seen any strengthening as this quarter began or as the last quarter ended? Have we seen linear results or just normal seasonality?.

Are you talking about the March quarter?.

In the current quarter, I mean, is that showing any -- is that just showing normal seasonality?.

Well, the March quarter, as we talked about earlier, Chinese New Year is early this year, earlier than normal. Also, we've got some rather large OEM customers with January year ends or quarter ends. And so linearity so far in the March quarter has been strong.

The question is, is how sustainable is that as we get past Chinese New Year, as well as we move into what traditionally would be weaker times of the year, March, and then, obviously, April. But that's the next quarter. So those typically, from a seasonal perspective, are getting into the weaker times of the year for us. .

The next question comes from Scott Craig, Bank of America. .

Steve, I was just wondering, on the PC market you talked about next quarter, the conservatism. How much of that is coming from the consumer market versus the commercial market? And then from an OpEx standpoint, let's just make the assumption that MOFCOM doesn't get released anytime soon.

But what's the right sort of OpEx range that you guys can run it in? Is it the $600 million you're talking about next quarter? Or can you gradually burn some of that down a little bit back into that $500 million, $595 million range you talked about historically?.

Yes, so on the PC front, just to add a little bit more color, we have seen -- where the strength has come has been in the commercial segment. So the cautiousness is clearly in the consumer market. And so that's that. Let me give a little bit of context to the OpEx situation, and then I'll have Tim comment on the specific numbers.

We're in a bit of a transitioning kind of period, really for 2 different reasons. One is, is that we've got the pending application or submission to MOFCOM, and what may or may not be the outcome of that, which at this point we don't know what the decision will be.

The second thing is, is that we've got these recent acquisitions that we've done and investments that we're making in Enterprise SSD.

One of the things that we want to make sure, we know that we are disadvantaged from a financial perspective versus our, in this case, largest competitor from an OpEx perspective, because we are required to carry, in some cases, 2x of whatever it happens to be from an investment perspective, given the regulatory situation that we're in.

One of the things that we want to make sure that we are doing, which does drive a higher level of OpEx, is that we are investing appropriately in some of these new initiatives. And so as we go through this transition period, finding that right level of OpEx is a bit more challenging than otherwise it would be.

And so that provides a bit more context in terms of, from a business perspective, what we're dealing with in terms of our operating expenses. So Tim can comment on the specific numbers. .

Yes, so our guide for the December quarter was -- for non-GAAP, was $595 million. We actually came in non-GAAP at around $616 million. And the major differences there were driven by the stock appreciation rights, which covered more than 60% of the difference between those 2 numbers, and the balance was performance incentives.

And in the longer term -- sorry, in the near term, near to midterm, I think $600 million run rate is probably a better number to go with for now. So a $600 million number is one that you should be plugging into the models. .

The next question is from Sherri Scribner with Deutsche Bank. .

I was hoping to get a little bit of detail on your cash flexibility. Tim, I think you said you have $700 million in cash in the U.S. I know you have a strategy of spending about 50% of your free cash flow on dividends and buybacks, but it looks like your U.S. cash is getting a little tight.

So I just wanted to get a sense of how much longer you can sustain that. I know you just did a refinance of your debt, but maybe some detail there would be helpful. .

Yes, Sherri. The -- you're right in the numbers, $700 million as we closed the quarter. However, our -- the renegotiation of the bank loan did improve our position. We did that renegotiation for a number of reasons. The first one being, obviously, taking advantage of the market conditions. We also got lower rates.

We got a longer time period, extending from 2017 up to 2019. We upsized the facility also. And the biggest advantage relative to your question is that we brought it from offshore to onshore. So consequently, the $700 million now has the capability to be able to be up around $3 billion or so.

So consequently, we've taken action in order to ensure that we don't get tight relative to continuing to meet our obligations or what we've promised on the capital allocation front. .

Okay. Tim, that's helpful. And then I just also wanted to get an update on your CapEx plans. I know you guys were in the middle of upgrading your wafer facility, that took a couple of years.

Is that finished? And what would you view is the investments you need to make in CapEx this year?.

Yes, we'd be able to stay within our 5% to 7% model. We've actually, for the first couple of quarters, I think we've been running more like 4%. We're -- from a CapEx viewpoint, I think we're underutilized in heads. We're underutilized also in substrates and sputtering, though not as much underutilized in heads.

And of course, in assembly and in test, we continue to balance that and respond to the market. So I think we'll be -- we are pretty comfortable we will stay within the model, the 5% to 7% model. .

And the wafer is done, is that right or no?.

Yes. .

Yes. .

Next question is from Mark Moskowitz with JPMorgan. .

I just want to build off of Sherri's question on CapEx.

Steve, what's kind of your view if the market or the TAM improves by 5% to 7% this year, let's -- hypothetical, what would you be -- what would be your response? Will you kind of be measured and then not really have to add capacity during the first few quarters, or would you have to add at a pretty big pace? I guess we're just -- we're often just kind of curious in terms of what would be the kind of the puts and takes? Do you have it to really increase the CapEx if the...

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I think we're addressing it at a little bit more general level. I think that we are in pretty good shape from an overall capacity perspective. In other words, if you saw the TAM increase to the number that you're talking about, we would not have to add a lot of capacity. We might have to add a bit of test assembly, but that tends to be lower cost.

So I would expect that our capital budget or capital spending should be closer to the low end of that 5% to 7%. And certainly, where we're at year to date, we're actually below that. So I don't envision us making any meaningful capital additions this year that would spike that number upwards. .

Okay. And then the other question is a little more bigger picture.

Just given the talent that WD has been hiring, as well as acquiring on the software side, how should investors think about your longer-term kind of place in the ecosystem of the data center? Are you going to have more of an impact in terms of helping design and architect systems versus just building the devices that go in the systems? And how does that impact your interaction with both the end customer as well as the OEM customer?.

Well, that's a bit of a complicated question in the sense that the storage ecosystem, as we've alluded to, is changing quite dramatically in a number of different ways, and for, really, all participants. So that is for us and our primary competitors. It is for, I will call, our traditional customers.

And it's also for some of our newer, if you want to call it, non-traditional customers, so some of the hyperscale guys. Also, the use cases, in other words, what people are doing with data, is changing quite dramatically.

That then gets into increased complexity, increased fragmentation, increased opportunity for us and, if you want to call it, increased customization.

That's allowing us the opportunity, whether it happens to be by providing additional tiers from a product perspective, if it happens to be adding different value from a software perspective, it allows us the opportunity to add value to our customers, whether they be hyperscale or traditional customers, in a different way.

As we do that and if we do it -- if we execute appropriately, that certainly does provide us with the opportunity to look at margin expansion over time. We're certainly not committing to that, but we do think that that's an opportunity that we should be striving to realize as we move forward. .

Next question is from Amit Daryanani with RBC Capital Markets. .

A couple of questions for me. One, maybe if you could just start -- if you could talk about your enterprise business. Looks like total units are kind of flat on a sequential basis. Any dynamics you saw within the business-critical and capacity-optimized side would be helpful. .

Nothing particular in terms of performance or capacity enterprise. Capacity enterprise can be a bit lumpy. The -- in other words, it's a little bit project-based. We did -- and I'm not concerned about this, just so that everybody is aware. I think we did lose a bit of share in the quarter.

That just tends to be the lumpiness about particular projects, and which customers, and that kind of thing.

But the long-term and overall industry level from a demand perspective, things played out more or less as we expected it, nothing to really speak of, and we continue to feel very positive about how we're positioned from an overall competitive standpoint. .

Got it.

And then, I guess, if I look at the free cash flow generation, which you guys talked about, has obviously been very strong for the last several quarters now, how do you think about the 50-commitment, the returning 50% of free cash flow back to shareholders? Given the deals that you guys have done, and now you have a good portfolio in the flash[ph] side, do you start to evaluate that and potentially move that number higher? Or do you need the MOFCOM decision to be behind you to revalue that 50% threshold?.

Certainly, the MOFCOM decision would help and the synergies that we would pick up from that would certainly be a help. But we do evaluate the percentage of free cash flow that we are allocating. And when we made the decision in September 2012, it was a pretty big decision for the company. It was something that we hadn't done before.

So we're at the point where we're constantly evaluating it, and once we see that there is an opportunity to be able to respond to it and particularly, if we get some significant synergies from integration, then we would look more favorably at increasing it. .

Ananda Baruah with Brean Capital. .

Two if I could. I guess the first one goes back to gross margin, Steve and Tim.

Steve, earlier, you commented that, I guess, what you saw as the meaningful drivers, our ability to add value, and then if you mix appropriately and sort of get SSD integrated in a responsible way, does that also suggest that TAM stays, let's call it, like a 135 million to 145 million range -- 130 million to 145 million range, where it's kind of been the last 6 to 8 quarters, that you would also have the expectation for margins to continue to appreciate over time?.

So the -- if you go back to what we've talked about in terms of longer-term unit growth, which we talked about in September of 2012, we have not updated our expectations at this point, but we talked about a longer-term 3% unit growth. The real big swing factor there is what actually happens with PC sales. That does not assume growth in PC sales.

It's more -- so the question is, what exactly? Because that's such a big part of the number, right? And so my comment -- if the TAM drops significantly, then obviously, we'd have to look at something. But I don't think -- we are not assuming that there is going to be a meaningful TAM expansion from an overall perspective.

So if the TAM was in the 135-ish million range, just kind of use that as a round number. My comment that I made in terms of margin expansion still stands. .

Okay. Great. That's very helpful. And then just a follow-up for me, guys.

What are your TAM expectations for 2014 calendar?.

We haven't given a number, and at this point, I don't think we're going to be giving a number. We have to kind of wait and see. There's still a fair amount of cautiousness out there, uncertainty. But again, we'll have to continue to monitor. .

Next is from Jayson Noland with Robert Baird. .

Steve, I wanted to come back to your comment in the prepared remarks about customization in the cloud. I assume this relates back to the helium drives.

But do you expect to see a fairly wide portfolio with specs that maybe differ by customer or by industry vertical?.

Yes. I mean, in other words, the use cases that we're seeing for various different customers are different. And so, accordingly, the solutions or the product suite that they're looking for varies. So there may be some customers that go to extremes that have no interest in Enterprise SSDs for whatever reason.

And then you may have other customers that have a high degree of interest in that, but no interest in the helium-filled drive. So it depends upon how they are utilizing data in their organization. That's impacting how we work with those particular customers. .

It's a really interesting dynamic. I assume more R&D spend would be involved, and likely higher-ASP products and a higher-profit product also. .

Correct. .

Steven Fox with Cross Research. .

Just two questions for me. First of all, it looks like your average capacity per drive accelerated for the first time in about 3 quarters.

Can you sort of talk about how much of that trend is sustainable going out over the next few quarters? And what drove it in the most recent quarter? And then secondly, I think you mentioned the SSD sales of $155 million. There was sort of, I guess, a onetime project in there.

Just sort of how impactful is that as we look towards the next quarter on a sequential basis?.

I'll address the average gigabyte, and Steve will address the SSD. So average gigabyte, the -- what contributed to that was a couple of factors. The first one is the strength in branded products, and that has a significantly higher per-drive capacity than the rest of the consumer business.

And of course, we also had a strong distribution channel in the quarter. So that drove most of that improvement. .

And then in terms of Enterprise SSD, the sole-source opportunity was meaningful enough that we felt compelled to comment on it, obviously. And given that, and that it is a bit of a nonrecurring situation, we may see our revenue decline slightly going into this quarter. But obviously, it's still a bit early to call that for sure. .

And just to follow up on that, there's -- I mean, depending on who you talk to, you could see Enterprise SSD demand be as high as like 30%, 40%, if not greater, depending on what you think about capital spending.

I mean, is that the type of industry you're sort of benchmarking against when you talk about outperforming the industry in coming quarters?.

Yes. .

Next question is from Joe Yoo with Citi Research. .

So your hard drive ASPs were up meaningfully on a sequential basis, despite gaming actually being strong. So I wanted to ask what drove the increase.

And related to that, can you provide some color on the like-for-like pricing and cost declines for the quarter? And were they better or worse than expected?.

Okay. So pricing was driven again by the strength of the channel and the strength of the consumer in branded. And that does tend to drive higher average ASP. And from a cost viewpoint, the cost decline has slowed down because the areal density improvement has slowed down.

So what we're seeing is somewhere in the region of between 1% and 2% of cost decline. And pricing is following cost decline, so we're seeing pricing decline in moderation as well as a result of that. .

I see. And as a follow-up on the Enterprise SSD space or business, you guided again for another $0.10 dilution from the acquisitions in the March quarter.

So should we be modeling a $0.10 dilution for much of this year, this calendar year, or should we be looking at some kind of relief from that dilution as we get into the second half?.

That dilution will remain pretty much right through the end of the year, because we'll begin to see the accretion in the early half of 2015. So consequently, we should keep that dilution in the model through the calendar year. .

Next is from Nehal Chokshi with Technology Insights Research. .

With the WD My Cloud, can you provide any metrics around the traction you're getting with this? And also, is it reasonable to believe that this is an incremental TAM above the current branded market, given the increased functionality and effective ASPs companies like Dropbox are charging beyond initial free capacity? Anything you can do to help us size this opportunity in an incremental fashion will be definitely helpful.

.

Yes, it's an interesting question. I'm not sure that, at this point, we have enough data to know if it's incremental to the traditional business versus just substituting other units. And so I think we'll have to continue to monitor that. Relative to specific data, we traditionally have not broken out specific sales of a given product.

And so -- but we're very encouraged by the response from the marketplace so far. And we have, I'll call it, high expectations for continued success in 2014. .

And if I may, I'd like to ask about desktops. I'm not quite sure I understand why desktops were down when Intel reported an 11% increase year-over-year in desktops from their perspective. .

We had a bit of share loss that's not reflective of the industry. Desktop, as an overall statement, is a pretty stable market. .

Our next question comes from Joe Wittine with Longbow Research. .

I think the enterprise has been beat to death pretty well, but I'm going to ask a question again. You saw the flattening in the back half of the year. I'm just curious what's a reasonable expectation for unit growth going forward as we look into calendar '14.

From reading between what you said, it sounds like we got a little bit of a pause in some of the capacity buildouts. So looking out over the next 4 quarters, theoretically, some of those ebbs and flows kind of gets smoothed out.

Are we still looking at a high-single-digit/10% kind of unit number that I think you last spoke about at your most recent analyst day?.

Yes, what we're looking for is somewhere in the region of high-single digits on an annual basis, and particularly in capacity. In performance, we -- that's going to be pretty much flat, I would say. .

Okay. Great. And then on the cash return to shareholders, it seems like right now you're actually trending closer to 40% of the current run rate.

I understand, maybe the cash flow weakens with the seasonality coming up here in the first half of the calendar year, but is that kind of the rate right now to expect, perhaps as you're still accruing $25 million a quarter for the Seagate court ruling? Or could there be a step-up there even absent a court ruling and absent a MOFCOM ruling, let's say?.

Well, it's hard to be pretty precise about it, but our objective is to meet our obligations, which is to pay out 50% of the free cash flow. Unfortunately, there were a couple of things that happened in the December quarter which mitigated against that.

One of them was we had to pay for the Virident acquisition and also, we had the secondary offering with Hitachi. And both of those... .

Closed the window. .

Didn't allow us to be able to be active in the market during the period that those things were open. So consequently, that mitigated against our ability to get to the 50%. .

Okay. And then finally, a very quick follow-up.

Tim, the $0.10 dilution that's there from the SSD acquisition, is that totally on the OpEx line? So -- and if that's the case, is it about $20 million, $25 million per quarter, in that range?.

Yes, it's mostly in the OpEx line. .

Next question is from Rob Cihra with Evercore. .

Hopefully, I can get two questions in just to keep the pattern going. One, just on hybrid drives, nobody talks about them all of a sudden. I was just wondering what your progress is like there in the December quarter maybe versus your expectations.

And then separate from that, in gaming, given the good strong start for the new game console cycles, obviously, it's helped the past couple of quarters.

If you look at seasonality in that, it's not cyclicality, and through the year, how do you plan for that, given you don't have necessarily the same sort of seasonality you might have in most businesses? There's more of a cyclicality to it and particularly, maybe Steve, you have history there from your Hitachi days.

How do you plan for that, given that it's sort of driven by 2 customers?.

Yes. So on the hybrid, the volumes for 2013 were modest, which was more or less consistent with what our expectations. And what we have said historically and it remains the case, is that hybrid is more of a 2014 story for us. We'll have to continue to see at what level we make momentum from a customer perspective, acceptance of that kind of a solution.

But things are tracking to our expectations. We did not expect the volumes to be that large in 2013. Relative to gaming, it's an interesting question. There is not really seasonality there. I mean, there's a bit of it in terms of when they build.

But they tend to build earlier in the year, put them on boats, get them stocked up and save on the shipping costs, and that sort of thing. So I would say that we're very encouraged by the reception to the new gaming consoles. And I think that, that -- and also the fact that it's a one-to-one attach rate with hard drives.

We do not obviously have all of that business, but we participate in a very healthy rate with the 2 customers that you commented on. And we do view that as a bit of a tailwind for the drive industry going into 2014. .

So thank you, all, for joining us, and we look forward to updating you as we go forward. So thank you very much. .

Thank you. This does conclude today's conference call. You may disconnect at this time..