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Western Digital Corporation (NASDAQ:WDC)

F2Q14 Earnings Conference Call

January 22, 2014 5:00 PM ET

Executives

Robert Blair - VP, IR

Stephen Milligan - President and CEO

Timothy Leyden - CFO

Analysts

Kathryn Huberty - Morgan Stanley

Richard Kugele - Needham and Company

Aaron Rakers - Stifel Nicolaus

Keith Bachman - BMO Capital Markets

Mark Miller - Noble Financial Capital Markets

Scott Craig - Bank of America-Merrill Lynch

Sherri Scribner - Deutsche Bank

Mark Moskowitz - JP Morgan

Amit Daryanani - RBC Capital Markets

Ananda Baruah - Brean Capital

Jayson Noland - Robert W. Baird & Co., Inc

Steven Fox - Cross Research

Joe Yoo - Citigroup Global Markets

Nehal Chokshi - Technology Insights Research

Joseph Wittine - Longbow Research

Rob Cihra - Evercore Partners

Operator

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 Mr. Bob Blair. You may begin, sir.

Robert Blair

Thank you. As we begin, I want to mention that we'll 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. 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 with 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 acquisitions of HGST, VeloBit, sTec and Virident, employee termination benefits and other charges and charges to litigation. 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 are aware that there has been some -- a technical issue with accessing our investor summary posted on our Investor website, and that's in the process right now, being addressed and taken care of. We ask that participants limit their comments to a single question and one follow-up question in the Q&A session today. I also want to note that copies of remarks from today's call will be available on the Investor's 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.

Stephen 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 continue 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 remained 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 continued to grow, reflecting strong customer response to our enterprise and branded products. These are two growing businesses, where we have established leadership position. 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 two 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 investments in both the traditional and capacity enterprise markets.

I will now turn the call over to Tim Leyden.

Timothy 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 clients and enterprise, and the anticipated seasonal pick-up 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.

R&D and SG&A spending totaled $650 million for the December quarter. SG&A included the following items: $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 pre-tax 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 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 US.

I will now provide our guidance for the March quarter. We expect revenue to be seasonally down, and in a 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 the share count of approximately 243 million.

Accordingly, we estimate non-GAAP earnings per share 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.

Question-and-Answer Session

Operator

(Operator Instructions). And our first quarter comes from Katie Huberty with Morgan Stanley. Your line is open.

Kathryn Huberty - Morgan Stanley

Hey good afternoon. Can you hear me okay?

Stephen Milligan

Yes.

Kathryn Huberty - Morgan Stanley

How would you characterize the compute and enterprise market 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? Thanks.

Stephen Milligan

Sure Katie. 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 the 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 may be a bit stronger than what we expected it to be.

Also, the gaming market, gaming business was certainly stronger than what we expected. The new gaming consoles appeared to be -- consumers appeared to be responding to them very favorably, and that's encouraging to us, we are 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 are seeing right now, because we haven't seen it frankly for several years, is we are seeing seasonality return a bit. If you go back in time, we've had various things that impacted seasonality. We have had earthquake in Japan, we have had floods in Thailand, we have had other kinds of situations that have -- may be 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 are looking at a TAM reduction of probably in the 5% to 7%, may be 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 are 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 will have to see how demand picks up after that.

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

Kathryn Huberty - Morgan Stanley

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 four quarters, for that type of margin upside?

Stephen Milligan

To answer that question in kind of a generic way; we are going to have to continue to do, which is really what -- we are 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 is an opportunity for us to see our margins creep up a bit. I mean, that's really what we have been doing. Obviously we are going to continue to do the things that historically we have done, which I will call it the normal 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.

Kathryn Huberty - Morgan Stanley

Okay. Thank you very much.

Operator

Next question comes from Rich Kugele with Needham. Your line is open.

Richard Kugele - Needham and Company

Thank you. Good afternoon. 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 at early calendar 2015 is driven by just revenue growth, or do you have some operational changes that you are trying to make as well? Just trying to understand the puts and takes that gets you from here, with $0.10 dilution to the accretion?

Stephen Milligan

Rich, I think there is a couple of different factors. I mean, one, we are 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 have got the right mix of employees, and so that process is ongoing, and we 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.

Richard Kugele - Needham and Company

Okay. Then secondly, just looking at obviously Xyratex taken out by Seagate. Can you just comment on your view of testers and gate relationship with Teradyne?

Stephen Milligan

Yeah. So really 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 comment 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 are obviously looking at various different ways that we can manage any potential impact that might occur, related to that transaction, and part of that has to do with our relationship with Teradyne.

Richard Kugele - Needham and Company

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

Stephen Milligan

Yes.

Richard Kugele - Needham and Company

Okay. Then lastly, because I have been asked the question, many disruptions from the unrest in Thailand. I know, you guys have been there very-very long time, and are seeing these things from time to time, but this could have been asked?

Stephen Milligan

Yeah, and no disruption, and we are obviously monitoring the situation very-very closely. 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 about the center of Bangkok. Our facilities, we have two primary facilities in Thailand that are pretty well outside the Bangkok area, but we do have employees that are located and so we are making sure that we have 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 have seen this before. We don't -- we continue to take it seriously, because it could become more volatile, so we 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.

Richard Kugele - Needham and Company

Okay. Thank you very much.

Operator

Next question comes from Aaron Rakers with Stifel. Your line is open.

Aaron Rakers - Stifel Nicolaus

Yeah. Thanks for taking the question. I guess, first question for me is, just to go into the free cash flow generation. You have 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 four to eight day target range, which is reiterated in the material today. So just curious, how you are 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 four to eight day range, if that's your stated target?

Timothy Leyden

Yes, this is Tim. We have got opportunity in inventory, definitely and we have actually been in transition a little bit, because we 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 two purposes, first of all to smooth out some of the linearity challenges, because we are making choices to take spikes out of the production, and to build ahead, where necessary, and to carry a little bit extra inventory, that's one particular item from an inventory viewpoint.

Secondly, we have also been making choices to put more inventory on the ocean, 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 have got some room there.

In terms of DSOs, we got worse on DSOs quarter-on-quarter, and that's driven a little bit by the peculiar linearity in the December quarter; because -- 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 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 four to eight, we are going to reevaluate it, because I do think that there were some differences in our business that now have to be dealt with, and we are going to have to reevaluate if the four to eight is really appropriate. But we certainly got opportunity there in order to be able to generate more cash, and of course, we got to keep the profitability and Steve talked a little bit about also about driving higher gross margin, higher ROC and that would help us also to continue to generate -- strong cash generation that we have been seeing for eight quarters now, in excess of $500 million.

Aaron Rakers - Stifel Nicolaus

Okay, great.

Stephen Milligan

And just to add one comment to that, just quickly. Absent Tim's comment in terms of -- because we are evaluating whether or not the four to eight makes sense, given different dynamics in our business, which I think is -- which is obviously appropriate. The other thing is, is that, there is no way that we are going to get within that range, under the whole separate arrangement. The whole 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 will be looking for an opportunity to request that that be lifted in March, and that should help us address some of this as well.

Aaron Rakers - Stifel Nicolaus

Great. As a quick follow-up I'd just like to understand, as you think about the SSD business growing and kind of growing to your model, so first of all, what was the dilutive impact that we recognized in the December quarter? Do you still see a $0.20 dilution in total for fiscal 2015, and how do we think about that business ramping in the context of gross margin flowing, on a consolidated P&L?

Timothy Leyden

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.

Aaron Rakers - Stifel Nicolaus

Perfect. Thank you.

Operator

Next question comes from Keith Bachman with Bank of Montreal. Your line is open.

Keith Bachman - BMO Capital Markets

Hi guys. I wanted to go back to TAM for a second. Last year in March, at this same conference call, you guided revenues for the March quarter to be down, four to six I believe it was; revenues end up coming down sequentially about 2%, and the TAM was relatively flattish. So to Katie's question, I think you intimated that the TAM would be, in the low 130 range, 133, 135. I understand Chinese New Year is a few weeks earlier this year than last. But what's really the difference on how you are 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?

Stephen Milligan

Let me comment on that. Really, the dynamics that we are seeing, just to kind of oversimplify it, is it's primarily related to the PC market. And I know there has been a lot of commentary or speculation in terms of what's happening in 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 calendar 2014. That cautiousness is factored into the guidance that we have provided. And not only that, the visibility that our customers have, is a bit -- I mean, in terms of demand environment, they're just very cautious.

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

Keith Bachman - BMO Capital Markets

Gambling.

Stephen Milligan

And so that's very good. So if there does happen to be, at this time, 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. There is still a fair amount of cautiousness out there, Keith.

Keith Bachman - BMO Capital Markets

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

Stephen Milligan

Sure. I will 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 whole separate restriction. In terms of how the process plays out from there, I am 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 are going to have to see how that goes. In the meantime, our working relationship, more from the standpoint of us complying with all the separate, continues with MOFCOM and continues to be constructive, and we will continue a dialog 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 will inform the investment community, as we learn more -- as to how that's going to play out.

Keith Bachman - BMO Capital Markets

Okay, great.

Stephen Milligan

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.

Keith Bachman - BMO Capital Markets

Okay. Fair enough. Thanks guys. I will cede the floor.

Operator

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

Mark Miller - Noble Financial Capital Markets

Thank you for taking my question and congratulations on the quarter. IBM reported, I think Intel also reported that the server business was somewhat softer, and there are some specifics there for both firms, for example, Intel, they had some problems with its motherboard shipments, with its new Xenon chip. And I am just wondering about the enterprise market. You have been flat there for the last couple of quarters on units. Were there some industry specific things that are impacting the market, and how does that look?

Stephen Milligan

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.

Mark Miller - Noble Financial Capital Markets

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?

Stephen Milligan

Are you talking about the March quarter?

Mark Miller - Noble Financial Capital Markets

The current quarter, I mean, is that showing any -- is it just showing normal seasonality?

Stephen Milligan

Well the March quarter, as we talked about earlier, Chinese New Year is early this year, earlier than normal. Also we 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, when we move into, what traditionally would be weaker times of the year, March and then obviously April, but that's the next year. But those typically, from a seasonal perspective, are getting into the weaker times of the year for us.

Mark Miller - Noble Financial Capital Markets

Thank you.

Operator

Next question comes from Scott Craig with Bank of America-Merrill Lynch. Your line is open.

Scott Craig - Bank of America-Merrill Lynch

Thanks. Good afternoon. 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 are talking about next quarter or can you gradually burn some of that down a little bit, back into that 500, 595 range you talked about historically? Thanks.

Stephen Milligan

So on the PC front, just to add a little bit more color. We have seen, where the strength is coming, it 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 will have Tim comment on the specific numbers.

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

The second thing is, that we have got these recent acquisitions that we have done, and investments that we are 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, OpEx perspective; because we are required to carry, in some cases, 2X of whatever happens to be from an investment perspective, given the regulatory situation that we are 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. So that provides a bit more context, in terms of -- from the business perspective, what we are dealing with, in terms of our operating expenses. So Tim can comment on the specific numbers.

Timothy Leyden

So, our guide for the December quarter was -- for non-GAAP was $595 million. We actually came in on GAAP at around $616 million. The major difference there were driven by the stock appreciation rates, which covered more than 60% of the difference between those two numbers, and the balance was performance incentives. And in the near to mid term, I think the 600 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 model.

Scott Craig - Bank of America-Merrill Lynch

Thank you.

Operator

Next question is from Sherri Scribner with Deutsche Bank. Your line is open.

Sherri Scribner - Deutsche Bank

Hi, thank you. 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 US. I know you have a strategy of spending about 60% of your free cash flow on dividends and buybacks. But it looks like your US 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, so may be some detail there would be helpful?

Timothy Leyden

Yeah Sherri. You're right, and the number is 700 million as we close the quarter. However, 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. And we also got lower rates, we got 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 have taken action in order to ensure that we don't get tight, relative to continuing to meet our obligations of what we have promised on the capital allocation front.

Sherri Scribner - Deutsche Bank

Okay. Thanks Tim, that's helpful. And then I guess also, wanted an update on your CapEx plan. I know you guys are in the middle of upgrading your wafer facility, that took a couple of years. Is that finished, and what would you view as the investments you need to make in CapEx this year? Thanks.

Timothy Leyden

Yeah, we'd be able to stay within our 5% to 7% model. Actually, for the first couple of quarters, I think we have been running more like 4%, and we are -- from a CapEx viewpoint, I think we are underutilized in [heads]. We are underutilized also in substrates and sputtering going out as much underutilized in hedge. And of course in assembly and in tests, we continue to balance that and respond to the market. So I think, we are pretty comfortable within the model, the 5% to 7% model.

Sherri Scribner - Deutsche Bank

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

Timothy Leyden

Yes.

Sherri Scribner - Deutsche Bank

Okay. Thank you.

Operator

Next question is from Mark Moskowitz with JP Morgan. Your line is open.

Mark Moskowitz - JP Morgan

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, which is hypothetical, what would be your response? Would you kind of be measured and not really have that capacity during the first few quarters, or would you have to add at a pretty big pace? I guess, we are just kind of curious, in terms of what would be the kind of puts and takes that you have to really increase the CapEx?

Stephen Milligan

I think we are addressing at a little bit more general level. I think that we are in a pretty good shape from an overall capacity perspective. In other words, you saw the TAM increase to the number that you are 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 are at year-to-date, we are actually below that. So I don't envision us making any meaningful capital additions this year, that would strike that number upwards.

Mark Moskowitz - JP Morgan

Okay. 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 architect systems versus 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?

Stephen Milligan

Well, that's a bit of a complicated question, in the sense that the storage ecosystem, as we have alluded to, is changing quite dramatically, in a number of different ways, and for really, all participations. So that is for us, and our primary competitors, it is for, I will call, our traditional customers, and its also for some of our newer, you may call it, non-traditional customers, so some of the hyperscale guys. Also, the used 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 peers from a cost 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, any 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 are 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.

Mark Moskowitz - JP Morgan

Thank you.

Operator

Next question is from Amit Daryanani with RBC Capital Markets. Your line is open.

Amit Daryanani - RBC Capital Markets

Thanks a lot. Good afternoon guys. Couple of questions for me, maybe if you could talk about your enterprise business, looks like total units are kind of flat on a sequential basis. Any dynamics you see within the business [critical] and capacity optimized side would be helpful.

Stephen Milligan

Nothing particular in terms of performance or capacity enterprise. Capacity enterprise can be a bit lumpy. In other words, it's a little bit project based. We did, and I am not concerned about this, 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 the 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 are positioned from an overall competitive standpoint.

Amit Daryanani - RBC Capital Markets

Got it. And then, I guess if I look at the free cash flow generation, which you guys talked about as obviously being very strong for the last couple of quarters now, how do you think about the 50 commitment -- or kind of 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 far 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?

Stephen Milligan

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 they are allocating. When we made the decision in September of 2012, those are pretty big decisions for the company. It was something that we hadn't done before. So we are at the point where we are 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 favorable at increasing it.

Amit Daryanani - RBC Capital Markets

Thank you.

Operator

Ananda Baruah with Brean Capital, your line is open.

Ananda Baruah - Brean Capital

Hey, thanks guys for taking the question. Two if I could, I guess the first one is back to gross margins, Steve and Tim. Steve, earlier, you commented that, I guess that you thought the meaningful driver is, our ability to add value, and then if you mix appropriately and sort of get at the integrated and a responsible way, does that often suggest that TAM stays, let's call it like a 130 to 145 range where it has kind of been the last six to eight quarters, that you would also have the expectation for margins to continue to appreciate over time?

Stephen Milligan

So, if you go back to what we have 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. So my comment, if the TAM dropped 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 meaningful TAM expansion from an overall perspective. So the TAM was in the 135-ish range, just kind of use that as a round number. My comment that I made in terms of margin expansion stands.

Ananda Baruah - Brean Capital

Okay, great. That's very helpful. Then just a follow-up for me guys, what are your TAM expectations for 2014 calendar?

Stephen Milligan

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

Ananda Baruah - Brean Capital

Okay great. Thanks.

Operator

Next is from Jayson Noland with Robert Baird. Your line is open.

Jayson Noland - Robert W. Baird & Co., Inc

Okay, thank you. Steve, I wanted to come back to your comment and the prepared remarks about customization in the cloud. I assume this relates back to the helium drive, but do you expect to see a fairly wide portfolio with specs that may be differ by customer or by industry vertical?

Stephen Milligan

Yes. I mean, in other words, the used cases that we are seeing for various different customers are different. So accordingly, the solutions or the product suite that they are 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.

Jayson Noland - Robert W. Baird & Co., Inc

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

Stephen Milligan

Right.

Jayson Noland - Robert W. Baird & Co., Inc

Thank you.

Operator

Steven Fox with Cross Research, your line is open.

Steven Fox - Cross Research

Thanks. Good afternoon. Just two questions for me. First off, it looks like your average capacity per drive accelerated for the first time in about three 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, I guess there were sort of -- I guess a one time in there. Just sort of how impactful is that, as we look towards the next quarter on a sequential basis?

Timothy Leyden

I will address the average gigabyte and Steve will address the SSD. So average gigabyte -- contributing to that was a couple of factors. The first one is the strength of branded products, and that has a significantly higher per drive capacity than the rest of the consumer business, and of course, we also had strong distribution channel in the quarter. So that drove most of that improvement.

Stephen Milligan

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 non-recurring situation that we may see, our revenue declined slightly going into this quarter. But obviously, it's still a bit early to call that for sure.

Steven Fox - Cross Research

And just to follow-up on that, I mean, depending on who you talk to, you could see enterprise SSD demand be as high as 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?

Stephen Milligan

Yes.

Steven Fox - Cross Research

Perfect. Thank you.

Operator

Next question is from Joe Yoo with Citi Research. Your line is open.

Joe Yoo - Citigroup Global Markets

Thank you. So your hard drive ASPs were meaningfully, on a sequential basis, despite gaming actually being strong. So 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?

Timothy Leyden

So pricing was driven again by the strength of the channel and the strength of the consumer in branded, and that goes then to drive higher average ASP, and from a cost viewpoint, the cost to time has slowed down, because the area of density improvement has slowed down. So what we are seeing is, somewhere in the region of between 1% and 2% of cost decline, and pricing is following cost decline. So we are seeing pricing decline moderation as well, as a result of that.

Joe Yoo - Citigroup Global Markets

And as a follow-up of the enterprise SSD space business. You guided again for another $0.10 dilution from the acquisition 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 release from that dilution, as we get into the second half?

Timothy Leyden

That dilution will remain pretty much right through the end of the year; because we began to see the accretion in the early part of 2013. So consequently, we should keep that dilution in the model, through the calendar year.

Joe Yoo - Citigroup Global Markets

Great. Thank you, Tim.

Operator

Next is from Nehal Chokshi with Technology Insights Research. Your line is open.

Nehal Chokshi - Technology Insights Research

Yes. Thanks for taking my question. With the stability in My Cloud, can you provide any metrics around the traction you are getting with this, and also, is it reasonable to believe that this is an incremental TAM above the current blended market and the increased functionality, [and in terms of] ASPs companies like DropBox are charging beyond initial free capacity? Anything you can do to help us size the opportunity, incremental (inaudible) would be definitely helpful?

Stephen Milligan

Yeah, it's an interesting question. I am not sure, that at this point we have an updated analysis incremental to the traditional business versus, just substituting other units. And so, I think we will have to continue to monitor that. Relative to specific data, we traditionally have not broken out specific sales of a given product, and so, we are very encouraged by the response from the marketplace so far. We have, I will call it, high expectations for continued success in 2014.

Nehal Chokshi - Technology Insights Research

And if I may, if I could ask about desktops. Not quite sure I understand why desktops were down, and Dell recorded an 11% increase year-over-year in desktops from their perspective?

Stephen Milligan

We had a bit of share loss, and that's reflective of the industry. Desktop, as an overall statement, is a pretty stable market.

Nehal Chokshi - Technology Insights Research

Great. Thank you.

Operator

Our next question comes from Joe Wittine with Longbow Research. Your line is open.

Joseph Wittine - Longbow Research

Hi thanks. I think the enterprise has been beat to death pretty well, but I might ask the question again. You saw the flattening in the back half of the year, I am just curious, what's a reasonable expectation for unit growth going forward as you look into calendar 2014. From reading between what you said, it sounds like we got a little bit of a pause in some of the capacity you've build out. So looking out over the next four quarters, theoretically, some of those ebbs and flows kind of get smoothed out, we are 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?

Timothy Leyden

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

Joseph Wittine - Longbow Research

Okay, great. And then on the cash return to shareholders, it seems like right now you are actually trending closer to 40% of the current run rate. You 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 are still incurring $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?

Timothy Leyden

I was trying 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 didn't allow us to be able to be exiting the market during the period that those things were open. So consequentially, that mitigated against our opportunity to get to the 50%.

Joseph Wittine - Longbow Research

Okay. Then finally, very quick follow-up Tim; the $0.10 dilution that's there from the SSD acquisition, is that totally on the OpEx line, and if that's the case, is it about $20 million, $25 million per quarter in that range?

Timothy Leyden

Yeah, it's mostly in the OpEx line.

Joseph Wittine - Longbow Research

Thanks guys.

Operator

Next question is from Rob Cihra with Evercore Partners. Your line is open.

Rob Cihra - Evercore Partners

Thanks very much. Hopefully I can get two questions in, just to keep the pattern going. One just on hybrid drives, I know we talked about them all of a sudden. Just wondering, what your progress is like there in the December quarter, maybe versus your expectations? And then separate from that, and gaming, given that you -- given the strong start for the new game console cycles, obviously it has helped the past couple of quarters. If you look at seasonality in that, if 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, just 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 two customers? Thanks.

Stephen Milligan

Yeah. 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 will have to continue and 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 is 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 two customers that you commented on and we do view that as a bit of a tailwind for the drive industry going into 2014.

Rob Cihra - Evercore Partners

Great. Thanks very much.

Stephen Milligan

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

Operator

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

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