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Xyratex (NASDAQ:XRTX)

Q1 2013 Earnings Call

April 04, 2013 4:30 pm ET

Executives

Brad Driver - Vice President of Investor Relations

Ernest J. Sampias - Interim Chief Executive Officer, Director, Chairman of Audit Committee, Member of Nominations and Governance Committee and Member of Compensation Committee

Richard Charles Pearce - Chief Financial Officer, General Manager of Capital Equipment and Director

Analysts

Ananda Baruah - Brean Capital LLC, Research Division

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

Glenn Hanus - Needham & Company, LLC, Research Division

Zachary Buckley

Operator

Good day, ladies and gentlemen. Welcome to the First Quarter 2013 Xyratex Earnings Conference Call. My name is Philip, and I will be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host today, Mr. Brad Driver, VP of Investor Relations. Please proceed, sir.

Brad Driver

Thank you, Philip, and good afternoon, everyone. Thank you for taking the time to join us this afternoon. I'd like to welcome investors, research analysts and others listening today to Xyratex's Fiscal First Quarter 2013 Results Conference Call.

On our call today are Ernie Sampias, Interim Chief Executive Officer and Director; and Richard Pearce, Chief Financial Officer. Also on the call today is Ed Prager, GM of our Storage Solutions business. Ed will be available for questions following the formal comment by Ernie and Richard.

Today's call is being recorded and will be available for replay on Xyratex's Investor Relations homepage at www.xyratex.com.

Our press release is available both on PR Newswire and our website. Following our recent executive leadership change, the format for our 1Q earnings call will be different from our prior format. Following my introductory comments, Ernie will make some brief comments, and then Richard will follow with a detailed review of our financial results, our 2Q outlook and an update on our business.

I'd like to remind everyone that today's comments, including the question-and-answer session, will include forward-looking statements including, but not limited to, a forecast of future revenue and earnings and other financial and business activities. These statements are subject to risks and uncertainties that may cause actual results and events to differ materially. These risks and uncertainties are detailed in Xyratex's filings with the Securities and Exchange Commission, including the company's 20-F dated February 21, 2013.

Also, please note that in addition to reporting financial results in accordance with Generally Accepted Accounting Principles, or GAAP, Xyratex routinely reports certain non-GAAP financial results. These non-GAAP measures, together with the corresponding GAAP numbers and the reconciliation to GAAP, are contained in our earnings press release. We encourage listeners to review these items.

I would now like to turn the call over to Ernie Sampias.

Ernest J. Sampias

Thank you, Brad, and good afternoon, everyone. I'd like to begin by thanking Steve Barber for his enormous contributions to Xyratex's development, especially the dedication and energy he brought to the company. Steve has worked hard to lead the company through many transitions in our industry, and we appreciate the leadership he had demonstrated over the last 19 years. With regard to our search for a new CEO, we have started the process and have engaged an executive search firm. As far as my immediate areas of focus as a member of the Board of Directors for the past 8 years, I have been very involved in the discussions and direction of our strategy.

Within our 2 core businesses, the OEM Storage Solutions business and the Capital Equipment business, we continue to develop and deliver compelling technology through our established customer base, as well as consistently identifying new customer and product opportunities. We see both of these businesses providing long-term contribution to the company. With our more recent strategic initiatives to address the High Performance Computing, Big Data and cloud markets, we are making encouraging progress. We will be looking forward -- we will be looking to focus our investments within the areas where we have already had significant success and will carefully review our opportunities to expand into new markets, verticals and geographies. I will also be speaking with our customers and partners to assure them that we are committed, as we have always been, to ensuring that we will continue to invest in and develop new technology that will meet their technology and demand requirements.

Additionally, I will engage with our team and potential customers and partners to help further our efforts to expand our market opportunities. I believe we are well positioned to improve our market opportunities with a focus on execution and excellent management team and a strong portfolio of products and solutions. My priorities will include a detailed cost analysis of development activities and being disciplined in our expenditures and investments while also making sure that our businesses deliver more consistent and reliable returns.

Finally, I would like to give you an update on the recent changes to our board structure. As per press release earlier this week, I can confirm that we have reached an agreement with our largest shareholder, Baker Street Capital, regarding, among other things, the composition of the Board of Directors of Xyratex. New directors recommended by Baker Street will join the board with Vadim Perelman joining immediately and Ken Traub joining immediately after our AGM in June.

I would now like to turn the call over to Richard for a detailed review of the quarter's results, outlook and business update.

Richard Charles Pearce

Thank you, Ernie, and good afternoon, everyone. Firstly, I'd like to provide you with some commentary about our results for the first quarter of 2013. Please note that all numbers are in accordance with GAAP unless stated otherwise.

I was encouraged by our performance in the first quarter. We have seen stability in our 2 core businesses, and generally, our customers appear more positive in their near-term opportunities. Revenue in each of our product areas met or exceeded our expectations. Revenue for the first quarter was $195.6 million, down 34% as compared to the first quarter of last year and down 26% from our prior fiscal quarter. Sales of our Enterprise Data Storage Solutions products in the first quarter were $176.5 million, representing a decrease of $95.5 million or 35% compared to the first quarter of last year and down to 12% compared with $200.1 million in our prior fiscal quarter. The reduction from the prior quarter, as we have discussed previously, primarily reflects the proportional product volume shift as our annually declining contract with our previous largest customer, NetApp.

Sales of our Capital Equipment products in the first quarter were $19.1 million, down 19% compared to the first quarter of last year and down 71% compared with our prior fiscal quarter. We often experience low revenue in our first quarter due to seasonality in the HDD market. We have experienced a good level of customer orders in the first quarter and expect to record significantly higher revenues in the remaining 3 quarters of fiscal 2013.

Gross margin for Q1 2013 was 18.8% compared to 17.9% in the same period a year ago and 14.6% in our prior fiscal quarter. The increase from the prior quarter was expected and was primarily due to a change in customer and product mix in both product segments. For Q1 2013, the gross margin from our Enterprise Data Storage Solutions products was 17.9%, up from 17.3% a year ago and 14.2% in the prior quarter. The increase, as compared to the last quarter, was primarily due to changes in customer and product mix, including revenue from our ClusterStor product line and the reduction in revenues from NetApp. For Q1 2013, gross margin for the Capital Equipment products was 28.9% compared to 25.5% in the first quarter of last year and the prior quarter. The increase in gross margin in the quarter was primarily due to product mix, offset by the effect of lower volumes.

Non-GAAP operating expenses in the quarter were $40.8 million compared to $39.8 million in Q1 of last year and $46.8 million last quarter. Expenses last quarter included $4.2 million of restructuring, being the headcount reductions related to the reduction in revenues. We continue to expect 2013 operating expenses to be at similar overall level to 2012. We will be undertaking further restructuring in Q2, primarily in connection with our OEM Storage product lines. We plan that this will be offset by some carefully targeted further increases to enable growth of the Solutions products, particularly in sales and support.

GAAP net loss in the quarter was $5.1 million or $0.19 per share compared to GAAP net income of $10.9 million or $0.38 per share -- per diluted share, sorry, in the first quarter of 2012. On a non-GAAP basis, net loss for the first quarter was $3.6 million or $0.13 per share compared to non-GAAP net income of $11.4 million or $0.40 per diluted share in the first quarter a year ago. The reconciliation between non-GAAP and GAAP net income is provided in our press release.

Turning our attention now to the balance sheet. Cash and cash equivalents at the end of the quarter was $92.8 million, down from $117.2 million at the end of Q4. This position recognizes the payment during the quarter of a special dividend and acceleration of a Q1 2013 quarterly dividend, representing approximately $56 million in aggregate. Cash generated from operations in the quarter was $37.9 million.

Inventories decreased by $27 million to $144 million in the quarter. Inventory turns were 4.5 compared to 5.4 the previous quarter due to the low Capital Equipment revenues in the quarter. I am pleased with the progress we have made in reducing our inventory in the quarter. We are targeting further decreases during 2013 as inventory related to certain end of life customer programs is turned off.

Accounts receivable decreased by $34 million in the quarter to $99 million. Days sales outstanding were 45, unchanged from the previous quarter. Headcount at the end of the February quarter was 1,861 permanent employees, a reduction of 63 employees or 3% over the previous quarter end, predominately from our operations activities as we scale down our capability, in line with current demand.

I will now provide you with our business outlook for our fiscal second quarter 2013 ending May 31. For our second quarter of 2013, we are projecting total revenue to be in the range of $190 million to $220 million, down 36% to 41% as compared to last year and up 3% to down 8% compared to 1Q '13.

For Q2, gross margin is expected to be 20.5% to 21.5%. We are estimating non-GAAP earnings per share to be between a loss of $0.15 and earnings of $0.09. Non-GAAP earnings per share excludes noncash equity compensation, amortization of intangible assets, specified nonrecurring items and related taxation expense.

The number of shares outstanding at the end of Q2 on a weighted average treasury method is expected to be 27.9 million. Our cash position at the end of Q2 is expected to be approximately flat with Q1.

I'd now like to provide you with a broad business overview. We continue to believe that the overall Data Storage market, and specifically the external storage market, is experiencing some positive dynamics that continue to offer us some good opportunities. Storage spending rebounded in the December quarter for the broader storage industry, and we remain optimistic about spending trends through 2013 and beyond. We believe that there is pent-up demand for storage that could be released over the next several quarters as a result of the growing demand for Big Data solutions. In fact, long term, storage demand should continue to benefit from the growth in unstructured data as more digital content is moved online and need to be secured.

According to IDC, petabytes shipped for external storage in 4Q '12 grew 28% year-over-year. It is estimated that terabytes shipped will grow at 30% in 2014 and 2015. We believe data will continue to grow at healthy rates, long term, driven by trends in cloud computing and unstructured data, which should be positive across our product ranges. Whilst disk drive unit shipments are stable to slightly down as compared with a year ago, the average capacity of disk drive shipped continues to increase at significant rate to keep up with the overall petabyte growth. This is being driven by demand for higher-capacity devices for cloud applications where total cost of ownership is one of the most important factors.

The core of the data center is expected to remain on HDDs given their position of the cheapest and largest repository for exponentially growing data demands, while the edge of the network will increasingly shift to SSDs. Increased disk drive unit capacity results in increased manufacturing test times and increasing requirements for component associated capital products, both of which is positive for our Capital Equipment business.

Recent challenges support this position, and there's a slight shortage of 2-terabyte to 4-terabyte drives due to lower pricing and higher demand as spend on cloud infrastructure continues to increase. It is these factors that are driving near-term demand for our process equipment.

In our Capital Equipment business, we have experienced demand slightly above our expectations for a number of our products for installation in the first half of the year and for the full year. We currently have over 80% of our fiscal year forecast revenues for this business covered by committed purchase orders, or in some instances, working to expedite delivery of systems for our customers. We believe the overall capital investment of the HDD provided continues to be impacted by the overcapacity that was created a couple of years back and the recent consolidation of major players. We see the situation working itself out over the next year or so.

In our Storage Solutions business, we are experiencing stable demand through the first half of this year across the majority of our customers, and in one case, we are aggressively expediting material supply to meet their near-term demand increases. We successfully launched a new Tier 1 customer during the quarter, and although the volumes are currently low, the relationship is good, and we expect to see improving demand over the course of the year. We continue to see strong interest in our market-leading high-density OneStor H4 [ph] drive platform in both storage server appliance and expansion enclosure formats. This platform has recently been qualified by Hitachi-LG and is in qualification with one of our current Tier 1 customers for their anticipated product launch in mid-year.

In addition, this product forms the core storage element of our ClusterStor high-performance storage product range. We entered this year with an established and growing business with IBM, 2 major new product programs ramping with HP 3PAR and with the yet to be named new Tier 1 customer, a new and growing relationship with Microsoft and a range of emerging customer partnerships. This business is well positioned to capture further market share as storage brands explore opportunities to outsource their platform designs and focus internal resources on software and applications.

In our ClusterStor high-performance and Big Data storage businesses, we continue to expand our position in the market and gain industry recognition for our performance leadership. We added 6 new ClusterStor customers this quarter. And this included our first customer in Asia, a new market for ClusterStor and one where we are seeing increasing opportunities; 2 new customers within the U.S. government, which is a key segment for us; another large U.S. academic customer; and 2 new large European research facilities.

We also had a number of repeat customers that includes a large commercial customer in the oil and gas market. This represents approximately $7 million in new sales in Q1 in addition to the $12 million NCSA Blue Waters revenue that was recognized in the quarter following full system acceptance.

I believe that we are making solid progress towards our prior guidance of achieving over $60 million in revenues for this business for this fiscal year with gross margins in the 35% to 55% range. This will represent significant growth over our 2012 first year revenues of approximately $15 million.

During the quarter, we also acquired the Lustre assets from Oracle, including the Lustre trademark, copyright and associated intellectual property. Importantly, the acquisition included the transfer of responsibility for approximately 18 Lustre support contracts with end-user customers together with a number of Lustre developers joining the Xyratex team. This transaction further supports Xyratex's position as a leader in the Lustre open-source community and represented a strategic move for us to ensure that these assets remained with the company that was focused on collaborating with the open-source community. In addition, it expands our end-user customer base for our Lustre support and professional services. This was an important step in further strengthening our ClusterStor business.

Our focus this year is primarily on enabling our go-to-market compute partners, building on our OEM relationship with Cray as they ramp their Sonexion storage business and enabling our recently announced reseller partnerships with Dell and HP through the training of their global sales organizations. As a result, we have been investing in our sales and marketing capability in order to build awareness of the ClusterStor value proposition of industry-leading price performance and lowest total cost of ownership. Additionally, we announced a strategic partnership with Pentaho, a leading provider of data analytics software, and we are working with them to integrate their technology into our high-performance ClusterStor scale out storage architecture. Embedding the Pentaho analytics engine would enable us to address the growing need of the Big Data market by delivering a high-performance data analytics platform later this year.

Looking at our broader strategic initiatives. In our Storage Solutions and Capital Equipment businesses, our focus continues to be on investing on core technologies that meet the requirements of our customers and partners while being operationally efficient in order to deliver sustainable contribution. Given the inherent capital spending nature of the HDD industry, it is unlikely that our Capital Equipment business will be profitable every quarter. However, I am confident that the changes we have made to date can result in a profitable business at variable revenue levels without jeopardizing the technology development and operational support required by our partners.

Both core businesses require an appropriate level of investment in new technology to meet the requirements of our existing customers, and equally importantly, position ourselves to win new programs, both with existing, as well as new customers. Our focus in investments are on platform architecture, systems integration and customer satisfaction. In the Capital Equipment business, our focus is on development of core technology to meet emerging customer process and productivity needs through a collaborative partnership with both the disk drive manufacturers and component suppliers. An example of such technology is the asynchronous multi-sound, which we are shifting from Q2, providing higher productivity and individual thermal environment for each drive, addressing technology requirements for higher-capacity drives.

In the Enterprise Storage Solutions business, we continue to invest in technology that will enable our customers to take a leadership position with their future generation products. One example of such an investment is that of 12-gigabit per second SAS, which will enable full bandwidth solid-state Storage Solutions, which is critical for taking advantage of the throughput that solid state can deliver.

In the HPC business, to expand our accessible market and increase our profit margins for the wider company, we have invested in developing an industry-leading High Performance Computing data storage appliance, our ClusterStor product series, to address this high-growth HPC and Big Data market. We are achieving market acceptance and product sales in multiple end-user market segments from U.S. and U.K. government applications to oil and gas and academia. The technology is proven, and our focus is now on increasing market awareness and share and enabling our OEM and reseller partners to grow end-user sales. We will be expanding our ClusterStor portfolio with the release of an exciting new product specifically targeted at the departmental segments of the HPC and Big Data market. We have received very positive feedback from partner customers previews [ph] on this product, and in response, we have already received advanced quarters. This new product will enable our ClusterStor business to address an incremental accessible market of approximately $1.6 billion and complements our existing product offerings.

With regard to some of the other operational changes that we have made since last year and are currently being implemented, we have successfully outsourced development of a number of noncore product areas to Southeast Asia and India-based partners. We are in the process of consolidating our North American operations to Mexico from Northern California, and we expect this to be completed by mid-year. This consolidation will better serve our customer base in meeting their supply chain requirements. And we continue to manage headcount in recognition of our reducing top line revenue as we focus only on those activities and investments where we can bring true value to our customers. I would like to note the professionalism demonstrated by our employee base as we address this difficult situation.

In summary, I am encouraged by the progress we have made to date in positioning the company to be more of a Storage Solutions company. Our established businesses are performing well, and I believe both can provide long-term, sustainable contribution. In Capital Equipment, we are focused on our core competencies and the needs of our customers and have rightsized the business in this near-term period of reduced disk drive capital equipment spending without compromising our key technology roadmaps and ultimate product delivery. In Storage Solutions, we are diversifying our customer base and bringing new products to bear at the same time as we focus on costs in recognition of the conclusion of our relationship with NetApp. I believe we have a technology leadership position with our ClusterStor HPC and Big Data solution and are making good progress in enabling our go-to-market sales partners as we look to increase revenues over $60 million this year.

And finally, I'd like to welcome Vadim Perelman to the board and Ernie Sampias to the role of Interim CEO. I look forward to working for Ernie and the trust that our employees will continue to demonstrate the same levels of commitment and innovation under the new leadership.

That concludes our formal comments. I'd now like to open the call up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] First question comes from the line of Ananda Baruah of Brean Capital.

Ananda Baruah - Brean Capital LLC, Research Division

A couple if I could. I guess, Ernie, I guess to what extent could you share with us -- I know you went a little bit into sort of what some of the, I guess, strategic initiatives are and where you guys are looking kind of to make investments and pull back from some of the investment, more or less [ph] to reduce cost by moving some of the stuff sort of overseas. Can you give us any insight -- or what more insight can you give us into sort of what, I guess, Baker Street is wanting to start out to do strategically and initially? And I guess is there sort of like, I don't know, like a Plan A, Plan B sort of thing? If there's any thinking that you could share with us would be really helpful.

Ernest J. Sampias

Ananda, sure. I'll try to do my best in terms of giving you a concise answer. First of all, I guess, let me just say that from my priorities as Interim CEO or my mandate from the board, the new board, as we structured, including Baker Street, my 4 priorities: number one, work closely with our partners, both customers and suppliers, to ensure continued organizational focus on making sure we meet our operating commitments and results for 2013. Secondly, conduct a search for a new CEO. And the successful candidate will have a demonstrated track record of driving consistently profitable growth. Third, I'm going to evaluate opportunities across the organization for operating efficiencies. And fourth, I'm going to evaluate our development activities to a return on investment analysis wins. So those are the mandates and the objectives that I've been given in my interim role by the newly formed board, including Baker Street. With regard to any insight into Baker Street's in terms of immediate plans, I think the best thing to do there is look at the letter that they sent with the public document and that's when they were shareholders outside of the board. And from my perspective, and I think the rest of the board's perspective, the one thing we agreed with Baker Street on when they were not on the board and just shareholders is the fact that we all believe Xyratex is undervalued. And we're going to do our best to improve the value for all of our shareholders. And that includes the -- looking at how to improve the operational performance and more consistent profitability. So at this point, that's about the only insight I can share with you

Ananda Baruah - Brean Capital LLC, Research Division

That's actually very helpful, Ernie. I appreciate that. And I guess, is there any way to -- I guess, just on some of things that you talked about, the newer initiatives, is there any way for you guys to quantify, I guess, maybe what the cost savings might be for moving some of the biggest Northern California operations into Mexico and moving some of the productions to Asia. And then I have one follow-up after that.

Richard Charles Pearce

Yes, Ananda. I think in the projections that we previously given is the model out there -- that those initiatives have already been taken into consideration. So yes, there are savings which have been made. When I look at our overall OpEx base, and as per my comments, I'm expecting our operating expenses to stay relatively flat as we move from 2012 into 2013. From a pure operating perspective, obviously, those costs are coming down somewhat in line with revenue reductions. But yes, I don't know that there's any new news on expense reductions [indiscernible] of the comment that I made about where we have actually taken expense out and are ongoing with doing that this year.

Ananda Baruah - Brean Capital LLC, Research Division

Got it. And I guess just the one last one for me for now is, you guys mentioned that orders of sort of drive test equipment has -- was a little stronger than you thought it would be and actually looking to be a little bit better going through the year than you think it would be -- you thought previously would be. Can you just talk about what the nature of the orders are and what you think is driving better-than-expected demand there?

Richard Charles Pearce

Yes. I mean, as I made in my comments, yes, we did -- I did phrase as slightly better. And I think, to the extent that we've got 80% of our expectations, which, as you would expect, are not considerably different to those which are out there in the market at the moment covered by purchase orders, that's a very strong position for us at the end of March, so kind of 1/3 of the way into the year and probably a stronger position than I witnessed for some years. And I think a large part of that is being driven by the higher-capacity drives, again, as I mentioned, which require longer test times, primarily in the 3.5-inch market space. So -- and as you know, we've bought some new products to bear in that market space at the back end of last year. I know I've mentioned, again, in my scripted comments, part of that new product is now shipping with the asynchronous multi-cell, which is a feature, particularly with one of our customers, which they're putting a large amount of value behind. So yes, they are the items which are driving that. And as I said, it's a slight increase. But also, I think the more important factor is the confidence that we have behind those numbers in terms of the purchase order coverage.

Operator

Your next question comes from the line of Aaron Rakers from Stifel, Nicolaus.

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

A couple of quick clarifications and some questions. So first of all, I don't know if I caught it correctly, but I think you guided 20% to 21.5% gross margin. Can you help us understand what you anticipate of the 2 segments, maybe take it even further both on a revenue standpoint in terms of the guidance as well as the gross margin in that guidance?

Richard Charles Pearce

Sure, Aaron. So I actually guided 20.5% to 21.5%, just for clarity. And then in terms of the 2 segments, my expectation from a revenue perspective would be that the Enterprise Data Storage Solutions business would be somewhere in the range of $150 million to $170 million. And then on the Capital Equipment business, being somewhere at between $40 million and $50 million. From a margin perspective, I think I provided margin, sort of guidance range for the Storage Solutions business last quarter at between 15% and 18%. And we worked towards the top end of that margin in Q1. And again, I would give a similar range in Q2. But again, I expect it to be near the top of that range than towards the bottom end of that range. In the Capital Equipment business, again, I think that we provided -- I provided guidance, really, for the full year of approximately 30%. This is increasing the margins yet relatively from last year when we had a number of challenges, which we covered in last year and part of those were hang out [ph] in 2011. So I feel pretty comfortable in that sort of average margin throughout the year. We had 29% margins in Q1. And my expectation would be that it'd be around the 30% now going out in each of the quarters, which, again, as per my comments, we have relatively even spread now of revenue expectations from Q2, Q3 and Q4 as we stand today.

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

Okay, perfect. That's very helpful. And then in the context of just thinking about the finalization of the burn-off or now-normal NetApp business, can you give us a breakdown of your systems of revenue? Obviously, trying to understand what looks to be some positive trends in the IBM and HP relationship as well.

Richard Charles Pearce

Yes. I mean, I guess, consistent with the normal course, Aaron, I'll give you approximate percentages rather than definitive numbers. So NetApp was around 28% in the first quarter, which is the first quarter that I can remember that they have been our largest customer, actually, throughout the business. IBM was actually 30% in the first quarter. So they were our biggest customer in the quarter. Dell was 15%. HP was actually just under 10%, between 8% and 10%. And in fact, Cray, because of the NCS Blue Waters recognition that we got as well as some further revenues in the first quarter, was approximately 10%.

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

Okay, very helpful. And then final 2 questions from me, did you guys disclose what you expect as far as the cash exiting this current quarter?

Richard Charles Pearce

Yes. Again, obviously, I didn't speak clearly enough, Aaron. But I just -- I expect the cash to be at a very similar level in Q2 as it was in Q1. We have actually created quite a bit of cash, obviously, in the first quarter as inventories declined. And obviously, we got below our Capital Equipment revenues in Q1. As we start to increase our inventories for the Capital Equipment business in Q2 and Q3, that requires a little bit of working capital. And obviously, we're not forecasting significant profits in the quarter. We didn't make profits in Q1. So my expectation is that we'll be flattish for the next quarter and possibly into Q3 as well. We need to take a better look at that as we go through the quarter. But yes, actually end of Q2, pretty similar level.

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then the final thing, you guys alluded to actually tightness, if not constraints, on high-capacity 3.5-inch drives. Can you elaborate a little bit on that? When did you start to see that? And to what degree did you see that in the quarter?

Richard Charles Pearce

Yes. That's not something that we personally seen [ph] from our business in what we're using, I guess, more at the enterprise end. So we're not experiencing that. That was more information that we really got from IDC in terms of some shortage in 2 to 4 terabytes. So it's not something that we are experiencing and impacting our business. It's just something that we're aware are out there in the market.

Operator

The next question comes from the line of Glenn Hanus from Needham.

Glenn Hanus - Needham & Company, LLC, Research Division

So can you -- going back to the first speaker, could you help me reconcile a little bit better the comments you're making on this call versus what I read, like, in the Baker letter? I mean, in there, it kind of makes it sound like there -- they have qualms about the "unproven investments" in HPC and cloud initiatives. They're clearly more negative about those opportunities or more concerned about them. And then on this call, it sounds like you're continuing to invest and look for opportunities. And so what -- how should I kind of reconcile the letter and your commentary on this call?

Richard Charles Pearce

Ernie, are you happy to take that?

Ernest J. Sampias

Sure, I -- Richard and I can add whatever color I can add.

Richard Charles Pearce

Okay, good. So yes, I think, Ernie summarized pretty well in his opening comments when -- obviously, the letter that we originally got from Baker Street was very much a shareholder on the outside looking in. Baker Street now are more so on the inside and obviously, getting a greater insight into what the business opportunities actually are. They only came on to the board earlier this week. And I've spent a day with them and that's been my only exposure to them. But I think in the short term, that they very much want to understand the opportunities which are in those business areas. And I'm not expecting to see any significant changes in terms of our strategy in the near term. That said, I think, as per Ernie's comments, they will be looking at us to take with them a look at the opportunities and the investments that we are making with a view to making a better and nearer-term return from those businesses, which I do think is a possibility. And obviously, with some of the revenues that we see ramping and the opportunities that we have out there, I think that they are very willing to listen and look and review those businesses without taking any near knee-jerk or near-term sort of reactions, which, otherwise, one might lead into the original letter, which was made public. So I wouldn't read too much into that original letter now that Baker Street are part of the company and, I would say, working with us in a, from my experience at one day with them, a cohesive and collaborative way.

Glenn Hanus - Needham & Company, LLC, Research Division

Okay, that's very helpful. Ernie, did -- was there something you wanted to add or...

Ernest J. Sampias

Glenn, and I don't know if you remember me from my McDATA...

Glenn Hanus - Needham & Company, LLC, Research Division

Oh, yes, of course. Yes.

Ernest J. Sampias

Anyway, the -- I think in terms of what Richard comment -- Richard and I both had 1 day now at a board meeting earlier this week with the new board, including the Baker Street representative, Vadim Perelman. And now, you need to keep in mind that, as a board member of Xyratex, board members, including myself, have now a fiduciary duty to maximize the value of Xyratex for all shareholders. And so I think to Richard's point, once you are on the inside, you have a much better appreciation and more knowledge about the opportunities than you do when you're on the outside as a private investor. So I think that -- again, I think you have to take the fact that Baker Street is now insiders. And we all have, from a board perspective, a responsibility to maximize the value for all shareholders. And that's what we're going to be about.

Glenn Hanus - Needham & Company, LLC, Research Division

Okay, great. That's very helpful. Could I ask you, maybe, just clarify a little bit more when you talked about the further restructure in Q2 to the OEM Storage business, targeting storage products, sales and support? Can you just maybe flesh that out a little bit more?

Richard Charles Pearce

Yes. We have a restructuring program going on at the moment outside of the pure operational, which we will be undertaking obviously in -- primarily in Northern California, as we move those products, primarily down to Guadalajara in Mexico. So my expectation is that we'll be taking out another 25 to 35 heads in that business in roles obviously, associated to a degree with some of the areas where we're seeing some revenue decline. But as I said in my statements, in fact, I do expect to be almost replacing some of those expense savings with additional heads in, particularly, the sales, marketing and support areas, particularly helping some of those -- the newer products we just talked about in HPC and Big Data world.

Glenn Hanus - Needham & Company, LLC, Research Division

And that's more of a direct sales effort, right?

Richard Charles Pearce

Yes. I mean, it's very much a sort of sell-with type arrangement in that side of the business. So we have our business partners. As we talked about earlier, we have HP, Dell and Cray. But we are definitely having to increase the amount of sales. It's a different model than our traditional OEM-type sales model in that we are having to actually provide the training to their sales people and also our own sales people to actually go and sell with that very large sales organization.

Glenn Hanus - Needham & Company, LLC, Research Division

Okay. And lastly, I mean, I know you don't give annual guidance per se. But just kind of relative to the Street numbers, on the HDD side, I don't know where people -- I'm at around $150 million. And I think on the other side, I'm around $750 million. I don't know if that's where the Street is exactly. But can you just sort of comment about your feelings about those outlooks for those businesses for the year?

Richard Charles Pearce

Yes. I think the Street is very much in a similar position as they were in Q1, where we provided some thoughts on where we would be for the full year. So overall, I think the Street has us at around $870 million at a -- at an overall level. And as we said about Capital Equipment represents somewhere between $140 million and $150 million of that. And at this stage, I wouldn't say that there is any new information to lead me to believe that they weren't appropriate numbers to be out there in the street.

Operator

The next question comes from the line of Zach Buckley from Buckley Capital Partners.

Zachary Buckley

You disclosed in the SEC filing that you have formed a strategic committee. Can you please provide more detail on that? And also, would that include something like selling the company?

Ernest J. Sampias

The strategic -- this is Ernie. Richard, let me take this one, if you don't mind. And if you have any color you'd like to add, please do so. The -- we formed a strategic committee that was part of the -- a requirement from the settlement agreement with Baker Street. And so that's about as much color as I can share with you on that particular question.

Richard Charles Pearce

Yes. I guess, in my perspective, the strategic committee and obviously, I'm familiar with the charter of that strategic committee, is kind of as broad as the suggestion as the title suggests. So Baker Street do want to understand the strategy of the company a little better. And as you would expect, they do have participation on that committee. But yes, I can say quite openly that the primary objective of that committee is not to sell the company. I think, if you look at the share price today and somebody came in with an offer of $20 a share rather than $10 a share, then the company and the directors would have to look at that very seriously. But I can categorically say, again, that the primary objective of that committee is not selling the company.

Operator

[Operator Instructions] And your next question comes from the line of Ananda Baruah from Brean Capital.

Ananda Baruah - Brean Capital LLC, Research Division

Richard, just more of a clarification about the comment that you made earlier with regards to the driver -- the drive business not being profitable on a regular basis. Is that somewhat of a longer-term comment or is that something that you're referring to potentially a near-term comment as well?

Richard Charles Pearce

No. What -- sorry, I made you -- I'm glad you've asked for the clarity. I think my comments were that the drive business would not be profitable on a regular quarterly basis. And that's -- that has always been the case historically and it is my expectation because of the lumpiness of that business to continue going into the future. And again to put it into context, in the first quarter with revenues of $20 million, that business was not profitable. Yes, that the -- the purpose of actually that comment was to say that, notwithstanding the fact that on a quarterly basis, the lumpiness will mean that there will be quarters of profitability and some of losses. Overall, given where we rightsized that business to now, yes, my expectation is that it will be in a position to make consistent annual contribution. So really, that was the purpose of that. But equally, yes, we know we're never going to be able to make a positive contribution every quarter. And that's something that we accept, and I think our investors accept. But I thank you for wanting the clarity because maybe other investors would have needed to get that, if I wasn't clear.

Ananda Baruah - Brean Capital LLC, Research Division

Understood, I appreciate that. And then just one more point of clarification. I think during your comments with regards to drive business, you also made a comment or there's a comment made that some of the orders you guys thought had been, I think, expedited or pulled forward. I was just wondering what visibility you have in sort of the dynamics that lead to that.

Richard Charles Pearce

Yes. I mean I don't want to necessarily speak for hard disk drive vendors specifically and individually. But yes, we are seeing, particularly in the 3.5-inch area, that at least one of our customers would like to have more capacity available sooner than they got at the moment or the schedules in terms of our delivery during Q2 and Q3 would [indiscernible] at this time. So we are looking to do as much as we can to expedite and get the installations of both 3.5-inch systems sooner rather than later. And I can only assume that, either because they are not manufacturing as much as they would like to at the moment, which may be the case, but I think it's more likely that where they see the visibility and the opportunities to ship more 3.5-inch as we go through Q2 and Q3. Obviously, as capacities are increasing, test times are increasing, the requirements are being increased.

Ananda Baruah - Brean Capital LLC, Research Division

Got it. Are those for desk-side drives or for enterprise drives?

Richard Charles Pearce

I don't know. But my expectation would be that they were for a mixture of enterprise-cloud-type drives.

Operator

[Operator Instructions] And your next question comes from the line of Kenneth Miller from Nokomis Capital.

It seems Kenneth has dropped off the line. At this point, there are no more questions. Ladies and gentlemen, this concludes today's question-and-answer session. And I would now like to turn it back over to Brad Driver for closing remarks.

Brad Driver

Thanks, Philip. Once again, thank you for joining us this afternoon. We look forward to speaking with you again on our Q2 earnings call, which will be scheduled for late June, early July. In May, we'll be at the Barclays Technology Conference in New York and we'll provide a bit of update in our presentation at that time. And as always, you are welcome to call me if you have any additional questions over the course of the quarter. For the time being, have a nice rest of the week and weekend. Thanks.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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