Fusion-io's CEO Discusses F2Q 2014 Results - Earnings Call Transcript

Jan.22.14 | About: Fusion-io, Inc. (FIO)

Fusion-io, Inc. (NYSE:FIO)

F2Q 2014 Results Earnings Call

January 22, 2014 5:00 PM ET

Executives

Nancy Fazioli - Investor Relations

Shane Robison - Chief Executive Officer

Lance Smith - Chief Operating Officer

Ted Hull - Chief Financial Officer

Analysts

Kulbinder Garcha - Credit Suisse

Steve Milunovich - UBS

Jerry Liu - Morgan Stanley

Lou Miscioscia - CLSA

Bill Shope - Goldman Sachs

Gary Mobley - Benchmark

Mitch Steves - RBC Capital Markets

Abhey Lamba - Mizuho Securities

Ryan Bergan - Piper Jaffray

Rajesh Ghai - Macquarie Capital

Brent Bracelin - Pacific Crest

Ben Reitzes - Barclays

Srini Nandury - Summit Research

Operator

Welcome to the Fusion-io Second Quarter 2014 Earnings Call. My name is Leslie, and I will be your operator for today. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session. Please note that this conference is being recorded.

I’ll now turn the call over to Ms. Nancy Fazioli. Ms. Fazioli, you may begin.

Nancy Fazioli

Thank you, Operator. Good afternoon, everyone. And thank you for joining Fusion-io's fiscal second quarter 2014 earnings conference call. On the call today are Fusion-io's CEO, Shane Robison; COO, Lance Smith; and CFO, Ted Hull.

Please note that a replay of this call will be available on the Investor Relations page of our website at fusionio.com within a few hours and will be available for at least a week from the time of this call. Unauthorized recording of this call is not permitted.

During today's call, we will be referencing both GAAP and non-GAAP financial measures and wish to note that a copy of the press release and financial tables, which include a GAAP to non-GAAP reconciliation and other supplemental financial information, is available on the Investor Relations page of our website.

Some of the statements we will make during this call constitute forward-looking statements within the meaning of the federal securities laws. Accordingly, we wish to caution you that such statements are just predictions based on current expectations and assumptions regarding future events and business performance and involve risks and uncertainties that could cause actual results to differ materially.

We refer you to the registration statements and reports that we file with the U.S. Securities and Exchange Commission, which are available on our website, and identify important factors that could cause the actual results to differ materially from those contained in our projections and other forward-looking statements. Fusion-io undertakes no obligation to update any forward-looking statements to actual results or changes in the company's expectations.

With that, I'll turn the call over to Shane.

Shane Robison

Thank you, Nancy. Good afternoon, everyone, and thank you all for joining us today. Our Q2 results were solid. We delivered $94.5 million in revenue with 58% non-GAAP gross margin and a $0.06 non-GAAP EPS loss.

Our balance sheet remains healthy. We added $19 million in cash in the quarter, bringing our total cash and cash equivalents balance to $244 million. This sound financial position enables us to continue invest, innovate and execute on our business plan.

We are a little more than halfway through year long transformation of the company. This involved a much more leveraged OEM sales strategy, significant changes in the senior management team.

In December, we rounded out a world-class executive team with the addition of Ted Hull as CFO; and Ian Whiting, leading the Sales and Marketing Organizations. Both Ted and Ian have hit the ground running in December and are making a positive impact on the business. Both bring strong operational expertise and perspective on larger company processes to their roles. We are very excited to have them as part of the team.

In October, we welcomed David Windley to lead our Human Resources Department. David joined us from Yahoo! and previously held senior management roles at Intuit and several other large technology companies.

David is a great partner in a critical role of the company as our employees are our greatest asset. I'm pleased by our continued ability to retain and attract exceptional talent and I appreciate the focus David has on preserving and enhancing our positive workplace culture.

Gary Smerdon, our Chief Strategy Officer who we introduced the last quarter has taken on additional responsibilities in the quarter and will now also lead our Product Management Organization.

In addition to these executive level management changes, we have recently added new CIO, Keith Brown; a new SVP of R&D, Robert Hon; a new VP of FP&A, [Cathy Dwyer]; and just this week, a new Head of Sales in Asia-Pacific, Charlie Foo, who will help us address our untapped opportunity in the Asia region.

I'm pleased that we now have the management on Board to grow the company to the next level. The high caliber of talent that we've been able to attract speaks to the opportunity in front of us and they are already having a positive impact on the second half.

Reflecting on the first half of the year, we saw positive momentum in both Enterprise and Hyperscale markets. We are successfully partnering with ISVs, including SAP, Microsoft, Oracle and VMware on industry-leading application acceleration solutions and we continue to be designed into next-generation data centers around the world.

A significant component of our Enterprise strategy is to enhance the depth and breathe of our OEM relationships. As part of that strategy, we are pleased to announce today a new OEM relationship with Lenovo. This will integrate our ioScale solutions into Lenovo ThinkServer systems which will be available in China. This partnership gives us an important foothold in the region and we are excited to collaborate further.

For businesses large and small across the globe, flash is a key catalyst for new products and services. As cloud computing and web services continue to grow, our customers invest in flash in tandem with their own customer growth. These investments are often substantial, but as we’ve said in the past can be non-linear in nature.

Our Q3 outlook factors in this non-linear nature of the Hyperscale market and the changes in our sales and go-to-market strategy, as well as significant management transitions that were implemented in the first half. While we exceeded expectations in Q2, we expect revenue to be in line with Q2 to slightly up sequentially in Q3.

Our strategy in the second half is to operationalize all of the changes we made in the first half, which we believe will drive more consistent growth and better visibility into the long-term business.

With regard to the Appliance segment of our business, which includes ION and ioControl, our performance advantage has been demonstrated not only by numerous whitepapers and benchmarks, the documents side-by-side comparisons of our solutions with that of the competition, but also by customers who experience breakthrough performance of our hybrid and all-flash acceleration solutions.

We believe there is a lot of opportunity for growth in this segment that can come with better integration with Enterprise and SME customers. In the Enterprise, staying true to our roots as an application centric solution, our strength with ion is accelerating key database and virtualization solutions.

In the fast scoring small and medium Enterprise market, we offer a hybrid flash accelerator that wins own performance, application level control, cost and simplicity. On February 6th, we will hold an Analyst Day where we’ll go deep into our strategy for application acceleration using Fusion-io technology. Please join our webcast to learn more.

So I’d now like to turn the call over to Lance Smith, our Chief Operating Officer for more details on the market and our solutions.

Lance Smith

Thanks Shane and good afternoon everyone. You are going to hear more from me at our Analyst Day. So I’m going to be relatively brief and cover just a few items that we know are of interest, first on NAND pricing and industry dynamics.

We continue to see consistent NAND pricing and supply in the marketplace. And with our strategic NAND engagements and inventory strategy, we do not expect NAND availability to impact margins or fulfillment in the second half of fiscal 2014. Both IDC and Gartner’s recent reports are worldwide NAND supply indicate.

They expect supply demand balance across the year due to lean capital spending at offsetting market dynamics. As we have said previously, we anticipate longer life cycle in NAND technologies, stretching beyond the 15 to 18 months inside the few transitions we’ve seen in the past years.

Long reason for this significant increase in complexity that comes with continued process strength and managing persistent memory in the data center solutions. We believe our ability to extract the full potential from commodity NAND continues to be an important differentiator for Fusion-io. This allows us to meet both the performance and reliability demands of mission-critical applications and cost requirements of volume deployments.

There has been lots of discussion in the marketplace about new solid state technologies and alternative approaches to connectivity. We believe Fusion-io is best positioned to deliver next-generation solutions in NAND technologies as they make good economic sense for customers.

Our third generation product line leverages 2y nanomenter and 1x nanometer flash memory with the ability to support TLC NAND. We made exciting technical advancements and began sampling last quarter and we are expanding sample delivery to a broader customer base this quarter.

In time, we see opportunities for smaller geometry ClearNAND, 3D NAND and next-generation NVM media but not in the near-term. PCI-Express remains the connectivity of choice for the solid state memory tier. It provides the latency, power, density and most importantly server and application interoperability that require for industry-standard solid-state memory solutions.

But what adds Fusion-io’s programmable extension such as atomic rights, extended pace memory and key value store. Solid state can achieve its full potential without niche or esoteric implementation. Our innovation engine has not slowed down.

In the past few months, we have announced performance and expanded feature update to ion data accelerator for the fastest all flash application appliance. ioTurbine for server and desktop virtualization acceleration and ioControl for the most cost-effective hybrid solutions.

We had some exciting software development that we’ll be able to cover with you in a few weeks. With that, I will turn it over to Ted Hull, our new Chief Financial Officer.

Ted Hull

Thank you, Lance. I am excited to have joined the team here at Fusion-io and see tremendous opportunity for us in the market. It is right for our technology. Our sleeves are rolled up. We’re focused and we’re moving the business forward.

I look forward to the opportunity to work with all of you in the investment community. Let me now turn to our fiscal second quarter results and then our outlook. As a reminder, the financial results I discussed are on a non-GAAP basis unless otherwise indicated.

Turning to revenue, revenue in the second quarter was $94.5 million, up 10% over the prior quarter. Services support and maintenance revenue in the second quarter was approximately $9 million, consistent with our performance in the prior quarters.

Looking at the customer contacts, one customer and two OEM partners exceeded 10% of revenue in the quarter. We had 12 total end-user customers whose orders exceeded $1 million each in Q2, including a global software company, a leading Chinese Internet company, a growing IT platform provider, one of the world's largest retailers and a Japanese Internet service provider. In addition to large service providers, additional strong verticals with financial services and telecommunications.

Turning now to gross margin. In the second quarter, our gross margin was 57.6%, down 180 point sequentially but above our expectation for the quarter, due to higher Enterprise product mix.

Moving to operating expense, our operating expenses totaled $65 million in the quarter, up 4% or $2.5 million from the prior quarter, driven by executive transition expenses, sales compensation and higher revenue, and increased marketing expenses. Our operating loss for the quarter was $11 million or 11.4% of revenue. Net loss in Q2 was $6 million or $0.06 net loss per share.

Moving to the cash flow statement. We delivered cash from operations of $13 million in the quarter. In CapEx, total capital expenditures for the quarter were $2.6 million.

Moving to the balance sheet, our cash and cash equivalents totaled $244 million, up $19 million sequentially driven by cash from operations. Deferred revenue in the second quarter, driven primarily by support and maintenance contracts, was $37.5 million, up $300,000 from the prior quarter.

On accounts receivable, accounts receivable stood at approximately $50 million this quarter, a decrease of $13.5 million from the prior quarter due to revenue linearity. Net DSOs were 49 days. Total inventory at the end of second quarter was $80 million, up $6 million from the prior quarter.

Turning to the outlook for the fiscal third quarter of 2014, as Shane indicated earlier in the call, we expect revenue to be in line to slightly up sequentially. Gross margin is expected to be approximately 51% to 53% based on product mix.

We expect an operating margin loss of approximately 15% to 20%. We expect diluted shares outstanding to be approximately 107 million shares.

To close, it's been an exciting first seven weeks on the job. My perspective is the market opportunity for Fusion-io is even greater than I anticipated coming in. I consider it a privilege to be part of a world-class management team, beating one of the industries most exciting technology companies. I’m pleased that you will have a chance to meet the new team during the Analyst Day.

Thank you. Now I will turn it over for Q&A. Operator?

Question-and-Answer Session

Operator

(Operator Instruction) Our first question comes from Kulbinder Garcha with Credit Suisse. Please go ahead.

Kulbinder Garcha - Credit Suisse

Hi. Maybe a question for Shane, just in terms of revenue visibility from where we are now, can you give us -- and your confidence is to be the ability to predict revenue that seem to be stabilizing them. I’m kind of curious as you operationalize the team as you mentioned it. Is it fair to say that you are looking for touch, growing from this quarter almost how we reached the trough do you think and then the second question is kind of linked wise, what precisely is the size of your Enterprise business now? Can you give me a ballpark? I’m trying to understand because that seems to be a bit more stable. It seems to be a bit more predictable. It has higher gross margins and so if that’s got to a significant size in your revenue mix, I guess that’s going to bring predictability, is that the way we are thinking about it and what is the size? Thanks.

Shane Robison

So we're working through the visibility, the challenges that we’ve had. We are still working through the change in the sales strategy to a much more OEM-friendly strategy. And then that as you are aware has a different cycle time and a direct sales model. We’ve made a lot of leadership changes across the whole company in the last three, four months.

So we're digesting all of that. It is interesting right now. It's sort of the seasonally down quarter for some of our partners in the server space. And then as we talked about on the call, we are working through the nonlinearity in the Hyperscale piece of business. So to answer your question directly, we hope to have better visibility as we continue to address the visibility issues that I just walk through. And we will see how that goes over the course of the rest of this year.

Operator

Our next question comes from Steve Milunovich with UBS. Please go ahead.

Steve Milunovich - UBS

Thanks. Can you talk a bit about your Hyperscale business? You indicated your Enterprise business increase in the mix, which is why the gross margin was there. Was that Hyperscale was weaker with Enterprise strong, can you say anything about Facebook and Apple and what about delays that you talked about last quarter in some of the data center build outs, are those starting to move forward?

Shane Robison

So let me start by just reiterating, Facebook and Apple continue to be important customers for us. And while we are not wreaking amount, everybody is aware of them and they continue to be important Hyperscale customers for us. As we said, the nonlinear nature of the Hyperscale business continues to behave that way and some data center deployments are moving in and some are moving out and we are were working through that.

Some of it has to do with just construction cycles and locations and some of it has to do with the nature of our customers, Hyperscale business growth, which is really the driver for when they want to deploy our technology in their data centers. On the Enterprise side of the business, we are going to continue to I think see good momentum there with the OEM partnerships that we are developing and the mission-critical application, acceleration solutions. You will hear a lot more about that at the Analyst Meeting on the 6th.

Operator

Our next question is from Katy Huberty with Morgan Stanley. Please go ahead.

Jerry Liu - Morgan Stanley

Hi. It’s Jerry Liu for Katy Huberty. I just want to better understand the strength in the December quarter and how that translates into the guidance. First on revenue, definitely there is some product mix help. Can you just go into a little bit more detail, which products really drove the strength and any geographical differences? And then on the gross margin, can you go into little bit more detail on what helped the quarter but also why? In the March quarter, you are still expected to come down to the low 50s. Thanks.

Ted Hull

Hi, Jerry. This is Ted Hull. Thanks for the question. Let me try to answer it and let me know if we want to follow-up. But we did have some really good performance I think across our customer base. Just to give you a couple points, we had a couple OEM partners greater than 10%, end user greater than 10% for example. So we felt really good about -- broadly about our markets and our ability to sell into that.

In terms of the gross margin, we felt it was a really good quarter from that perspective. I think we saw good performance there as well. And as we are going forward, we are looking out into Q3 and we think the mix is going to favor more Hyperscale into Q3. And of course we really want to continue to grow that product line as well. So that’s kind of how we are seeing the revenue and the gross margins playing out. You can see our topline guidance as well as to where we are expecting to sequentially grow as well.

Operator

Next question comes from Lou Miscioscia with CLSA. Please go ahead.

Lou Miscioscia - CLSA

Sure. I just had a quick one and a follow-up. There was a big data center opening up in ION in 2015, do you think that’s going to have a material positive benefit to your revenue stream possibly in the September quarter?

Lance Smith

Hi. This is Lance. I will take that question. Lou, what we generally see is that if it’s an existing customer and they do expand their footprint in their business especially when it comes to brand new data centers, we typically anticipate joining in and fulfilling hardware Internet data center. Our expectation is quite high with some of our customers, especially the ones that are expanding in the near future. We do believe that there will be an impact improvement in revenues for the second half of our fiscal year 2014.

Operator

Our next question is from Bill Shope with Goldman Sachs. Please go ahead.

Bill Shope - Goldman Sachs

Okay. Thanks. Are there any changes to your thoughts on steady state gross margins compared beyond the March quarter guidance you provided and how are you thinking about that? And then I guess secondarily, are you seeing any changes in the competitive landscape or pricing trends particularly from the incumbent?

Shane Robison

So, I think the answer on the gross margin is we are trying to give you really as good a visibility as we can and to what’s the difference in the mix as it plays out each quarter. And that's really what drives the changes in a gross margin profile. So as we do see some big Hyperscale deployments in any given quarter, we see a little lower gross margins than we were in a quarter where it's more heavily sway towards the Enterprise side. On the competitive piece, I’m going to let Lance jump in. He is spending a lot of time on that right now.

Lance Smith

I would say I think I will generalize when I take a look at the competitive landscape. We’ve had quite a bit of consolidations in the marketplace. We have not yet seen the effects good or positive with the consolidation. It is still little too soon to tell. But we can tell you is that in terms of the mix of our business, customers are still having an appetite for higher capacity drives. They are also having an appetite for even increasing performance, that all looks pretty good.

So our reputation for performance for reliability continues to hold strong. Going forward, we believe that during our transition period between our Gen 2 and our Gen 3 platforms, it puts us in a better position I guess any competition that’s up and coming, especially when we look at advancements in our technology and improvements in our performance.

Operator

Next question is from Gary Mobley with Benchmark. Please go ahead.

Gary Mobley - Benchmark

Hi. Thanks for taking my question. I was curios to know where you guys stand with the qualification for the latest ioScale products with the various OEMs and relating to that I’m curios to know many different flash card vendors are qualified with each of these OEM partners and the point of question is just trying to give a sense of where you might rank with each of these server OEMs?

Lance Smith

Hi, Gary. This is Lance. I will definitely take that question. With respect ioScale, we’ve had one Tier 1 OEM that qualified last quarter. We also expect to have two Tier 1 OEMs qualifying this quarter, with the fourth Tier 1 OEM that continues to sell through the third-party offering.

So we think we are making pretty good progress with ioScale, especially in terms of position in our product families. ioScale address cost conscious customers who are actually deploying flash basically in the middle of their data center. So if they try to deploy flash with benefit of industry consolidation or better performance, but also trying to fit this sort of non-mission critical applications, ioScale is fitting pretty well there and the take-up on that is actually fairly strong.

Operator

Next question is from Amit Daryanani with RBC Capital Markets. Please go ahead.

Mitch Steves - RBC Capital Markets

Hi. This is Mitch Steves filling in for Amit here. My question is kind of surrounding the M&A that has been going on the space. So, one, I was wondering if you guys provide any update on your NexGen acquisition and the smaller acquisition you guys have done in the past? And then any commentary surrounding some of the card base acquisitions from WD and some of those (inaudible) guys?

Lance Smith

Let’s say, I heard a couple of questions here. The -- to the first one, I'll now speak to, this is Lance, again. I'll speak to acquisition of NexGen. This one actually was a very focused M&A, so that we could actually extend our market reach. Today, we have products that fit very nicely into Hyperscale and also into Enterprise.

But when you look at small and medium Enterprise, there is need to try and bring the end-customers cost down and also help them to avoid storage broadly. And this is where ioControl is the product line actually takes the benefit of flash, integrates it into a hybrid-based solution, which gives the end-customer the ability to tune or give the performance where the applications are needed.

That's worked extremely well and also keep the cost down. So what we’ve seen with our sales so far, is that customers are looking for end prices between a $1 to a $1 -- $1 to $5 per gigabyte in terms of end customer costs.

And when we take a look at the competition, as I mentioned before, in this consolidation of this card acquisition, this PCI-Express base or these high performance non-volatile events, it’s too early to tell. There is a lot of noise out there, claims about the performance.

What we have seen with respect to these non-volatile events, PCI-Express still is the connectivity of choice. What we have found is our IOPs are higher, our latencies like for instance the range could be 50% faster our right IOPs can be twice the performance this technologies. There’s still seems to be focused on a very specific applications and some of the press that we've seen points towards messenger-based applications rather than large-scale Enterprise applications or data bases or mission-critical applications.

So right now we have to tell you that we haven't really seen in the marketplace yet, but we have technologies compete against that. I think I've mentioned already our application acceleration through our programmable interfaces like atomic rights extending page memory and also key value store.

These key flash competitive and also keep flash as the ability to be utilized in these different applications and advanced technologies like ACM our commit memory. It can also deal with these types of NexGen applications, so we have a real broad use on a very standardized product line.

Operator

Our next question is from Abhey Lamba with Mizuho Securities. Please go ahead.

Abhey Lamba - Mizuho Securities

Yeah. Thanks. As you look at your growth opportunity ahead of you. Where do you think is a bigger opportunities in the cloud of service providers or is in the Enterprise s. And if you can talk about little bit about the competitive environments in both those categories in terms of the types of price preferring who you have seen in terms of competitors in those categories, that would be helpful?

Shane Robison

So, I'll speak to the growth opportunities and then Lance will outline the competitive dynamics in each. The answer to your question is, yes and yes. So we see the Hyperscale and in particular the service provider segment as a real growth opportunity. We've talk about this little bit in the past and we believe the Enterprise segment in terms of the total available market is actually a bigger opportunity for us. And it's an area where our strategy which is more and more focused on mission-critical application acceleration is an exceptionally good fit.

The other areas which you didn't mention which we think are big opportunities are other geographies. So, we've talked on the call about the introduction of the new sales leader for the Asia-Pacific region. We think that's almost an untapped market for us. We've got some customers there, but it's nothing like what I think we should have as we really penetrate that market and some of the other international markets. So, on the competitive front, I let Lance talk about that.

Lance Smith

Okay. And then the -- thanks Shane. In the three markets when we look at Hyperscale, Enterprise and SME. The landscape in the competition is a little bit different. We look at those opportunities based on a number of servers or the percentage of servers that are actually sold in that space. And if we take 8 to 10 million servers sold each year, about 55% of them are sold into Enterprise applications, about 25% in Hyperscale and about 25% in SME.

Starting at the bottom and working away to the top, SME is a very cost conscious. So the type of solutions we see there are either hybrid rate based or low cost SSDs. And these SSDs typically are of SATA interface. Typically that will have a high endurance, also typically doesn't have high performance requirement and so they're usually graded trying to get some performance at some level of reliability out of them.

Moving to Enterprise, about 55% of the servers are sold there, the competition comes at about three forms, PCI-Express, Enterprise Class SSDs or one that they're actually connected through SaaS or iSCSI interface and then flash arrays.

These types of competition it requires the integrative solutions like we have with ION rather than it compares in SME where you need somewhat hybrid-based solutions like ioControl or a wide variety of products like we stress between ioDrive for the high performance solutions and ioScale for the cost of optimize solutions.

And the Hyperscale different, these are scaled out solutions, meaning that our customer base or the customers in Hyperscale consume about 25% of the servers being sold every year. But they are actually adding servers because they have technologies they rolled out of the data centers, that the more servers they add, the better their quality of service in the more capacity that they have in their data center.

This actually requires to have a more distributed solution. And this is where our PCI-Express place extremely well. We have seen customers take sort of the higher end SSDs, rate them or take hard disks drives and rate them depending on what tune you are in the data center itself. So we've seen our customer base take high density ioDrives or ioScale base design and literally put them in every single one of those servers. So the competition itself either has to compete on performance or compete on density, interoperability to fit within these data centers.

And what we have showing from an application perspective across all of these segments, but if you could accelerate the application, you have a benefit for that customer either through return investments or consolidating their data footprint requirements or a higher level of performance and application, we have many times on this call talked about on how we're able to deliver more performance on an application 10X plus.

And our competition struggle for that, one of the key factors is latency, followed by IOPs and the bandwidth. Latency is a very critical component or attribute of storage that we consistently deliver.

Operator

Next question is from Andrew Nowinski with Piper Jaffray. Please go ahead.

Ryan Bergan - Piper Jaffray

Thanks, this is Ryan Bergan in for Andrew. Yesterday we heard from IBM that they continue to struggle with its hardware platform but the company did highlight flash as one of the areas it plans to invest heavily into. And while I understand, you may not address any particular OEM specifically.

Can you give any color on the progress in the increased adoption really you’re seeing from several OEMs that you seek further growth. And can we expect any more material announcements around greater integration. And what products can you highlight that you’re looking to integrate further with your existing OEM customers?

Ted Hull

So we spot -- go ahead Lance.

Lance Smith

Hi Ryan. This is Lance Smith. I think I’ll address that one also. IBM has made a number of announcements. One of key one that occur most recently is that their commitment to flash in the $1 billion that funding a bit could aside to develop flash into Enterprise. What I can tell you when we take a look at even to our most recent announcements, pretty fair. They’ve actually done some very specific features and support in their X6 servers and they’ve also announced some new flash system based solutions.

What’s nice about these announcements that it actually plays pretty well for Fusion-io. Keep in mind, we have branded based product in with Tier 1 servers. And this is where it plays perfectly for us and for our partners. IBM in particular has been selling for quite sometime. They are high IOPS adapters. These are both are ioDrive and ioDrive-dual based products including the use of most recently Fusion ioTurbine technology based IBM flash cache software. These are all supported on the new servers and have taken advantage by their customer base.

So what we’ve seen is not only its adoption but actually the full use of our technology throughout their product offerings. When we take a look at any kind of applied based solution, now we start talking about our ION based products and ioControl based products.

Many time we see the integration of flash either by us or user technology in the marketplace, adoption rate will go up. Customers today typically are utilizing software, is not storage aware.

And there are technologies that we have like IBM flash cache software based on ioTurbine acquisition. That it helps utilize flash in a way that our customers can leverage their existing software infrastructure or if they have deployed hardware in their data center, they already have a stand for instance, they can use ION as they cache in front-end for their stand in permutation either back in storage.

These will help on the adoption rate. These types of announcements like you seen from IBM and from our other partners like HP and Dell. They actually bring up the awareness and help us sell our products into the Enterprise space.

Operator

Next question from Alex Kurtz with Sterne Agee. Please go ahead.

Unidentified Analyst

Hi. This is (inaudible) for Alex today. Thanks for taking the question. So looking into the future how are you modeling expectation for your rep yield on the Enterprise side over the next 12 months or so. And as we become a more solution focus vendor, do you expect expanding the rep quarter to be the primary driver of this Enterprise growth or do you have other strategies in mind? Thanks.

Shane Robison

The strategy is pretty comprehensive than individual rep quarters are less of a driver then the partnerships with our OEMs, the leverage in the channel. You always see we’re going to have a direct sales force because it's important for us to make sure that the end customers are educated on a value proposition and what we can actually do. But you'll see us use a much more leverage model as we fulfill those opportunities through partners of a wide variety. And so I wouldn’t focus too much on sales reps quarters, although we make sure, we have them appropriately recorded to deliver on their bookings and revenue.

Operator

Next question is from Rajesh Ghai with Macquarie Capital. Please go ahead.

Rajesh Ghai - Macquarie Capital

Yes. Thanks. Let me if you could give me more color on your strategy to make ioScale available with OEM channel. As you mentioned that there’s one OEM qualified, is the base of qualifications by your expectations. Is ioScale helping you expand the New Year’s cases in Enterprise in the sense to expand the market and do you think this becomes a material part of your Enterprise revenue mix? Thank you.

Lance Smith

Hi Rajesh, this is Lance Smith again. I think I’ll address that. So I think I will iterate for you that with ioScale, we just begun a quarter ago, qualifying or making the ability for OEMs to qualify ioScale. On last quarter, we had one OEM that was fully qualified and selling those two OEM that will finish qualifying this quarter with the fourth continue to sell through third-party. So we see that the progress on qualification for ioScale is quite good and meet our expectation.

The second thing is ioScale in terms of how it fits on our product line, in fact, does increase our opportunities and it is incremental to our business. ioScale actually addresses those customers or the application that are cost conscious. And what we’re trying to do there is making sure that we can offer to our customers the right trade-off, performance trade-offs, the reliability trade-off, functional and feature trade-offs. So that they can hit the demands, whether it’s the total cost of ownership or the ROI that they’re trying to project in their portion of the data center that’s important to them.

Flash at the end of the day can be expensive especially compared something like a normal hard disk drive. The industry, we’ve just barely penetrated into what we believe the opportunity that flash represents. And this requires a couple of things either with our partners on generating solutions that we talked about especially at our last earning calls.

I’m working with the ISVs, working with the OEMs and integration these components. So that products like ioScale, when it’s needed, if it's just below the demands of ioDrive and this is the two tiers of products that we have to offer for marketplace.

Operator

Next question is from Brent Bracelin with Pacific Crest. Please go ahead.

Brent Bracelin - Pacific Crest

Thank you. I’ll try to squeeze a couple in here if I could. Your outlook implies return to growth for the first time in a year. Wanted to ask a couple of questions on really sustainability of that margin and then the expense structure. As you think about kind of the sustainability of growth here, it sounds like linearity improved in December quarter, tight to tightening of hyper scale, you’re now guiding the sequential improvement again on hyper scale. Is there something more sustainable you're seeing on the OEM or Enterprise adoption side that gives you confidence and return to growth next quarter or is it solely tied to hyper scale, a large order’s first question.

Second question on the gross margin outlook. Obviously the guide to low 50% gross margin indicated was tied to mix. But is there also some level of conservatism factor than to product cycle transition also in those gross margins. And then the third question last but not least here is the expense structure that obviously was 59% of the OpEx tied to sales. Is there any opportunity that you see that to reduce OpEx going forward in your short time there so far?

Shane Robison

See you had about 10 questions mixed in there. We’re going to try and answer them but if we forget one, we’ll come back to you.

Brent Bracelin - Pacific Crest

No problem.

Shane Robison

On the trajectory, we forget about the progress we made in Q2 and I want to reiterate our guidance which was in line with Q2 to slightly sequentially up. We’re seeing interesting strength in all three of the segments that we’re focused on. So we’re seeing strength in the Enterprise which has to do with the big mission-critical applications that we’re developing in partnerships with the ISVs and that's a very, very exciting piece of our business.

We’re looking forward to some growth in the I/O control space in small, medium Enterprise. And then there's always a mix in the Hyperscale part of the business as we see these big deployments. So it’s no one segment that is carrying the whole thing and that's actually good news from my perspective. I’ll let Ted talk a little about the margins.

Ted Hull

Yeah, from a gross margin standpoint, we are really coming off a good quarter. And as we looked into our Q3 and we see from our product mix and kind of where this market is, that's where we put the guidance. And it's our best estimate as to where we expect to land at this point in time. And your question on OpEx in terms of where we'd like to invest, I think I believe we have still significant opportunity around the world and the opportunity to penetrate in these multiple geographies.

Obviously, we want to be very smart, careful, how we invest and go after growth. But I think with all of the transitions that we have going on from the management team and I think we have very solid opportunities across the world. So there might be a couple ways to address the market, but that's where we want to invest where we will have growth as well as maintaining our product leadership going forward.

Operator

Our next question is from Ben Reitzes with Barclays. Please go ahead.

Ben Reitzes - Barclays

Hey, thanks a lot. Appreciate it. I wanted to ask about the potential for consolidation in the server market. It’s pretty well chronicle that IBM and Lenovo were in talks and IBM's looking to divest at least a lot of their server unit, would that impact you, do you think that if that were to take place you would be able to sustain any revenue here or would there be a revenue acceleration, any color around that would be very helpful? Thanks.

Shane Robison

These things are little hard to predict. But one of the things we announced on the call was a new partnership with Lenovo. So whether it’s a partnership with IBM or partnership with Lenovos, whoever owns that server business would view that as a good, strong opportunity for us.

The other piece of this is some of the partnership with IBM is with the storage part of the business. So when we talked about ioTurbine and IBM's rebranding of that to the FlashCache accelerator, taking advantage of our software. Even, if they sell their server business to Lenovo, which we just announced a partnership with, we still will be focused on partnering with them in other parts of the business.

Operator

Next question is from Srini Nandury from Summit Research. Please go ahead.

Srini Nandury - Summit Research

Well, thank you for taking my call. As we go back to your Lenovo relationship, you said that you want to qualify your ioScale part there, typically how long does it take for you to qualify a part like ioScale, like one of your new OEMs? And similarly how long does it take, if there are different times, what you called the periods and how long it takes for you to qualify your ioScale or your IOGEAR parts?

Lance Smith

Hi Srini, this is Lance Smith again. It depends on the OEM. It also depends on their launch window. Sometimes, they will launch particular times of the year. Sometimes, aligned with server launches and sometime aligned with other product launches. It could be anywhere between twice or four times a year an OEM will launch. Each OEM is different in their qualifications, at least what they do, how much they do and how long it usually takes could be anywhere between one quarter to as much as three quarters.

But we have not seen typically a difference between our different product lines or Ios driving ioScale. We have a lot of experience with our OEMs, so we tend to be on a fast path because they are used to our technology, they’ve seen our technology and so most of these qualifications are incremental instead of starting from scratch.

Usually, the work is interoperability on new server platforms because there’s usually a new server design, new electrical mechanicals and thermals there have to be tested. So hopefully that answers your question. There is a broad range but it can be pretty quick, took a long time depending on much experience we have with the customer or with an OEM.

Operator

And we have a follow-up from Lou Miscioscia from CLSA. Please go ahead.

Lou Miscioscia - CLSA

Okay. Thanks. I just want to circle back on the OEMs and especially when you look at IBM, recently they have started to replace NetApp in their mid-tier line, a product that we are OEMing now with IBM’s own product. Shane, as you know, OEMs traditionally want to maximize their own revenue, their own margins. So how long or a period of time do you think you have from here before IBM with their purchase of Texas Memory or any of the other ones really start to think that this is an area that they want to get aggressive in with either maybe somebody that’s going to bring it in at lower cost, or just their own type of product? Thank you.

Shane Robison

Well, this has always been a challenge in the technology world in general and I think that the window is as long as we make it. And by that I mean, as long as we are innovating ahead of everyone else and we have a solution that is more than competitive with what they can get in other places, I think we’ll continue to have an opportunity there to partner with them. It takes a long time to develop one of these systems at the level that we have and a huge R&D investment.

And new OEMs have their own set of priorities and issues and they’ll have to pick and choose where they want to make those investments. And we think we can provide him with a very, very attractive partnership that will allow them to invest in the areas where we are not at and take advantage of what we've done. And so, it's partially why as I said in the very beginning of the call, it's important for us to be able to continue to invest in our innovation engine and then in these partnerships as we go forward.

Operator

Thank you. At this time, I would like to turn the call back over to Nancy for final remarks.

Nancy Fazioli

Thank you, Operator. Regarding events for the quarter, please note that Fusion-io will hold an Analyst Day on February 6th. The event will be webcast and available on our Investor Relations website. Please contact Investor Relations with any question about the event.

In addition, the company will present at several conferences in February and March, including the Stifel Nicolaus Technology, Internet & Media Conference on February 10th, the Barclays Big Data Conference on February 11th, and the Goldman Sachs TMT Conference on February 12, and additionally present at the Morgan Stanley TMT conference on March 4th.

We will participate in a panel at the Pacific Crest Emerging Technology Conference also on March 4th. Please contact the Investor Relations department with any follow-up questions from this call. You can reach us at ir@fusionio.com. This concludes our call. Thank you for your participation and support and good evening.

Operator

And ladies and gentlemen, this concludes today’s conference. Thank you for participating. You may now disconnect.

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