QLogic's (QLGC) CEO Prasad Rampalli on Q1 2015 Results - Earnings Call Transcript

| About: QLogic Corporation (QLGC)

QLogic (NASDAQ:QLGC)

Q1 2015 Earnings Call

July 24, 2014 5:00 pm ET

Executives

Jean Hu - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Prasad L. Rampalli - Chief Executive Officer, President and Director

Analysts

Karl Ackerman - RBC Capital Markets, LLC, Research Division

Kathryn L. Huberty - Morgan Stanley, Research Division

Aaron C. Rakers - Stifel, Nicolaus & Company, Incorporated, Research Division

Tavy Rosner - Barclays Capital, Research Division

Ryan R. Bergan - Piper Jaffray Companies, Research Division

Jung Pak

Vlad Rom - Crédit Suisse AG, Research Division

Bill C. Shope - Goldman Sachs Group Inc., Research Division

Operator

Good day, and welcome to the QLogic Corporation Q1 FY '15 Earnings Announcement Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jean Hu, Chief Financial Officer. Please go ahead.

Jean Hu

Thank you, operator. Good afternoon, and welcome to QLogic's first quarter fiscal year 2015 earnings conference call. Joining me on the call today is Prasad Rampalli, our President and Chief Executive Officer. Prasad will open the call with a discussion of the current state of our business. Then I'll provide a review of our first quarter financial results, as well as the guidance for our second fiscal quarter. We'll then open the call for questions.

Certain of our comments today will include forward-looking statements regarding future events and our projections of our financial performance based on current expectations. These comments are subject to significant risks and uncertainties that could cause our actual results to differ materially from those expressed in these forward-looking statements.

We refer you to the documents QLogic filed with SEC, specifically our most recent Form 10-K. These documents identify important risk factors that could cause our actual results to differ materially from expectations. We do not intend to update the forward-looking statements that we make today.

In our first quarter earning press release issued earlier today, we reported both GAAP and the non-GAAP results. Of the references we'll make on our call today relate to non-GAAP results, unless otherwise stated. A reconciliation of the non-GAAP to the GAAP financial measures is available on our website under Investor Relations.

I would now turn the call over to Prasad. Prasad?

Prasad L. Rampalli

Thanks, Jean. I'm pleased with the solid financial performance in the first quarter of fiscal 2015. We delivered revenue of $119.4 million, up 6% from the first quarter of last year. The strength in our revenue was driven by a 12% year-over-year increase in revenue from Advanced Connectivity Platforms.

In addition, our net income increased 13% year-over-year to $18.5 million or $0.21 per diluted share in the first quarter. Both revenue and net income per share were above the midpoint of our guidance range.

We are very encouraged with the momentum and growth prospects for the revenue from our Ethernet products. This revenue doubled year-over-year, primarily due to the NetXtreme II products and represented more than 20% of our revenue from Advanced Connectivity Platforms.

Moving on to our business update. Our team is executing very well to further establish QLogic as a leader in data and storage networking connectivity products. Calendar year 2013 marked our 10th consecutive year of Fibre Channel Adapter market share leadership, a year in which we again grew our position.

We had a very strong start in 2014 and further increased our market share in the March quarter. Based on the most recent available industry data from the Dell'Oro Group, QLogic gained nearly 5 share points on a sequential quarter-over-quarter basis and achieved a 59% revenue market share in the March quarter. This resulted in a lead over our nearest competitor of more than 19 percentage points. With our strong results in the March quarter and our June quarter performance, we are well positioned to increase our Fibre Channel market share leadership in 2014.

We are very confident about our prospects for continued technology leadership in the Fibre Channel market. In our recently completed quarter, we've seen a significant acceleration of 16-Gig Fibre Channel adoption and expect that trend to continue with the upcoming Grantley server cycle.

We are also in active development with our first Gen 6 Fibre Channel product, which includes 32-gig lengths and many important new features and capabilities. We expect to have prototypes of our 32-gig product in-house this quarter, customer samples later this year and production units in calendar year 2015. We believe we have a significant time-to-market advantage on 32-gig Fibre Channel and look forward to meeting our customer expectations on need for performance.

An important and growing portion of our Fibre Channel products comes from storage connectivity. Supplies of storage systems and all-Flash arrays use our ASICs to provide storage network connectivity for their products. Over the past year or so, we have announced a number of storage customers that are using our products. That momentum continues with additional announcements forthcoming, and we are confident that we're on track to become the leader in this market.

To close on our Fibre Channel product update, I want to reiterate an important strategic technology and market alliance we announced earlier this year with Brocade. QLogic, the #1 supplier of Fibre Channel Adapters and Brocade, the #1 supplier of Fibre Channel fabric switches are working together to enhance end-to-end storage connectivity for end users, accelerate innovation in next-generation storage networking and drive the future for Fibre Channel technology. We continue to work with Brocade on activities to strengthen the storage area network ecosystem and expect this technology and marketing alliance will help both companies deliver better value-based products to the market.

Our Ethernet products focus on network connectivity for both servers and storage systems. We are realizing significant revenue growth from our NetXtreme II product line, and we're expecting continued growth with the upcoming Grantley server cycle. We are very well positioned to become the #2 player in this market.

Many of our Ethernet products are shipping to OEM customers today, and we have recently completed qualification on additional programs from key OEMs. A very important example is the recent announcement of the HP FlexFabric.

In early May, we announced our products were a key element of HP's latest Virtual Connect FlexFabric solution as a key enabler of the industry's first 20-gigabit Ethernet connectivity. Our Ethernet controllers are the core of HP's latest Virtual Connect FlexFabric adapters and deliver the industry's highest performing Ethernet, Fibre Channel over Ethernet and iSCSI connectivity available.

In addition, our converged switching technology is embedded in HP's latest Virtual Connect FlexFabric modules. The combination of our leading technologies in the HP FlexFabric architecture creates a high-performance, 20-gigabit Ethernet fabric ideal for data center convergence and virtualization.

Our Ethernet controllers enable the HP FlexFabric 20-gigabit dual port adapters, which provide 10 gigabit or 20-gigabit converged Ethernet connectivity to HP blade system servers. Leveraging HP's Flex-20 technology, these new adapters efficiently deliver twice the bandwidth of a 10-gigabit port while reducing the management overhead associated with multiple 10-gigabit adapters. These adapters offload Fibre Channel over Ethernet and iSCSI traffic, eliminating software overhead and reducing CPU cycles for improved performance while simplifying server-to-network storage connectivity.

The Ethernet market continues to grow very rapidly. Capitalizing on our strong position in the Ivy Bridge server cycle and upcoming Grantley server cycle with 10-Gigabit Ethernet LANs and NICs, our Ethernet business is expected to grow at a pace faster than the market.

In addition to the pre-Grantley programs, the 3 leading server providers account for well over 20 active qualification programs for NetXtreme II products. We expect solid demand across a variety of markets, including both enterprise and cloud and are confident that we'll expand our market share in the fast-growing server Ethernet connectivity market. We are working closely with all of our customers and are on track with these important qualifications.

Our 40-gigabit and 100-gigabit products are in-house and undergoing engineering testing. The 40-gigabit and 100-gigabit testing is going very well, and we are looking forward to customer sampling later this year. We are excited about the value and differentiation, as well as expanded use cases these new products will bring to the market.

Finally, I'm very pleased with our focus on execution and progress made to further establish us as a leader in data and storage networking connectivity products. The data center is ongoing -- undergoing a significant transformation as enterprises move to private and public clouds.

We believe that a redefined data and storage network I/O stack will be a key pillar for the next-generation data center and will be a significant catalyst for the workload transition to the cloud. This provides us a unique growth opportunity to build differentiated value-based products, which are an extension of our core networking connectivity capabilities and expand our technology leadership.

To further enhance our ability to execute this strategic objective, we have continued to build upon our strategic leadership team. We are very excited with the addition of 2 more key executives with significant industry experience joining our team.

Tony Carrozza joins us as Senior Vice President of Worldwide Sales, following key roles as Executive Vice President of Worldwide Sales at Silicon Graphics International and Senior Vice President of Worldwide Sales at Quantum Corporation. As a 30-year industry veteran, with extensive global sales leadership experience with broad OEM end users, Tony will enhance our ability to provide a broad range of server I/O solutions and value-added storage and networking solutions to a significant range of enterprise and cloud customers.

Ahmet Houssein joins us as Senior Vice President and General Manager, Ethernet products. A recognized technology leader with in-depth understanding of data center virtualization, cloud infrastructure, server, storage and networking systems, Ahmet adds extensive experience to our leadership team through his past general management roles at Intel and Adaptec and as President and CEO at Silverback and VirtenSys.

In summary, we are off to a good start in fiscal 2015, and we'll continue to drive our singular focus to expand our leadership position in the market for data and storage networking connectivity products. We are confident of maintaining our revenue and profit performance in the mature Fibre Channel market by continuing to deliver superior products, gain market share and capitalize on new storage connectivity opportunities.

We are making significant progress in the enterprise Ethernet market as our revenue from these products doubled from the prior year, and we are well positioned to build on this momentum with the upcoming Grantley cycle.

We will continue our solid discipline in driving operational efficiencies across the company. This will allow us to deploy our resources to develop new offerings that capitalize in our unique position in the server and storage connectivity markets and to contribute to our future growth and success.

I'll now turn the call over to Jean to provide a summary of our first quarter financial results. Jean?

Jean Hu

Thank you, Prasad. Our revenue in the first quarter was $119.4 million, up 6% from $113.1 million recorded in the same quarter last year. This revenue was above the middle point of our guidance range of $115 million to $122 million provided during our fourth quarter earnings call.

Our first quarter revenue from Advanced Connectivity Platforms, which are comprised primarily of adapters and the silicon for server and the storage connectivity applications, was $104.7 million, up 12% from $93.2 million recorded in the first quarter of last year.

First quarter revenue from Legacy Connectivity Products, which are comprised of primary switch products, was $14.7 million and declined from $19.9 million recorded in the first quarter of last year. This decline was consistent with our expectation, and we expect revenue from these products to continue to decline over time.

Our first quarter gross margin of 64.4% is consistent with the guidance that we provided during our fourth quarter earnings call.

Next, I'd like to cover our first quarter operating expenses. Total operating expenses were $57.6 million, down from $60 million reported in the first quarter of last year. Engineering expenses in the first quarter of $34.9 million declined from $36 million last year. Sales and marketing expenses in the first quarter was $15 million and it declined from $17.6 million last year.

G&A expenses in the first quarter was $7.7 million. Operating income in the first quarter of $19.4 million was the 16.2% of revenue and improved from 15.4% of revenue in the prior year.

Our first quarter net income of $18.5 million increased 13% from last year. This represents a net profit margin of 15.5%, an improvement from the 14.5% net profit margin last year. This is the 76th consecutive quarter of profitability for QLogic.

Our first quarter net income per diluted share of $0.21 was above the middle point of our guidance range of $0.17 to $0.22 provided during our fourth quarter earnings call.

Turning now to our balance sheet. Our cash and marketable securities were $250 million or nearly $3 per share at the end of the first quarter. We continue to maintain a very strong cash position and have no debt.

Now moving on to our near-term outlook for the second quarter of the fiscal 2015. We expect total revenue to be in the range of $121 million to $127 million. At the midpoint, we expect revenue from Advanced Connectivity Platforms to be up approximately 6% sequentially, driven primarily by a $3 million to $4 million increase in revenue for our Ethernet products.

We expect revenue from Legacy Connectivity Products to be approximately $30 million. Gross margin is expected to be in the range of 62% to 63%, and operating expenses are expected to be in the range of $55 million to $56 million.

When combined with a project tax rate of approximately 15% and a diluted share count of approximately 88.5 million shares, we expect to achieve non-GAAP earnings per diluted share of $0.19 to $0.24 in the second quarter.

Actual results for future periods may differ materially due to a number of factors, including those outlined during the course of this conference call, in our filings with SEC and in the disclaimer statement at the end of our earnings press release.

This concludes our prepared remarks. Operator, we'll now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Amit Daryanani with RBC Capital Markets.

Karl Ackerman - RBC Capital Markets, LLC, Research Division

This is Karl Ackerman on for Amit. Just curious when looking at the gross margin guidance for the second quarter, it is a little bit stepped down relative to the first quarter. And I was just curious if you could provide some incremental color on that. Is it largely from increased growth expectations from 10-Gigabit Ethernet business or is it mix related or can you provide just some more color on that if you don't mind?

Jean Hu

Yes, absolutely. So our gross margins primarily depend on product mix. So if you look at the middle point of our Q2 guidance, our Advanced Connectivity Platforms will grow 6% sequentially, which is primarily driven by a $3 million to $4 million increase in revenue for our Ethernet products. So that's why we guided the gross margin to be 62% to 63%. I think it's important to note we're really returning the company to a growth trajectory. We're growing revenue sequentially and overall gross margin pool dollars will increase going forward.

Karl Ackerman - RBC Capital Markets, LLC, Research Division

Got it. And then just one more, if I may. Now that Fusion-io is in the process of being acquired by SanDisk or just recently closed, do you foresee any increased risk to your fabric cash offering? If SanDisk provides potentially some increased capability on server side cache offerings?

Prasad L. Rampalli

Yes, this is Prasad. To me, what SanDisk did with Fusion-io is one of many plays that are happening to capture this lucrative and growing space on server side caching. And so we feel that there's enough room for all of us. Since this is really nascent, we expect by 2016, 2017, that this is going to be north of $7 billion to $8 billion as total serviceable TAM. And from our standpoint, we think a software-only solution is going to fall short beyond acceleration when you get to clustering and other capabilities that are needed on server side. And with our hardware capabilities, both in ASIC and firmware, we think we have distinct performance advantage, as well as native clustering that can be enabled in the data pad that our competition will not. So there's two points: one, is we have enough room for everybody; and number two, on a combination of hardware and software, native and the data pad is going to win the game, in my opinion.

Operator

We'll take our next question from Katy Huberty with Morgan Stanley.

Kathryn L. Huberty - Morgan Stanley, Research Division

So historically, Intel server cycles drive a couple point boost to server unit growth. So just curious whether you expect a similar impact from Grantley. And then also what quarter we should start to see the benefit?

Prasad L. Rampalli

Yes, thanks, Katy. Having come from Intel, I'm really looking forward to the upcoming Grantley cycle. When you look at the core capabilities of this next x86 generation, the key differentiators for me are really the number of cores. On a 2-socket Dion [ph] system, we are looking at 12 cores. That's a lot of cores at higher speeds. At the same time, we're looking at a 4-lane, 10-Gigabit Ethernet bandwidth capability. And on top of that, we have a significant opportunity with DDR4 memory that gives us enhanced memory capability. When you add up all these technologies and you throw in the mix of the need for end customers looking for moving to private cloud with more virtualization, which means more VM densities. They're going to be wanting more IOPS per virtual machine. And we think that, a, there's going to be a significant uptick in seller procurement from CIOs. I was just reading your own report the other day. You noted that there was going to be potentially a 4% increase in server consumption, ex HPC, and I tend to agree with that. I think it's probably going to be 4% to 5%, and that's a conservative estimate, in my opinion. But more importantly, I think it's going to lead to an accelerated transition from 8-gig to 16-gig on the Fibre Channel side. And it will also accelerate 1-gig to 10-gigabit Ethernet on the Ethernet side. And on both counts, we feel very good with our core products and how they'll be leveraged.

Kathryn L. Huberty - Morgan Stanley, Research Division

And does the impact hit in the calendar fourth quarter of this year? Is it more a calendar 2015 event?

Prasad L. Rampalli

Well, clearly, it's going to be with the onset of calendar Q4 of this year when Grantley launches across our server OEMs. And the average cycle with end customers, as you know, takes 1 year to 18 months. So we see a virtuous cycle that will build momentum coming into Grantley and will essentially complete itself over 18 months or which we hope to benefit significant volume gains with attach rates and transitions that our products will benefit from.

Kathryn L. Huberty - Morgan Stanley, Research Division

And do you hear any views yet around the impact of Microsoft Windows 2003 support expiration? Could there be an impact on server hardware upgrades or do you think that's largely a software upgrade?

Prasad L. Rampalli

Well, absolutely not. I mean, Windows Server 2003 is very long in the tooth. There's roughly about, in my estimation, 15 million-odd servers running on that operating system in the enterprise. And they are desperately in need of an upgrade, especially now that Microsoft has stopped support for it. And that will result in Grantley purchases, albeit with a higher consolidation ratio, given what the cores can do and capacity of memory. But factoring in the consolidation ratios and looking at these new purchases, I think there's a cumulative positive effect of it what the base Grantley technology provides. And I look at Windows 2003 server as a catalyst. It's not going to be earthshaking, but 10 million to 15 million servers is not short change, and we welcome that.

Kathryn L. Huberty - Morgan Stanley, Research Division

And then just finally, as you know, the server market has shifted over the last couple of years towards Taiwanese ODMs who are working directly with some of the hyper-scale customers. In the past, QLogic wasn't necessarily involved in those orders because you didn't have a network storage environment. Are you seeing that change as you bring Ethernet into the business or as the ODMs look to work with a broader number of customers, you expect those ODMs to become a bigger piece of your mix over the next couple of years?

Prasad L. Rampalli

Yes, Katy, absolutely, we do. Clearly, the NX II product line, as we look in our roadmap going forward is going to have 40-gigabit and 100-Gigabit Ethernet. And looking at future technology capabilities like Rocky, this is RDMA-over-Ethernet, we think that we are in the hunt with a sweet spot in many different workloads in the public cloud space. And we are pursuing the ODM consumption model with these service providers as a very compelling option for our end customers who are service providers in this case. So absolutely, yes. In short, NX II has -- NX II product line has opened doors for us to the service provider community, which we didn't have before. So we are very excited about this.

Operator

Our next question comes from Aaron Rakers with Stifel.

Aaron C. Rakers - Stifel, Nicolaus & Company, Incorporated, Research Division

So a couple here, just looking on -- looking at the outlook going forward. I know you -- Yes, so I know that you guys have talked about the Ethernet business being about 20% or more than 20% of your Advanced Connectivity Platform. So that leads us to estimate that basically, you saw about a 10% decline year-over-year in the core piece of that business x out Broadcom asset. Just remind us, is my math right there? And how are you forecasting, I guess, what would be largely the traditional Fibre Channel business going forward? It would look to imply that you're still guiding a fairly high single-digit decline year-over-year into this current quarter.

Jean Hu

Yes, Aaron, your math is certainly right. Certainly, if you look at our total Fibre Channel business, it was at around the 10% sequential decline for Q1. There are 2 parts of it, right? The first part that we talked about is our target side silicon revenue would have declined, largely due to the inventory buildup from some OEMs to launch new products in March quarter. So when we talk about the last quarter, we did mention we'll have an inventory situation with our targeted silicon. Our Fibre Channel Adapter, as you recall, last quarter we talked about it, it will have a sequential decline of 6% to 7%. That's how we guided. The performance of Q1 actually is quite consistent with our guidance. And if you look at our Q2 guidance, really, our Fibre Channel business overall, actually is going to grow 2% to 3% sequentially compared to Q1. And this is actually slightly better than our normal seasonality. And if I look at the year-over-year number of our Fibre Channel business, it's actually over -- for Q2, middle point of our guidance, we actually are going to grow slightly over last year. So I think that, as Prasad discussed last time, right, we really stabilizing our Fibre Channel revenue and by gaining market share and by ramping up target side Fibre Channel silicon revenue. So overall, we are actually quite happy about the result.

Prasad L. Rampalli

And just to add, that formula is really working. There is a mid-single-digit level decline on the server side. We don't prescribe to what our competition has set around high-single digits, double digits. We maintain that it's mid single-digit. And we are looking at a significant compensation, if you will, on the rate of growth on target side connectivity. If you look at all Flash arrays, they are growing at 30% to 40%. Looking at EMC's earnings just the other day, their fastest run rate product was XtremIO at 55% sequentially. And so using that as a proxy for the rest of the community, all flash arrays are taking off. And the good news for us...

Jean Hu

Go ahead, Aaron.

Prasad L. Rampalli

Yes, Aaron. Go ahead. I was just trying to complete a point. But the good news there is with the all-flash arrays, the attach rate on Fibre Channel adapters or Fibre Channel ASICs is 90%. So we feel that when you look at the math on server-side decline at 5%, the growth rate of target side connectivity, where we clearly are the incumbents with our design wins, accelerated with all-Flash arrays with the attach rate on Fibre Channel, with the market segment share that we are already gaining, as I mentioned, we feel that we are in a good position to stabilize and continue to stabilize the Fibre Channel market.

Aaron C. Rakers - Stifel, Nicolaus & Company, Incorporated, Research Division

Great. And just to kind of take that step further, I think last quarter you had talked about the asset that you had acquired from Broadcom contributing about $60 million in revenue in fiscal 2015. Given the strong performance that we've seen in this quarter and what looks to be continued strong performance in the current quarter, how are you looking at that revenue contribution? And have you changed at all your views on growing 10% to 12% for fiscal '15?

Jean Hu

Aaron, so when we look at the rev scale for fiscal '15, certainly we'll see continued momentum from the Ethernet business that we acquired. And also on the Fibre Channel side, we're quite happy with the outlook and the prospect of our Fibre Channel business overall. I think one thing certainly we noticed is our Legacy business is expected to be below what we thought. We used to talk about the high 20% decline. Right now, it certainly looks like it's over 30% decline. So the Ethernet revenue certainly is going to grow faster than we thought, but overall, I think we certainly think we're still in the range of 10% to 12% for the fiscal year '15.

Operator

We'll take our next question from Joseph Wolf with Barclays.

Tavy Rosner - Barclays Capital, Research Division

This is Tavy Rosner for Joseph. I was wondering if you can give us an update on the all-Flash market and the 16-Gig opportunity for QLogic. That market seems to be developing slower than expected in 2014. And it seems to be becoming a 2015 story. Would you agree with that?

Prasad L. Rampalli

Yes, could you just repeat the last part? You were a little garbled coming on. So I think your question was the trend line on the all-Flash market, did I get that right?

Tavy Rosner - Barclays Capital, Research Division

Yes, that's correct.

Prasad L. Rampalli

Yes, so when you talk about the all-Flash market, it really decomposes into 2 parts. One is the rate of acceleration of all-Flash arrays on the target side, and the other is server-side caching with SSD Flash as host-based deployment on servers for enabling performance benefits for applications. And on both counts, the way I look at -- and I'm looking at the Grantley server cycle coming and accelerating that phenomena of needing more Flash, because as you have more compute cycles on the server, you want to have a need for leveraging that mix with the appropriate onboard storage that's going to be Flash-based. And so you'll see PCIe Flash being a predominant mode of a lot of the applications that are hungry for MIPS and require a low-latency performance capability leveraging this. So I see that accelerating. I mean, I look at that as 10% to 12% growth, if not more on the server side. And if you look at the all-Flash array, I mean, it's a white hot market. The number of startups that are coming into the Silicon Valley are almost 1 a month. And when you look at some of the leading players like EMC and their projections of growth on their next-generation all-Flash array technology like XtremIO, we are talking about 20% to 30% year-on-year, but very significant growth, albeit from a small number today. So hopefully that gives you a sense of where I stand on this.

Jean Hu

Yes. And also we have design wins, the 16-Gig Fibre Channel and the Fibre Channel over Ethernet design wins with the majority of those all-Flash customers. So we certainly are very well positioned in that market.

Prasad L. Rampalli

Yes. So when you look at Grantley as well as the all-Flash phenomena, we think that our 16-big -- 16-Gig Fibre Channel share is going to grow pretty significantly through this Grantley cycle.

Operator

Our next question comes from Andrew Nowinski with Piper Jaffray.

Ryan R. Bergan - Piper Jaffray Companies, Research Division

This is Ryan in for Andrew. Can you give us details about the traction you're getting with the new designs at NetApp and EMC? They both recently announced several product refreshes.

Jean Hu

I don't think we disclosed the detailed customer design wins, unless we're getting to the point we agree with the customer to announce that. So I'm sorry about that, but we don't disclose the detail in customer design wins.

Ryan R. Bergan - Piper Jaffray Companies, Research Division

Okay. And I'm sorry if I missed this in the prepared remarks, but did you address the full year OpEx guidance and if you're still comfortable with the number you had given previously?

Jean Hu

No. We typically don't guide for the whole year. But if you look at the guidance we gave for Q2, it's between $55 million to $56 million. I think we're quite disciplined in continuing to control our OpEx and to manage our operating expense. I think if you look at the run rate, it's probably going to below 230, $230 million for the fiscal year.

Prasad L. Rampalli

Yes, we are going to be continuing to be very vigilant on our OpEx, and we're going to leverage that efficiency to growth areas that I've mentioned in my opening remarks.

Operator

We'll take our next question with Jung Pak with BMO Capital Markets.

Jung Pak

A question on the potential server upgrades with Grantley Windows 2003. How should we think about the impact for both your Fibre Channel and Ethernet businesses in the second half of calendar year 2014?

Prasad L. Rampalli

Yes, let me take that. First on the Ethernet side, in terms of total server count, we certainly -- when you look at the macros or calendar year '15, we think there's going to be a uptick with the branded OEMs and enterprise purchases to the tune of 4% to 5%, simply because of the compelling features of the 2-socket Grantley system and the architecture. And I mentioned this before in my response to Katy, much better memory with DDR4, much better capabilities in terms of number of cores, faster cores. And so that's going to drive a very significant upgrade, we think, in terms of CIO purchases, who'll truly leverage the TCO value proposition that this system brings. And for us, going into the Grantley cycle, we already have a very significant amount of default sockets across all the 3 branded OEMs. I mentioned that we have 20 active programs under qualification right now and all are targeting really well. And coming out of that, we feel that, that will carry into this 4% to 5% uptick in server purchases on the Ethernet side. The same thing is going to happen on the Fibre Channel side. I already mentioned that we are seeing a very significant transition to 16-gig. Almost all the target vendors and certainly the server vendors are supporting 16-gig today. And given our technology performance and the end user requirements on server side caching, we think that 16-gig is going to accelerate as well. So we're very bullish on all accounts.

Jung Pak

How much incremental benefit do you think that Windows 2003 support will have on the 4% to 5% from Grantley that you expect?

Prasad L. Rampalli

That's hard for me to slice and dice. I mean, the overall number set that I've observed in the enterprise with Windows 2003 server systems is roughly about $15 million. And then you had to make some assumptions on if CIOs are going to be getting rid of those 15 million servers, we still have to because there's no support for it from the OS side. They're going to buy Grantley systems, but they're going to consolidate those applications on Grantley servers on a ratio of 5:1 or 20:1 depending on their environment. And so as to how much Windows Server 2003 is going to impact absolute number of server counts, it's hard to say. It's dependent on consolidation-ratio assumptions, which is a dynamic range. But I would say that those 15 million servers, legacy servers would probably translate to maybe 5 million servers tied to Grantley, just a swag, but that's -- there's so much -- so many assumptions behind that.

Jung Pak

Fair enough. I guess the question is why wouldn't the server acceleration help your Fibre Channel business in that it may potentially be better than the 5% decline -- or mid single-digit decline that you guys are expecting in your Fibre Channel business?

Prasad L. Rampalli

So your question was why is...

Jean Hu

So Jung, I think if you look at our Fibre Channel business, right, it's -- we said low middle single-digit decline. But if the cycle is really different from what's the normal cycle, we don't know yet. But the Fibre Channel business is certainly, right now, we see the stabilization. If you look at our guidance for Q2, certainly, it's actually slightly better than normal seasonality. So we don't have a crystal ball for the future but the current trend for Q2 certainly it's slightly better than normal seasonality.

Jung Pak

Okay. And lastly, on the all-Flash arrays, can you talk about the opportunity for the incumbent storage OEMs versus the emerging storage players for all-Flash arrays?

Prasad L. Rampalli

Yes, I mean, this is -- it's really not my place to offer a commentary on my customers. And so I'll not be judgmental one way or the other, but it's where the buck's going. All the 3 branded OEMs are targeting all-Flash arrays in one form or the other. And then you have the incumbent. So it's early days. But for us, we are -- we see all of them as our customer. And the good news is we have a majority of the design wins across all of them, and we hope to accelerate that momentum that's happening with our technology from an end user perspective and reap the benefits.

Operator

Our next question comes from Vlad Rom with Crédit Suisse.

Vlad Rom - Crédit Suisse AG, Research Division

I have one question for Prasad and one for Jean. For Prasad, I just want to get your sense of how you're seeing the pricing environment, both on the Fibre Channel side where -- I mean, if you also have some pretty good products. And also on the 10-gig side, where there's potentially a large vendor that sets the reference price there.

Prasad L. Rampalli

Yes, in terms of pricing on the Fibre Channel side, clearly, look, we are looking to be competitive with what our competitor has to offer. But more importantly, we want to compete on features and capabilities. And so when we compare across our respective product sheets on 16-gig, for example, we feel pretty comfortable that we have an edge and a compelling value play with our OEM customers. And so they're going to continue to position our technology innovation as our driver. We are going to continue to lead with moving forward to the next gen. And as you well know, as I just said, we are at least -- I would say we are ahead on Gen 6 with our 32-gig implementation that's upcoming for next year. And we want to essentially compete with technology innovation and not degrade our price and gross margin in this business.

Vlad Rom - Crédit Suisse AG, Research Division

Okay. And then on the 10-Gig side? Is that...

Prasad L. Rampalli

Yes, on the 10-Gig side, the good news is we don't see a lot of competition from the competitor you mentioned. Frankly, my concern is more with what's going to happen with some of the other players who are going to come into this market, at least the big player that you didn't mention. And at this point, we feel pretty good with our pricing in the enterprise space. And more importantly, the features that we have with our NX II product line that serve the enterprise requirements, both on virtualization as well as low-latency requirements.

Vlad Rom - Crédit Suisse AG, Research Division

That's very helpful. And then Jean, just trying to understand the working capital dynamics. So now for 2 quarters in a row, operating cash flow has been negative. How does that rebound as we go through the year? How should we think about that? And kind of -- you're talking about the puts and takes for this quarter?

Jean Hu

Absolutely. So if you look at this quarter, the inventory increased by about $8 million. We have been building inventory up because target side ASIC revenue ramping up and also because the Ethernet business, the ASIC side, the -- really lead time is really long, sometimes going to 26 weeks, so we have to build up inventory for the -- not only the target side revenue ramp up but also for Grantley Ethernet business. So that's the inventory dynamics there. It's really for the future revenue are ramping up. On the accounts receivable side in Q2, it's quite unique. First, we don't have any aging issues. Actually, 99% of our accounts receivable is current and within 30 days. But this is the first quarter we acquired Broadcom's Ethernet business. They actually have a different fulfillment model and credit terms. So in Q1, we're integrating that business, so there's some difference on the terms and the collection. So 1/2 over the increase of accounts receivable is really tied to the NX II Ethernet business acquisition. Literally, after we close the transaction, we collected more than $10 million of receivable already. So that will change next quarter. So going forward, you will see our accounts receivable going back to a more of a normal DSO days, and the inventory is more tied to the future revenue ramp up. So that's basically the 2 major drivers of working capital. And the cash flow, if you look at Q1, we also have the incentive payout and some of the severance restructuring payout. So those are just the one-time event.

Operator

[Operator Instructions] We'll take our next question from Bill Shope with Goldman Sachs.

Bill C. Shope - Goldman Sachs Group Inc., Research Division

I just have a clarification on the gross margin guidance. I understand the growth focus, but how should we think about the steady state margin, given the relative growth you expect in Ethernet? Should 2Q sort of signal the new normal or should we think of that more as sort of a low point for the year, particularly given some of your optimism on Fibre Channel as we exit the calendar year?

Jean Hu

Yes, so Bill, the major driver of our overall gross margin certainly is a product mix. Of course, we typically don't guide more than a quarter, but if we look at the second half of fiscal '15, we certainly will see continued momentum from our Ethernet business. But typically, December quarter, our Fibre Channel business is a good quarter for Fibre Channel businesses, too. So overall, if we look at the mix, we think for fiscal '15, the gross margin should be around 62% to 63%. I think as you know, we closed the transaction of Broadcom's Ethernet business in March. June quarter is the first quarter we operated this business. Typically, it takes time to realize manufacturing cost, the synergy for acquisition. I think if we go beyond fiscal '15 in the longer term, we will have the opportunity to really realize the manufacturing cost synergies and the savings, and also we're going to implement more features on the Ethernet product. So I think in the longer term, we're going to improve the gross margin over Ethernet business. But for fiscal '15, we're comfortable with the 62% to 63% of gross margin.

Prasad L. Rampalli

Just to add to what Jean is saying, from -- our goal is to ensure that we are in a gross margin band of 62% to 64% for the foreseeable next year as well by looking at appropriate cost optimization opportunities on our cost of goods sold and also leveraging new features in our roadmap and monetizing them. As our mix shift happens with a predominant surge on Ethernet volumes, there will be no doubt absolute operating margin dollars coming in. But we also want to maintain our gross margin within a band.

Operator

And at this time, there are no further questions in the queue. Ms. Hu, I'd like to turn the conference back to you for any additional or closing remarks.

Jean Hu

Thank you. That concludes our call for today. We look forward to updating you on our progress next quarter. Thank you very much for your time, and goodbye.

Operator

That does conclude today's presentation. We thank you for your participation.

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