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Xyratex (NASDAQ:XRTX)

Q1 2011 Earnings Call

March 31, 2011 4:30 pm ET

Executives

Steve Barber - Chief Executive Officer and Director

Brad Driver - Investor Relations

Richard Pearce - Chief Financial Officer and Director

Analysts

Justin Martos

Keith Bachman - BMO Capital Markets U.S.

Marcelo Lima - Horn Eichenwald

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Glenn Hanus - Needham & Company, LLC

Shebly Seyrafi - Capstone Investments

Ananda Baruah - Brean Murray, Carret & Co., LLC

Nehal Sushil Chokshi

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2011 Xyratex Earnings Call. My name is Melanie, and I will be your coordinator for today. [Operator Instructions] I would now like to turn the call over to Mr. Brad Driver, Vice President of Investor Relations. Please proceed.

Brad Driver

Thank you, Melanie, 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 First Quarter 2011 Results Conference Call.

On our call today are Steve Barber, Chief Executive Officer; and Richard Pearce, Chief Financial Officer. Today's call is being recorded and will be available for replay on Xyratex's Investor Relations homepage at www.xyratex.com.

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 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 22, 2011.

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 corresponding GAAP numbers and 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 Richard to review the financial details of the quarter.

Richard Pearce

Thank you, Brad, and good afternoon, everyone. I'd like to thank you for joining us today. Our press release is available, both on PR Newswire and our website. I'd now like to provide you with some commentary about our results for the first quarter. Please note that all numbers are in accordance with GAAP unless stated otherwise.

Total revenue was $360 million, up 13% as compared to the first quarter of last year and down 9% from our prior fiscal quarter. Sales of our Networked Storage Solutions products were $334 million or 93% of total revenue. This is an increase of $63 million or 23% compared to the first quarter of last year and up slightly compared with $327 million in our prior fiscal quarter. The increase in revenue primarily reflects good demand across our customer base.

Sales of our Storage Infrastructure products were $26 million or 7% of total revenue, down $22 million or 45% compared to the first quarter of last year and down 62% compared to our prior fiscal quarter. This was at the low end of our expectations, which we believe was related to a number of changes in the 2.5-inch disk drive market, which Steve will explain later.

Gross margin was 13.7% for the quarter compared to 18.1% in the same period a year ago and 16.1% in our prior fiscal quarter. This decrease is primarily due to the impact of significant reduction in Storage Infrastructure revenues on product mix and operational efficiency. The gross margin for our Networked Storage Solutions products was above our expectations at 14.2%. This compares with 15.2% last year and 13.3% last quarter.

The better-than-expected NSS gross margin reflects variance to the product mix, particularly great sales of higher-margin Legacy Products. The gross margin for the Storage Infrastructure products was 9.7% compared to 34.7% last year and 29.7% last quarter. As already described, this was primarily as a result of the decrease in revenue in the quarter, relative to fixed overhead costs. This low-margin also resulted from provisions related to changes in the market.

Turning to non-GAAP expenses, our operating expenses totaled $43.5 million unchanged from last quarter and compared to $27.9 million in 1Q last year. I explained last quarter our rationale for increased investment in R&D to take advantage of the mid-to-long term opportunities we see in both divisions. However, our revenue forecast for the year for the SI division has reduced significantly as a result of changes to the 2.5-inch mobile disk drive market and WDs proposed acquisition of HGST. We are in the process of determining what expense reductions should be made without impacting our product roadmap or affecting the mid-to-long term opportunities which we have not really changed.

On a non-GAAP basis, net income was $7.5 million or $0.24 per diluted share compared to a net income of $29.4 million a year ago and net income of $21.9 million in the prior quarter due to the impact of higher expenses and lower SI revenues. Our net income benefited from approximately $2 million reduction in tax provisions, following the closure of the U.K. tax investigation.

Turning our attention to the balance sheet. Cash and cash equivalents at the end of the quarter was $98.2 million compared with $90.8 million at the end of Q4. Cash flow from operations was $23.4 million in the quarter. We used $5.7 million cash in our purchase of MRS and $7.2 million in normal levels of capital expenditure. Inventory is decreased by $19 million to $176.9 million in the quarter. Inventory turns were 7.1 compared to 6.7 for the previous quarter. Accounts receivable decreased by $17.2 million in the quarter to $191.8 million. Days sales outstanding were 48 in the quarter, unchanged from the previous quarter. Headcount at the end of the February quarter was 2,171 permanent employees, an increase of 1% or 21 employees.

In summary, this was a challenging quarter with a number of moving parts. Two of our customers announced significant acquisitions that present us with some good opportunities if we can continue to execute. The demand environment and order visibility remain uncertain, given the global issues that have recently occurred. And as a result, we are very focused on cash management in every area.

The markets we serve remains highly competitive. However, I believe we remain well-positioned to take advantage of the growth opportunities in the markets we currently serve, as well as potential incremental new markets we are looking to access in 2011 and beyond. And we have the financial resources to address these opportunities.

Now before I turn it over to Steve for his comments, I'd like to provide you with our business outlook for our fiscal second quarter 2011 ending May 31. Our business outlook is based on current business expectations. It should be noted that there are a series of forward-looking statements in today's guidance that involve risks and uncertainties. Actual results may differ materially from our statements or projections. In order to clearly understand the risks involved, it is recommended that each investor review the risk factors outlined in our Form 20-F filing.

For our second quarter of 2011, we are projecting total revenue to be in the range of $320 million to $365 million, down 30% to 20% as compared to last year and down 11% to up 1% compared to 1Q. This is represented by revenue from Networked Storage Solutions of $300 million to $330 million and from Storage Infrastructure of $20 million to $35 million.

For Q2, gross margin is expected to be 13% to 13.5%. We are estimating non-GAAP earnings per share to be between a loss of $0.12 and earnings of $0.06. Non-GAAP earnings per share excludes non-cash equity compensation and amortization of intangible assets. The number of shares outstanding at the end of Q2 on a weighted average treasury method is expected to be $31.7 million. Our cash at the end of Q2 is expected to be approximately $100 million.

Before I turn it over to Steve, I would like to also announce that in the light of the company's recent stock value the Xyratex board has approved a recommencement of the share repurchase plan it initially approved during the first quarter of 2008, and to increase the maximum value of shares that may be repurchased up to $50 million of its current outstanding shares. Repurchases can be made after the 30th of April and the impact of repurchases have not been included in the cash and share count forecast at the end of Q2 that I've just provided. I'll now hand it over to Steve for his comments.

Steve Barber

Thank you, Richard, and good afternoon, everyone. As Richard has outlined in our financial results, we experienced differing dynamics across our two business areas in our first quarter. The demand in our Networked Storage Solutions business in the range of our expectations but softer than anticipated demand in our Storage Infrastructure business. The less than expected demand in SI reflects a slowdown in notebook sales, which has reduced demand in 2.5-inch mobile disk drives in January and February. And as a result to being delayed in incremental CapEx investments by our disk-drive customers.

Due to the number of significant changes in the markets we serve recently, we are lowering our prior generally revenue forecast for both the fiscal second quarter and full fiscal year. I believe our second quarter guidance reflects the level of uncertainty and limited visibility we are currently seeing in the market, as a result of these changes.

Today's storage market environment is currently experiencing significant change, resulting from the recent major industry consolidation announcement of Western Digital and Hitachi GST. The uncertainty of component supply and demand, as a result of the earthquake and subsequent tragic events in Japan and the slowdown in notebook PC shipment in January and February. We believe these factors may result in disk drive unit shipments, potentially only increasing by 5% this year compared to around 10% historically. While these dynamics may result in a pause in demand in the market, in particular, disk drive capital equipment market, we view the consolidation is a positive for Xyratex, even with the potential of some share shifts in the disk drive market may occur. We believe we are well-positioned for the DPS equipment segment due to our existing relationship with Western Digital and Seagate and our pending qualification with Toshiba, as well as our product line breadth that exudes both 2.5-inch and 3.5-inch capability.

With this market position and product portfolio, we believe we remain well-positioned to retain and potentially expand our market share of the capital budgets with the manufacturers. As a result of potentially reduced disk drive unit shipment this year, we anticipate that CapEx spending by the disk drive industry may fall below historical levels, with capacity utilization rates held at higher than normal level through the second half of the year.

Until the achievable operation efficiencies of the recently announced industry consolidation between WD and HGST are better understood. Further, the impact of the uncertain situation in Japan has introduced a bias towards under capitalization by the industry versus a historical over-capitalization ahead of any major consolidation.

The level of component supply disruption resulting from the Japanese disaster is not yet fully understood by the wider electronic industry nor the result in potential demand implication for disk drive and other components. Separately, in our Invest business, the acquisition of LSI's Engenio storage division by NetApp should have no material impact to our existing business with NetApp. And in our view potentially strengthens our position as the leading independent OEM provider of enterprise class storage systems in the market. Overall, I remain optimistic with regard to our future growth as a result of all the recent changes in both the markets we serve. We have a strong existing customer base and good opportunity to expand both the depth and breadth within these customers, as well as creating opportunities with new customers in both businesses.

I will now review our two businesses separately, starting with Networked Storage Solutions. Our fiscal first quarter revenues of $334 million, up 23.3% year-over-year was at the lower end of revenue guidance due in part to component supply challenges impacting new system build by our larger customers. Resulting in the recent reduced demand from storage imperative early in the year. Aside from this, overall demand across our custom base was unexpected, with some products experiencing positive in-quarter upside demand. We shipped just over 1,000 petabytes or just over 1 exabyte of enterprise storage in our fiscal first quarter, representing a 24.4% growth over the prior quarter and 59.9% growth over a year ago.

Based on recently published data on the total petabytes shipped for calendar Q4 2010, we estimate that of Xyratex once again maintained its position as a leading player in the market shipping almost 18% of the total ship capacity. For calendar 2010, Xyratex gained almost four points of capacity share by shipping 90% into the enterprise disk systems market.

In terms of enterprise type shipped, we continue to see an increasing trend towards SAS in the enterprise market. In the quarter, we shipped 72.03 petabytes of Fibre Channel, 711.77 petabytes of SATA, 216.18 petabytes of SAS, up over 150% year-over-year and 340 terabytes of SSD, up 189% year-over-year. I'm going to carry some several factors that compares in the IT market but a few of the more interesting ones, Xyratex include the growth of big data such as the massive size of data an oil company accumulates when exploring for new sources of oil, or the data that supports the rendering of video movie in 3D movies. These option of cloud computing and the growth in data consumption due to the growth of smart phones, tablets and increased bandwidth. These devices, along with increased bandwidth, have introduced a full range of applications that are generating significant demand with this product base data storage.

We've been investing in several initiatives, which will allow Xyratex to capitalize on these shifts in the IT market. As I mentioned in our last earnings call, we're leveraging our acquisition, ClusterStor, to develop storage solutions for the high-performance computing market based on the Lustre File System. We engage in a number of our current OEM customers, plus emerging market leaders to bring to market solutions that address the market needs of scalable, high-performance reliable data storage system with trusted file systems. Emerging cloud storage markets require many of these same characteristics and we're designing our solutions to be adaptable to specific partner at once.

In support of this growth market, we are introducing higher density and performance versions of our OneStor storage application platform. These platforms incorporate server and storage functionality into a single unit, along with Xyratex's innovative software, developed to enable our OEM's partner system management capability. We're seeing increased demand for these flexible solution loading blocks as OEM partners develop application-specific appliances.

We're seeing new opportunities with emerging market OEMs with data in terms of applications. These customers typically face significant value on the execution we provide in system design hence, in integration. We're excited about the opportunity presented by these partners as they seek to leverage Xyratex's differentiated technology scale and prints of capability enable them to execute for their market leadership objective.

As an example, we recently began shipping our integrated OneStor application platform to the emerging cloud appliance provider. We're actively engaging incremental relationship with security and medical market-focused OEMs integrating Xyratex solution into these fast-growing segments. In addition, to these new vertical market opportunities, we continue to be encouraged by the growth opportunity in our existing core OEM business. Our major customers are highly focused on strengthening their position in the rapidly growing data storage market, investing in major acquisitions and new product announcements.

We're seeing positive growth in our IBM business following their launch on the quarter of V7000 platform. In addition, we're working closely with HP and Dell to assist in the integration of the 3PAR and Compellent businesses respectively as they position these products within their storage portfolio and leverage their global sales capability. The recent announcement of NetApp's intention to acquire LSI's Engenio storage division, should have little, if any impact on Xyratex over the next two years through to the provisions within the multiyear agreement we entered into in 2008.

As we stated previously, this agreement requires NetApp to source at least 75% of their overall demand in FY '11 and 50% of total demand in FY '12 from Xyratex. Based on the public statements made by NetApp, a primary motivation in making this acquisition is to increase its accessible market not currently addressable with their core untapped products.

Engenio's high-performance, big bandwidth technology enables NetApp to serve significant incremental market, including video capture, surveillance and scientific research. While this acquisition has not impact our current business with NetApp, it is important to note that when this agreement is in place, we implemented several strategic initiatives to replace the revenue that would eventually go away as a result of this agreement.

These strategies include expanding our Tier 1 customer beyond NetApp where we have grown our Tier 1 customer base and associated revenue significantly since 2008. We now provide our data storage solutions to five of the top server and storage OEM. Including Dell, EMC, IBM, HP and NetApp. Recent acquisitions and design wins of these OEMs has made a significant increases in revenue from the space of customers.

Introducing computer technology is our OneStor family where we started delivering a range of application platforms in 2008, incorporating Intel server functionality in single and dual motherboard configurations. These platforms now account for approximately 20% of our subsystem shipments and providing increased software solutions content to our OEM partners. We made significant investments in both trusted file systems and software development capabilities, that will enable Xyratex and our OEM partners to capitalize on the fast-growing HBC data storage markets and the emerging cloud market.

In summary, I remain optimistic in my view of the data storage market and the many opportunities that exist for us. Enterprise data growth and related demand for data storage, it's full-class analyst to continue to grow over 40% CAGR, with storage spending remaining a top priority with regard to data center spending.

According to recent industry report, worldwide storage revenue grew over 18% to $19.4 billion last year and exceeded the previous all-time high of $18 billion in 2008. Total external storage capacity shipped in 2010 grew over 55% year-over-year to 16 exabytes, with Xyratex shipping three exabytes or 19% of the total to OEM customers. Though we operate in a highly competitive market, we believe we remain well-positioned as industry acknowledged independent noncompetitive OEM partner to leading storage companies.

Moving now to our Storage Infrastructure business. As Richard mentioned, revenue for the fiscal first quarter was $26.3 million which is at the lower end of our guidance. Looking forward, as I mentioned earlier, there are a number of significant factors affecting the disk drive market, which of course is to revise our second quarter and fiscal year revenue outlook.

We've reduced our disk drive unit's growth rate assumptions reflecting the slowdown in 2.5-inch mobile demand seen here to date. Offset to some degree by the apparent strength we're seeing in 3.5-inch demand, which combined, may result in a reduction in demand for incremental DPS capital equipment. In addition, our previous full-year revenue guidance for FY '11 anticipate this contribution in the latter half of the year, for an addition of the Hitachi GST as a new customer.

We estimate now, that the reduction in 2.5-inch disk drive growth rate, the acquisition of Hitachi GST by Western Digital, and the impact of the Japan tragedy, will result in approximately $145 million reduction to our prior fiscal year 2011 revenue outlook range. This revised revenue outlook is based on our assessment that disk drive unit shipments will now only increase by 5% in 2011 to 685 million units. The rapid pace of market shifts in the various Disk Drive segments, particularly in the Customer segment, requires our customers to continue to adjust capability, as well as production capacity. Cost of ownership, capital productivity and operational flexibility are key requirements to support all manufacturers across the disk drive supply chain, and it's where we focus our innovation and product roadmap.

As Richard mentioned previously, we're taking steps to reduce the level of our investments in R&D and SG&A spending to reflect the anticipated lower 2.5-inch disk drive growth rate. We will focus these reductions around specific programs, ensuring that our actions are aligned, we're delivering the incremental capacity requirement and key technology developments required by our customers.

Our strategic plan for this business is to secure the technology and leadership position within the disk drive industry, providing a continued stream of equipment innovation supporting the aerial identity roadmap of the disk drive industry. Xyratex's flexible business model in this scale and global infrastructure, providing operational efficiency leverage, that is necessary to enable this business to maintain appropriate levels of R&D investments in capital equipment innovation.

In the medium to longer term, I remain the positive and optimistic in our growth outlook in this business. There are a number of positive industry trends, which supports my view and our continued significant investment in the business. Including the following. Our engagements for Toshiba DSC has progressed better than original planned and we expect to see shipments of early production volumes, pulled in our fiscal 2011.

[indiscernible] in the case, we will then be selling three of the four disk drive manufacturers. Disk drive companies are increasingly shifting more internally funded R&D effort into aerial density innovation, and away from equipment development due to the technology challenges ahead. And therefore, we're relying on third-party providers like ourselves for capital equipment. We view Western Digital's acquisition of HGST as a positive and positions us well in the combined USB[ph] as it assesses its operational capabilities and CapEx plans moving forward.

We anticipate being the recipient of a material proportion of its CapEx spend. And with the continued strength this 3.5-inch disk drive demand, we believe we are well-positioned to support the industry growth. Since we're the only independent provider of 3.5-inch disk process systems.

In summary, although there are currently many moving parts and uncertainties, I remain positive in our opportunities to grow this business over the medium to longer term. Data content creation continues to grow with disk drives remaining the only viable storage technology. Solid state storage continuous to increase their significance, notably, through the recent explosive growth in tablet PCs and smartphones. However, it's important to realize the total capacity of solid state storage devices contribute only 2% to 5% of the world's data storage needs, not on account of unit price but limited by production capacity of these devices.

In addition, it's important to recognize the data content viewed on mobile devices, originate some data centers or file storage providers, utilizing exclusively disk drives. Our positioning within two of the four leading disk drive manufacturers is very strong. We're making good progress in securing a position with third-party provider. As a result, we remain confident on the opportunity in the disk drive industry and the growth of the disk drive markets. On the Capital Equipment business, revenues will inevitably vary quarter-on-quarter, although overall, this is a growth business that we'll continue to invest in.

In conclusion, I'd like to take this opportunity once again to express my thanks and appreciation to all our worldwide employees for their contributions. We're clearly in an uncertain business environment currently and need to remain focused on excellent execution in all our activities, while remaining flexible to meet our customers' changing requirements. I remain optimistic as to the market opportunities available to us, provided that we continue to focus on our business execution. That completes our prepared comments. I would now like to open up the call to any questions at this time.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Aaron Rakers with Stifel Nicolaus.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

First of all, can you help us understand the gross margin line in the Storage Infrastructure business? I think you cited clearly fixed cost overhead or coverage there. If I look back in time, you had a quarter where you did only $10.5 million in revenue but that was an 18% gross margin. So can you help us bridge the gap between fixed overhead versus what sounded like a change in provisions?

Richard Pearce

I won't be specific on the actual number that went into each area. Obviously as the business has grown, I think the $10.5 million number that you're talking about, I guess it was Q2 of 2009, was when that happened at that time. Our operations have actually grown to be able to meet the increases that we've seen in SI and the different product that we now cover. So there's a bigger cost base there. But I think underlying that is also from additional provisions that we've seen because of changes in the market, so that's the bigger factor. Overall, in terms of the product that we provide in SI from a sort of materials margin perspective and a pricing perspective, we haven't seen significant changes. But obviously on such low revenue and levels, the additional provisions that have been placed in there, obviously have an overriding factor on that and that brought the margins right down.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

So what's your gross margin assumption for this next quarter in the SI business?

Richard Pearce

I think again obviously, based on the forecast given, our midpoint for Q2 is not dissimilar from that in Q1. And obviously, there's little that we can do in the near term in terms of our operating cost base. I would be expecting the margins to pick up a little bit in that business, so they'd be around the 15% level, but we'll still have the low revenue and the relatively high fixed operating costs bearing down that business. That said, once we expect the revenues to pick up as we move into the second half of the year, then I will expect margins to return to the sort of 30%, 35% that we've seen historically.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

And then on the other side of the business, can you give us the breakdown of your major customers there, NetApp as well as Dell and IBM? What you're expecting from NetApp this next quarter? And then can you help us understand whether or not, you've mentioned their component constraint issues, is that issue still persisting, is that issue improving? What's the status on that situation? And then I'll cede the floor.

Richard Pearce

I'm not sure if we've got too much data on the component issue but I think it was communicated that NetApp had during the 1Q. So I can't talk specifically about to what extent that impacted us and what extent it may going forward. If I'm going to take your other question, in terms of the proportions of business in Q1, NetApp was approximately 54%, Dell was approximately 17% and IBM was approximately 13%. As we look out into Q2, we do actually see the NetApp side of the business reducing. And in fact going slightly below the 50% level, the primary reason for that is as we previously communicated, the second source of activity with network clients on the more-recent products, the 24-bay product effectively came into being in Q1 but we didn't see a significant proportion of the business actually move across the second source during that period. Our expectation is that they will start to ramp that into the second quarter and also if that product continues to grow, relative to the old legacy product then we see the impact of that and that's affecting the revenue from our perspective producing on NetApp. But obviously, shouldn't be seen as a direction in terms of overall NetApp revenue.

Operator

Our next question comes from the line of Shebly Seyrafi with Capstone Investments.

Shebly Seyrafi - Capstone Investments

Related to the prior question, it looks like your revenue and Storage Infrastructure is going to ramp perhaps, and I'm just estimating here around the $50 million a quarter or so in the back half of this year. And I'm wondering, if you think you can get to a 30% gross margin with only $50 million versus -- you were like $70 million to $100 million when you were at 30% recently, do you think with half that amount, you can get to a 30% gross margin?

Richard Pearce

Yes. It obviously depends with the product mix within that. So I think in Q4 of last year, which you may be referring to where we did have revenues of $70 million, the margin was approximately 30%. So I think we had communicated at that time if there were some lower margin products, which we understood we're going to be within there. But if you look back to the first quarter of 2010, we actually had $48 million at that time and the gross margin of just under 35%. So in spite of the additional operating costs which have been taken on board through 2010, which we've just discussed as in terms of that proportion, then I still think that as we get to those $50 million type levels into the back half of the year, that we can maintain that 30%-type margin, yes.

Shebly Seyrafi - Capstone Investments

You said earlier that you feel confident about the NetApp relationship over the next two years, 75% sourcing this year and 50% next year. But maybe if you can talk about after 2012? How confident are you keeping the business? How do you think Engenio impact your business with NetApp after fiscal 2012?

Steve Barber

Shebly, it's Steve here. Those -- we are in the comment, expecting the current agreement should remain as it's currently defined. The terms thereafter are to some extent, dependent on our execution, cost takedown moving forward. That contract currently extends beyond that point, beyond the 2012 timeframe. And therefore from our standpoint, we feel confident in our ongoing relationship with NetApp. As I said in the comment, all indications with NetApps acquisition with Engenio was more about accessing additional markets spaces, as oppose to acquiring hardware development capability. Clearly, time will tell but that's certainly the indication that we're being given at this time.

Shebly Seyrafi - Capstone Investments

You have now a share repurchase program, $50 million and your share price is around $10 million, $11 million. So that looks like a 5 million out of 30 million shares outstanding, if that's the potential at least. And you're basically guiding, because I think you're going to be starting with one month to go in the quarter, it was certainly about flat shares outstanding in the fiscal Q2 quarter, but maybe you can talk about how you think shares may trend over the following three quarters? Do you think it can go down to $1 million, $2 million a quarter? How do you think that, that could trend?

Richard Pearce

I guess that all depends a little bit on the business in share price movements, et cetera. As you said, the improvement that's being given, perhaps a $50 million worth of shares. We are going to wait sometime as is customary to enact that share repurchased plan. So we're not going to stop buying shares until 30 days in this time, essentially at the beginning of May. The board and the manager of the company feel that at current valuations, that it represents good value for the company to repurchase its shares. And therefore at this type of pricing, the company would intend to be relatively aggressive in that share buyback as it goes through the second half of the year.

Shebly Seyrafi - Capstone Investments

Your NSS gross margin went up to 14%. Maybe you can describe or elaborate a little bit more on what drove that increase? And whether you think you can stay now going forward at 14% or more this year?

Richard Pearce

In terms of what was driving that as I made in my comments, it is related to Legacy Products. So some of the older products which we've maintained longer than we originally expected to, I think that part of that may well remain into the second quarter. So therefore, already expect second quarter maybe just say in the 13% type range, but in the longer term, we maintain our expectations that margins in that business, at least in sort of medium term will be in the 11.5% to 12.5% range that we consistently provided over the last three quarters.

Operator

Our next question comes from the line of Keith Bachman with Bank of Montreal.

Keith Bachman - BMO Capital Markets U.S.

First, you called out some of your customers on the NSS side and address NetApp. I was wondering if you could give the same color on EMC?

Richard Pearce

Address the EMC in terms of what, Keith?

Keith Bachman - BMO Capital Markets U.S.

What you think your longer-term relationship with EMC is here on their Storage Infrastructure? Specifically with data domain?

Steve Barber

As I said publicly, previously, we anticipate that, that project over time will be something that EMC will put on to existing EMC hardware platforms. We are not getting indications of the timeframe for that but that is currently our -- I guess our medium-term thinking that if the product refreshes, that EMC are proposing for that product's message, that business will migrate away from Xyratex's hardware to EMC based platforms.

Keith Bachman - BMO Capital Markets U.S.

I mean, is it reasonable to just assume if that occurs over the course of FY '12 or hard to say at this point?

Steve Barber

I'd say at this point. I think our -- I guess our quarter's planning, is that we would assume that business declined through the course of this year.

Keith Bachman - BMO Capital Markets U.S.

And has there been any change at Dell?

Steve Barber

Not specifically. The current program they're supporting with EqualLogic continue. At the moment, there's a lot of focus on working with them to integrate the component platform working through that transition with the Dell virtual organization?

Keith Bachman - BMO Capital Markets U.S.

And then maybe we'll change gears. On the other side of business I was hoping to see your color on how you think, what you think the longer-term opportunity is with WDM, Hitachi? So it sounds like this year, purchases will slow down from both organizations because the Hard Drive business is slower. But what's your thoughts on what the longer-term opportunities might be if you look at next year with FY '12?

Steve Barber

I think as indicated in the comment, consolidation of this type will inevitably result in a pause until this time as potential share shift in demand is understood. On that topic, we think of that, the share shift could be limited. We figured if we anticipate a significant share shift in demand as you saw in previous consolidation with Seagate, Maxtor or Toshiba, Fujitsu. I think because of the product set and lack of overlap in this particular case, which is a less shift. But overall, I think that topic is really on the minds that is part of their review process that the other drive providers are currently assessing. And I think we'll get better clarity through the course of our second quarter as to the assumptions that the other drive manufacturers are assuming, with regard to potential share gains. Moving forward, clearly is assuming that this transaction is approved, the combined entity becomes a very significant player in the drive space. And the fundamental requirements, incremental production capacity was simply scale up base on the proportion share that they hold in the marketplace. But we're not expecting any impact with regard to the medium or longer-term. I think we would anticipate going into next year with the fundamental growth drivers of unit volumes and aerial density or drive capacity driving lead to incremental production capacity. The reason for us lowering our outlook in this year, is really driven by the fact that inevitably, there will be a pause. And I think it's compounded, as I said, by the unexpected slowdown in notebook sales that we saw in January and February, which resulted in reduced 2.5 inch mobile demand and clearly caused some concern with our drive customers and caused them to slow down and defer demand for incremental capacity. I do think that's compounded now by tragic events in Japan where there's clearly unknown questions or unknown situation with regard to supply of core component. And I know there has already been commented in analyst reports regarding supply of 3.5-inch aluminum substrate. Which will inevitably in our view, caused the drive companies to be a little cautious about adding significant incremental capacity, even if they believe that they are going to benefit for market-share shifts. I think they inevitably, be cautious until they understand the supply line. And by the way, demand on this other technologies are affected that the influence demand for disk drive is a result of core component supply coming out Japan. That I think it's just going to create in our view, a pause, certainly, in the first half of this year until people truly understand the demand and supply characteristics of the drive market.

Operator

Our next question comes from the line of Ananda Baruah with Brean Murray.

Ananda Baruah - Brean Murray, Carret & Co., LLC

I guess just to continue on with that line of thinking if I could. I guess if you think about 2012 and the SI side of the business, can you help us think about what the factors are that kind of maybe went into through the previous SI guidance, and then in the context of the pause we have here because of the WD and Hitachi combination. And then the 2.5-inch as well. What would it take, in terms of I guess market demand, casually get back sort of to the range you were talking about before at some point in time? If you assume, it sounds like you're assuming that kind of share shift potential with WD and Hitachi is going to be greatest. As some folks have talked about maybe it being. And I'm certain you've seen some sort of -- kind of ongoing penetration into Hitachi. I'm sure you won't share those but can you give us some sort of framework of how to think about what market conditions you need to be, to get back to what the previous guidance was?

Steve Barber

I'm Steve here. I think it's fundamentally around our assumptions on 2.5-inch mobile demand. So it's a significant slowdown in the demand in that sector as you first ingested in January and February. I guess we're still waiting for March's numbers on notebook sales. As result of that, we've scaled back our unit growth assumptions for the entire market. As I said too, they're on 5% unit growth in 2011. Our original assumptions coming into the year which defined our revenue range initial outlook for 2011 was based on a 10% unit growth, which took us into around the $720 million per unit, which would be a typical growth for a normal or a normal year. We don't view that data or integration and storage demand has slowed down in this environment. But I think there will be clearly some caution. And as it stands here right now, as I said in the earlier comment, it is very clear that the disk drive customers that we serve are having the same debate as to what the overall TAM is going to be for 2011, calendar 2011. And therefore what material planning and capacity planning that they wish to put in place. Right now, there is a clear cost on adding incremental capacity until it's better understood. And within that, as I said earlier, we are still seeing continued demand for 3.5-inch, and the comments are all related to 2.5-inch mobile.

Ananda Baruah - Brean Murray, Carret & Co., LLC

And I guess can you give us what your sense is of the overall storage systems market, NetApps component constraints not withstanding any detail around sort of changes in the demand environment will be helpful?

Steve Barber

Certainly, as I said earlier in the comments, we view the market overall demand as normal. We're not seeing any dynamics with regard to demand across our customer base. As Richard indicated, we're clearly seeing the effects of moving from 100% to 35% of NetApps demand coming into this quarter, which moves the needle on our revenue projections. But with regard overall demand, I would say it's pretty solid or normal demand. There's certainly no indications of changes both from our aspect or what we're seeing from enterprise drive demand that our customers are seeing.

Ananda Baruah - Brean Murray, Carret & Co., LLC

And I guess just going over to the cost side of things, have you guys yet begun to think about cutting costs? I guess maybe whether it's OpEx or some areas of some of your fixed cost that you've alluded to? Or you're pretty much just standing pat right now, and just seeing how the second half of the year materializes?

Steve Barber

I'll let Richard comment as well, but we are currently actively assessing where we may be able to reduce our cost. And linking us to very specific products and programs, which we believe will be delayed as a result of this cost, this pause and caution in the marketplace. The fine balance just to make sure that we continue to invest in those products that our customers will require of us. Both from a capacity and technology standpoint. But we do think, under the current environment, with reducing our revenue expectations for this year, we need to reduce our cost base, our run rate cost base. And we will, as I said in the comments, be taking those actions through the course of this quarter, such that you will see the effect in our comp base coming into fiscal third quarter.

Richard Pearce

I agree to those statements of Steve. And I think our preliminary sort of calculation would indicate that we're relooking to take $3 million to $4 million out of our expense run rates just under 10% in Q3 as Steve said. There's not many actions that we can take which will have an effect on Q2 at this time. Although we are looking across the board, but we'd be looking to take that sort of level out in Q3 and maintain that, if not take it into more out as we move that into Q4. But as I said, they stay our preliminary, and we are spending a lot of time looking at, as Steve said, areas that are not going to affect the long-term roadmaps and on technology commitments to our customers.

Ananda Baruah - Brean Murray, Carret & Co., LLC

Just on the buyback. Is this, would the buyback be something that you sort of expect, I guess keep alive ongoingly for the foreseeable future? So if you go through what you guys announced today, is it something that you just will keep looking to renew to some extent?

Richard Pearce

I guess the expectation is that the level that the board have approved up to should take us through some months straight quarter at this stage. And in setting the level of the buyback at $50 million maximum, as we look through to the second half of the year, based on the latest projections, we would expect to create that type of level of cash into the second half of the year. So in fact, our current cash reserves are around $100 million, even if we were to buyback as the maximum level through the second half of the year, we would still expect to have cash levels at sort of the $100 million level at the end of the year. And I think when we got to that, we'd have to assess the cash that the company had and the opportunity that they have in the following year, and oversee the respected share price at that time, so that made the decision whether or not we would want to extend that.

Operator

Our next question comes from the line of Glenn Hanus with Stephens.

Glenn Hanus - Needham & Company, LLC

First, on the NSS side. So one or two quick ones here. So 3PAR and Compellent, on the positive side, have you started to see any volume benefits from the acquisitions of those companies?

Richard Pearce

I think it's an area we're certainly optimistic that we will see increased demand once the sales organizations take effect. But my comments right now is all about focusing about integrating those businesses into the new owners. That work is well underway and within that, there is discussions about potential upside. But I certainly don't want to give any view as yet as to where that will end up.

Glenn Hanus - Needham & Company, LLC

Can you put anymore color around your comments on the supply challenge there with NetApp? Do you have a sense that it's been mostly resolved at this point?

Steve Barber

I really can't comment on NetApp supply chain to their Fibre. We certainly saw in our regard, slower pools of storage enclosure through the early part of this year, which ones they have their earnings calls, until it all became clear as to what the effect was. They did indicate in their earnings call that they anticipated, potentially some constraints continuing into 2Q. Specifically for us right now, in terms of commenting on that, is that we are going through this transition of moving from 100% to 35%. And that's not a step change, it's a gradual reduction. So that override any potential effect that we maybe have on NetApp shipping and earnings.

Glenn Hanus - Needham & Company, LLC

So shifting to the SI side of the business. As we could have come out of this period in 2011 going into 2012, are there some factors that would lead you to think of above sort of disk drive unit growth kind of snap back in capital equipment required going into the 2012 timeframe from some of the positive things going on? Whether it be Toshiba or the finality of the integration or some things going on with head test, media cleaning, optical inspection. How should we just kind of think about 2012?

Richard Pearce

I think there's certainly a potential for a catch-up. But I think we may see that earlier, we may have that our positive year depending on overall demand for data storage. I would have to say right now, it's difficult for us to judge the appetite for the driver this year to make those investments. And when that will -- whether we'll see an effect, hence we're being, I guess somewhat cautious in our outlook for this year. If you step back and look at the macro growth of data content, it's still growing at over 50% compound growth, ultimately you need disk drive to support that. And therefore, depending on assumptions you have on aerial density and average capacity of drives to that period, then in theory, you'd end up with a -- if the drive assumption on the 5% unit growth proves to be the case this year, then yes, there's certainly a potential for a catch-up moving into the part of next year. Our view right now, is that in this environment of cautiousness and pause, that the drive companies will run their facilities at higher-than-normal utilization rates until they truly understand the demand dynamics as well as the supply dynamics. And if that happens, then clearly that could create a pent-up demand for incremental capacity that we need to make sure that we are prepared and can respond to as when it occurs.

Operator

Our next question comes from the line of Marcelo Lima with Servertech[ph] .

Marcelo Lima - Horn Eichenwald

This is Marcelo Lima with Heller House. First, one is on cash management. I think you mentioned in the fourth quarter conference call that you had planned to start a dividend in the third fiscal quarter this year. I was wondering if you still have those plans on track? And related to that, I completely understand that your stock is trading at a very cheap level and it's easy to see how you reached that conclusion. Given the uncertainties in the business however, that you're outlining today, does it make sense to consider that stock repurchase authorization as something that you may consider not pulling the trigger on, as the quarter progresses and maybe even changing your mind on the dividend?

Richard Pearce

Yes, I'll take a step for you. From a dividend perspective, it's still our intention to pay and announce the dividend in the third quarter. So there's no changes there. In terms of our cash position, I don't anticipate that the size of the dividend will materially affect that. So we did discuss that very recently at a Board level and as I said, it's our intention to continue with that. In terms of the share repurchase, I mean again, when we look at the cash level, we've been going back to the statements that I've made in the previous sort of comments and questions regarding our cash levels. We feel that we've got sufficient funds within the business to undertake the investment opportunities that we see in front of us, as well as pulling the trigger on the share repurchase. As we said, the board has approved up to a maximum of $50 million and I think it's not our expectation that we would use all of that amount in the very near term. And in fact, the rules regarding how much you can actually buyback given the volume of our stock, wouldn't allow that anyway. So I think that we will constantly look at it in the face of the current business, the opportunities that we see in front of us. And obviously, the share prices that prevail at the time. So that's all I can really say at this stage.

Marcelo Lima - Horn Eichenwald

Somebody who's approaching your industry as sort of a newcomer, there is a lot of consolidation going on, a lot of shifting, a lot of movement going on with your customers and your competitors. Has the company considered or discussed or thought about the future of the business? You have two separate divisions. The SI and the NSS division that it appears that they could live within larger organizations in an industry consolidation, where you could have more economies of scale and perhaps, a broader customer base. Has that discussion happened recently? Does it make sense to consider perhaps either splitting the business or putting the company up for sale?

Steve Barber

There's a number of questions there. Clearly, the industry consolidation have taken place has related to the companies that have very specific digital property, end-user technologies that allow the buyers to access additional market share. In SI's business, Xyratex is, I guess the leading OEM provider as an independent provider or platform to the wider industry. And therefore, never say never, but I think it's unlikely that Xyratex would be seen as a -- that business, seen as an attractive target for one of our customers because ultimately, our customers buy from an independent source. And I think would find it difficult buying from a competitor. Therefore, when you look at potential routes for this business, clearly, in over $1 million of business today continues to grow as we gain share with the customers we serve. We see an ongoing trend for the major storage brand to focus their energies and R&D on software applications, not on hardware. And we are clearly striving to position ourselves as a very reliable and trusted provider of hardware platforms to enable that industry to do just that to focus their efforts on software, and put that software onto our storage platform. So the scales, yes, we need to continue to look at how do we scale the business, do we partner with third-party, our fulfillment partners. Do we continue to grow our internal capability, those debates continue to be had, and will continue to be had as we see this business continue to grow. If I switch track to the SI business, clearly that business is focused uniquely on the disk drive market, providing capital equipment to that sector by CapEx comps. But because of capital equipment company or it inevitably has variable demand and variable revenues quarter-on-quarter depending on the timing of investments by the drive industry. But again, that business has grown by the fact that the disk drive sector again, which is to focus its R&D dollars on its products, in aerial density higher capacity drives, et cetera. And is looking to independent providers like ourselves to finish what they need and invest the dollars needed to continually innovate and raise the bar on the capability of the equipment that we provide. So ultimately, in the business model for those drive companies. So again, never say never, with a business that fits better in a larger capital equipment organization. I have to say potentially, however, the rest of the capital equipment industry is dominated by semiconductor capital equipment players, not disk drive industry. And for whatever reasons, the disk drive sector is not always seen as an attractive growth business. Although clearly, we remain very confident in the ongoing growth and need for disk drive and therefore, we are continuing to invest strongly in this business, because we believe it has a very positive long-term future.

Operator

Our next question comes from the line of Justin Martos with Jefferies.

Justin Martos

The question regarding -- could you reiterate the NSS revenue guidance? And then can you talk about when your largest customer started to ramp up? I guess this calendar year for the end within your guidance? Do you expect that 25, 75 split to I guess fully implemented by the end of your May quarter?

Richard Pearce

So our revenue guidance for the NSS business for the second quarter is $300 million to $330 million. I think within those expectations, we would expect the second sourcing of the latest product of NetApp to be up towards the top end of the 25% level.

Justin Martos

And you have also started ramping that 24-bay product as well?

Richard Pearce

That product has been ramping for the last year and a half, two years and it now represents the major proportion of that product. The Legacy product, and I think we've discussed in previous earnings calls, have probably exceeded our expectations in terms of its proportions over the last few quarters. But we're definitely starting to see here the new product really taking over, and as I said, becoming the dominant product now, which is provided to that customer.

Justin Martos

And then for the NSS margins, that would be -- I guess to make clear would be sort of a baseline that we could look at going forward? Because of -- I guess the mix of the...

Richard Pearce

Yes. I mean, There are -- well NetApp does represent around 50% of the business. They are not the only customer which what I'll refer to as Legacy product. So yes, there are other legacy products in there. And again, as I -- hopefully I was relatively clear on our previous question. I do anticipate the margins remaining at the higher end of our expectations at about the 13% level into Q2. But then I do expect them to settle back into the more medium-term expectations, which we've consistently provided in previous quarters, which are in the 11.5% to 12.5% range.

Operator

Our next question comes from the line of Aaron Rakers with Stifel Nicolaus.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

So are you reiterating your full year Systems business guidance that you previously laid out last quarter?

Richard Pearce

It isn't our practice to reiterate full year guidance as we go through the year. But I guess if we were anticipating any material deviations from that guidance, as we've indicated in the SI business, then we would be discussing that in the course.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

So we should really be thinking about the changing guidance just being for the full year, just being that 145 out of your SI segment?

Richard Pearce

Yes, I think primarily, obviously, we've also pointed to it and other people will be talking about beyond those factors coming out of the Japan situation, which we do need to considerate at this time. We'll have some effect -- I think it's definitely too early for us to predict the size of that effect, but that has been in some of our considerations as we look out towards the end of the year.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

And so if I take your guidance on your Systems business and what you've previously said about the NetApp dynamic with Jabil, it looks like you're guiding the NetApp business being down maybe mid teen sequentially just by my math. So first of all, is that a fair assessment? And secondly, if you strip out the puts and takes around Jabil, would you say the NetApp business would be up sequentially? How should we think about that?

Steve Barber

I guess that's difficult for us to sort of predict and say because we are uncertain of the proportion of the business which will go to Jabil in that quarter. I don't really want to be going in to comment on that. As we've seen the NetApp business have increased in the first quarter over the fourth quarter. Relatively, significantly. And I think overall, if it weren't for the Jabil impact, then I would expect that business to continue to increase. So it is the Jabil factor which has bought back down, but I really don't want to be going in to comment on the future of NetApp revenue, and I suggest that you speak to them about that.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

You guys said that you shipped 340 terabytes of SSDs, and I think you said it was up 189% year-over-year. I think a year ago, you reported 570 terabytes. So I know it's insignificant amount in the grand scheme of things, but I'm just trying to figure out if numbers are wrong or what the difference is there?

Steve Barber

I'll follow up with you separately into what's our terabytes, as in each over the same and over the last two years, we certainly see a significant growth. We continue to integrate it for our customers as we said previously. It's not in a storage device generally but as an accelerator for their software applications. So I'll separately follow up with you on that.

Operator

And our final question comes from the line of Nehal Chokshi with Technology Insights Research.

Nehal Sushil Chokshi

So for the Storage Infrastructure rather than the hard drive industry, you're scaled-back expectations were 5% year-over-year unit growth. So what about on a peak-to-peak basis? Most specifically, December quarter to December quarter basis. Because this will likely drive the bulk of the buying if necessary?

Steve Barber

If I understand your question correctly, yes, the bulk of the buying does take place in the second half of the year, aligned with shipments of disk drive. I think at this point, we haven't given any specific guidance for what we expect in the second half other than the overall reduction in the full year. Comparing like-for-like, year-in-year, at this stage, as I said earlier, we are erring, I think on a cautious view based on the very significant pause we're seeing and cautiousness in terms of total discussions with our disk drive customers. I'll have to say, I think it's the amount of variables at play here. And one of the earlier questions regarding overall could you see a step -- a step recovery in the need for CapEx. The answer is yes, we could, but it's unclear as to whether that will be a factor in the back half of this year or whether there will be an effect for next year. I apologize for being unclear in our response but I think until the true extent of component supply following the Japan event, and the demand because in fact if supply is impacting users or product that use disk drive, then that clearly has another factor that may drive companies to try and take into account. But I think we are going to be in this period of uncertainty, certainly through 2Q, until this time, as it becomes clear what has truly been affected from a product standpoint that relates to disk drive and the wider electronic industry?

Nehal Sushil Chokshi

And then as I triangulate the parameters that you have provided, it sounds like minimally, the assumption is that 10% year-over-year unit growth than the back half. Is that a correct triangulation?

Steve Barber

I think we need to do that calculations, but I think yes. Based on the very low shipments that we've seen in the first half, I think that's probably fair. Overall for the year, we're erring towards a 5% unit growth compared to 2010. But yes, it will be back-end biased, which is typical. I think this year, it's probably going to be more accentuated in the second half?

Nehal Sushil Chokshi

You mentioned to get it over -- get back into the 30% gross margin on the Storage Infrastructure. It is partially mix dependent. Could you give a little color as far as which products within Storage Infrastructure have the richer mix?

Richard Pearce

We don't actually give those details and actually even within products, depending on aspects and the feature functions of those products, there are different margin profile. So that unfortunately is a question that I cannot answer.

Operator

Ladies and gentlemen, that does conclude today's question-and-answer session. I'd like to turn the call back over to management for closing remarks. Please proceed.

Brad Driver

Once again, thank you for joining us this afternoon. We will report our Q2 results in late June. An exact date will be posted on our Investor website by mid-June. In the meantime, please feel free to contact me directly if you have any questions and have a nice weekend.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. That does conclude the presentation. You may disconnect. Have a wonderful day.

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