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OCZ Technology (NASDAQ:OCZ)

F4Q11 Earnings Call

May 3, 2011 5:00 p.m. ET

Executives

Bonnie Mott – IR Director

Ryan Petersen – CEO

Arthur Knapp - CFO

Analysts

Rich Kugele - Needham and Company

Aaron Rakers – Stiefel Nicolaus

Alex Kurtz – Sterne, Agee

Christian Schwab – Craig-Hallum Capital

Richard Shannon – Northland Capital

Operator

Good day, ladies and gentlemen. And welcome to the OCZ Technology fiscal 2011 fourth quarter and yearend financial results conference call. At this time, all participants are in a listen-only mode. Later we will conduct a questions-and-answer session and instructions will follow at that time. (Operator Instructions).

I would now like to introduce your host for today’s conference, Ms. Bonnie. Mott, Investor Relations Manager at OCZ Technologies. Ms. Mott, you may begin your conference.

Bonnie Mott

Good afternoon, and welcome everyone. On the call today are Ryan Petersen, CEO and Art Knapp, CFO. Ryan will provide a business overview and then Art will review the firm’s financial results. Following their formal remarks, we will open the floor to a few questions.

Before I turn the call over to them, I need to remind our listeners that the information is presented as of May 3, 2011. Please keep in mind that while being made available for listening after today, the information is current only as of today. Remarks made during this call may contain forward-looking statements that involved risks and uncertainties. Forward-looking statements on this call are made pursuant to this Safe Harbor Provisions of the Federal Securities Laws. Information contained in the forward-looking statements is based on current expectations and is subject to change and actual results may differ materially from forward-looking statements.

Some of the factors that could cause actual results to differ are discussed in the reports filed with the SEC. These documents are available on OCZ's website, www.ocztechnology.com.

With that, it is now my pleasure to turn the call over to Ryan Petersen.

Ryan Petersen

Thanks, and good day to all of you. We’re pleased with the results during fiscal 2011, as we have transformed this company from a simple DRAM module business to a leader in the virgining SSD market.

We were able to introduce an array of leading-edge products, drive demand in new markets, and exit from our unprofitable DRAM module products ahead of plan. When looking at the core SSD business, our fourth quarter was the best quarterly performance in the history of OCZ, in terms of both revenue and profitability. And we believe that we’re well positioned to take advantage of continued secular growth in the market.

The additional working capital provided through our financings in fiscal 2011, allowed us not only to increase manufacturing capacity and support increased demand for our SSD product, but to further advance our R&D and marketing efforts, positioning us well for the expected growth in the SSD market.

We expect our current – our recent capital raise in April, which was completed after the end of our fiscal year, to further these efforts in fiscal 2012. As most successful companies are built on the experience, hard work, and dedication of their employees, management team, and Board of Directors, it’s worth noting that our recent success has elevated our company profile, allowing us to enhance our management team and Board of Directors.

In the past 12 months, we’ve had several key additions to our management team, including Chief Sales Officer Richard Singh, who has helped drive the dramatic sales growth in quarter – in the third and fourth quarters, and the recent additions of Senior Vice President of Product Management, Steven Lee, and Indilinx’s co-founders Bumsoo Kim and Hyun Mo Chung who joined OCZ through the Indilinx acquisition.

I’ll discuss the acquisition in greater detail in just a moment.

I’d also like to welcome Ralph Smith to our Board of Directors. Ralph is the CEO of PLX Technology, and shares the Global Semiconductor Alliance Emerging Company Council. His expertise in managing market-leading semiconductor companies is extremely valuable given our recent acquisition of Indilinx, and we look forward to his value contributions.

In regards to our financial progress, as previously announced in the fourth quarter, net revenue totaled a record $64.4 million, of which 58.2 million or approximately 90% was generated from our SSD products, also a quarterly record.

Our fourth quarter year-over-year SSD growth rate increased to 380%, even higher than the 325% year-over-year growth rate we reported in the third quarter. On a sequential basis, the 58.2 million of SSD revenue in Q4 grew 40% over third quarter’s revenue of – or our SSD revenue, 41.5 million.

We achieved overall revenues of 190.1 million in fiscal 2011, of which 133.2 million were SSD revenues.

Of particular importance, 100 million or 75% of SSD revenues were generated in the second half of the fiscal year. And while seasonality is always a factor, this rapid growth was facilitated by the working capital increases from our financings completed in fiscal ’11, which allowed us to better fill pre-existing demand for our SSD products.

Taking a look at our SSD revenue by region, it’s important to note that regional data is based on the delivery destination. For example, large OEM clients who manufacture in Asia or Europe, and export the final product could be recognized as APAC or EU sales, based on the delivery destination specified by the client. Thus, we would expect that the majority of our revenue will continue to be shown as outside of the U.S. in line with hard drive industry trends.

The highlights, keep [inaudible] on regional growth, as SSD sales in North America, increased 160% to $19.4 million in the fourth quarter, up from just 7.5 million in the fourth quarter of last year.

SSD in EMEA increased 768%, to 30.9 million in the fourth quarter, up from 3.6 million in the fourth quarter of last year. These sales were driven primarily by growing adoption of our high performance and server-class SSDs in Western Europe. We feel that this reflects an increase in server-class SSD adoption among European OEMs.

SSD sales in the rest of the world category, which primarily refers to the APAC region including countries such as Japan, Korea, Taiwan, and China, have increased 610% to 7.9 million in the fourth quarter versus sales of 1.1 million in the fourth quarter of last year.

We believe that a large portion of our SSD sales into Asia are integrated into products and re-exported.

That being said, OCZ has historically been uncapitalized and as such has developed a distribution and a channel-assist based marketing strategy. This has resulted in the wide geographical base of sales with a low concentration of sales with large OEM clients. And though our recent OEM wins may eventually result in higher customer concentration, and potentially much higher revenue, we do credit much of our recent ability to achieve high growth in a short period of time to our channel strategy and we fully intend to exploit this strength and maintain broad-based global growth.

On that subject, it’s important to again note, that we recently completed a public offering, which netted to the company approximately $94 million. We feel that this working capital positions us well, not only to support increased SSD revenue and improve our purchasing power, but to contribute to increased OEM business as we believe are historical under capitalization has been an impediment to business with large OEMs.

In regards to profitability, during the year we were able to achieve a key milestone when in Q4 we posted our second consecutive positive non-GAAP operating income of $128,000 in fourth quarter. That includes 1.7 million in losses associated with DRAM products.

On DRAM, as previously announced, we have now exited this product area. We derived approximately $2 million in revenue from it in the fourth quarter, therefore we expect minimal ongoing impact of the DRAM product discontinuous in the future.

Now, I’d like to take a few minutes to speak more specifically about some recent key developments in our business. In the fourth quarter, we’ve seen increased SSD design and activity in several product areas, which suggests to us a near-term inflection point in market acceptance. We believe this inflection point relates directly to cost performance ratio of SSD versus traditional hard disk. And that moreover, SSDs will continue to gain adoption in markets where performance, reliability, and reduced power consumption are driving factors.

We believe that in particular our growth and increased design and activity has been driven by our ability to deliver the market the highest performing and most robust SSDs using cutting-edge NAND technology while simultaneously reducing the cost per gigabyte of SSDs.

One recent example being our critically acclaimed Vertex 3 and Deneva 2 in line of SSDs, which use the newest, synchronous mode, MLC 25 nanometer flash which already has flash interface fees of up to 200 megahertz. That’s up from the 50 megahertz supported with older-generation asynchronous mode NAND flash.

Coupled with what in some cases is the 30 to 40% cost decrease from the node mode from 3x NAND meter to 2x nanometer flash.

As recent analyst reports have noted, we have seen unexpectedly high demand for our Vertex 3 and Deneva 2 SSD with over 50% of our new bookings being generated in this product family. This substantial excess demand is an indicator that technological advances continue to be the primary driving factor in SSD adoption, which we feel placed to our innovation strength.

Independent market research indicates that adoption of enterprise SSDs will be centered on TCIE and SAS interfaces going forward. To take advantage of these high-growth segments within the SSD market, we have been investing significant resources into the design and deployment of new PCIe and SAS SSD as evidence by our recent releases of ground breaking new products and the high level of customer interest that we’ve seen in those products.

We’ve developed highly scalable platforms which are positioned well against our key competitors in both the standard format SSD subsegment, and PCIe SSD subsegment.

We continue to see demand drivers for OCZ’s PCI interface SSDs in the enterprise, and have had considerable success with the design in of our newest generation PCIes-based enterprise SSD including both Z-Drive rep 3 with VCAR architecture, which pulls multiple NAND flash controllers and storage processers into a virtual super controller, allowing for the highest possible hardware modem performance and our newest VeloDrive, which supports software mode, allowing the host to handle the data management function and providing reduced latency.

With the VeloDrive in particular, supporting third-party host-side data management software has been a critical issue, given that certain large enterprise data centers prefer to run their own host-side data management software. The ability to run the VeloDrive in multiple modes gives clients the freedom to configure and maximize performance. It also makes possible for seamless deployments and scalable multi-card solutions with rate stacks that may have already been qualified for the clients unique usage model.

In regards to our SAS and SAD enterprise drives, we’ve seen an increase in qualification sample request for our Helios Family of VCA enabled SAS 6-gigabyte-a-second enterprise SSD, which were first shown in January at CES.

We, in addition, intend to ship certain unannounced Helios Family SAS 6 gigabyte SSDs early in Q2 to the channel. We continue to see OEM ramp for our Deneva series of SAS and SAS SSDs, and are sampling the next generation Denvea 2, which supports both non-12 byte sectors in SAS mode and achieves speeds of up to 75,000 random-write IOPS with 550 and 520 megabytes sequential read and write speeds using the newest 2x nanometer mode MLC and EMLC flash.

While we feel that our older-generation Deneva SAS products were highly competitive, and at a lower price point than our competitors, the Devena 2 has significantly higher sequential speed and nearly doubled the random write performance over our nearest competitors. All at a lower price per gigabyte, which of course is driven by the utilization of newer/lower cost NAND flash.

Our technology leadership continues to increase our recognition with enterprises, OEMs and small businesses. Some of our customers supplement their own testing with independent third-party product evaluation. These product reviews benchmark our products against those of our peers and publish these results publically.

These independent product reviews continue to be highly favorable in validating our technology. As an example, our Vertex 3 line of SSDs had since launched 27 positive reviews from these independent product reviewers. All of which are available to view on our website.

One recent notable review was the SSD showdown in which Maximum PC Magazine reviewed four top performing SSD head to head. The Vertex 3 was described as “blazing past performance on all fronts.” And the reviewer commented “OCZ continues its tradition of blazing fast, random write performance both at high and low Q-depth, serving up more than 85,000 IOPS”.

As a result, the Vertex 3 was awarded the publications top honor, topping the latest offerings from competitors such as Micron’s crucial brand in Intel.

This growing market awareness and recognition has translated into solid business momentum. As every segment of our SSD business grew rapidly this quarter. In addition to our Tier 1 OEM that is now shipping in volume, we have continued to achieve a number of design wins. For example, we received orders recently from a large Asia-Pacific-based telecom service provider for our Deneva series of SSDs, and they’re expecting this client to start limited deployment this year, and to ramp considerably over the next 24 months.

We’ve recently received initial orders from our Deneva series with a new high-performance computing OEM who we expect to rule out to a major cloud-computing service provider over the next two quarters.

We have recently seen a sole source design in with our Deneva series to well-known enterprise-class storage system OEM, who we expect to ramp to mass production quantities in our fourth quarter. And though we are still determining potential revenue for this client, we’re excited in our ability to win and compete with this business.

We recently qualified our Deneva SSDs from [inaudible] to networks, a provider of next generation enterprise firewalls, and we’re in the final stages of qualification and pricing with a large data center for our VeloDrive. Should this business come to fruition, it could represent a significant portion of our PCIe-based SSD sales through fiscal ’13.

Now, I’d like take some time to discuss our controller strategy. We’re very excited about extending our core technology leadership position with the recent acquisition of Indilinx. Indilinx currently provides it’s line of SSD and flash controllers to SSD manufacturers and Tier 1 OEMs, across an array of product subsegments from embedded computing through industrial as well as the laptop and PC markets.

Indilinx controllers are currently utilized in a number of OCZ solid state [inaudible] including the Z-Drive series of PCIe-based SSDs.

Producing SSD controllers for OEM mitigation, and for use within our own product, significantly enhances our capabilities and yields cost reductions which help make SSDs more accessible to potential customers. This combination puts OCZ in an advantaged position as one of the few SSD manufacturers with captive controller production.

The acquisition will help to increase both revenues and gross margins as vertically integrate controller technology. It also provides critical support for current and future enterprise and OEM customers.

In regards specifically to new controller products, we expect to launch both our both our SATA SAS 6 gigabyte a second higher-performance SSD platform and the barefoot 2 SATA SAS 3 gigabyte a second and M- series SSD processer in the fiscal second quarter with follow-on product to be announced later in fiscal ’12.

On a go-forward basis, it’s important to note that as we are producing controllers for our own use, our capital expenditures rates and R&D expense will increase. As our historically low rate of capital expenditure and R&D expense was supported by using third-party IP manufacturers exclusively.

I will note however, the margin improvement that we gain, should easily outweigh those costs. We also plan to expand our SNT manufacturing located in Taiwan to support considerably higher volumes. I’ll let Art comment on the details, but in short, we plan to double our manufacturing capacity in the next 90 days in order to basically to support increased demand for our new product.

It’s always important to note that we enjoy a strong relationship with our technology partners, allowing us to deliver new product well in advanced of other SSD manufacturers, and that we believe by continuing to work with our partners on technology development we increase our chances for success in the long term.

I would like to call out specifically our relationship with SSD technology developer SandForce. We plan to continue to work and in fact, deepen our relationship with SandForce as evidenced by our recent launch of our critically-acclaimed Vertex 3 product line several months ahead of other third party adopters of SandForce-based processers. Thus, with the continued adoption of SSD products, our enhanced technology leadership position with Indilinx’s controller IP, the on-going recognition we’re receiving from independent third-party reviews and our strengthen balance sheet, we feel we are favorably positioned as a leading manufacturer of SSD as we begin this new fiscal year.

So at this point, I’ll turn things over to Art, for a financial overview. Art?

Art Knapp

Thanks, Ryan. And I’d also like to thank all of you who have invested in OCZ this past year, and in our recent follow-on offering. We really appreciate your support and I hope from Ryan’s comments that you can see we’re all hard at work here putting your money into building a terrific business.

Ryan covered the basic results, and there are detailed financials in the release. I’ll try to add some additional perspective and information.

We also showed a table of quarterly revenues for the past two years by product group, and then also by major geographic areas. This should help eliminate any confusion on the historic numbers as a year ago we began showing SSDs as a separate line item versus combined with other flash-based products such as USB drives, and camera cards.

There was also a transposed number in the table in our last 10-Q for which I apologize. The fourth quarter results contained our transformation – continued our transformation in the SSDs which represented 90% of revenue versus 8% in Q3, and 53% in Q2, and then 38% in Q4 of last year. Our historic DRAM memory products were only 3% in Q4 versus 48% a year ago.

With the strong SSD opportunities, we have not allocated our limited capital to the power supply products and they dropped to 7% of revenues from 14% a year ago. For the full fiscal year 2011, SSDs grew 206% and were 70% of revenues versus 30% in fiscal 2010. Memory products declined 50% and were 19% of revenue versus 50% in fiscal 2010.

Power supplies and other declined 27% and were 11% of revenues versus 20% last year. Overall revenue growth was 32% for the year but it is important to understand this revenue mix shift, when analyzing overall results, otherwise incorrect conclusions could be drawn, particularly on a geographic basis as we have consistently strong SSD growth in all regions.

For example in Q4, North America grew 24% from last year but it’s SSD growth was 161% while memory declined 96%. This dichotomy was similar to the Q3 results where the 12% revenue decline included 193% of SSD growth offset by 89% decline in memory.

As I stated last quarter, the growth rates outside North America has been even stronger, and those regions represented about two thirds of SSD revenues in the last two quarters versus less than 50% last year.

EMEA has shown SSD growth rates of 497% and 768% in Q3 and Q4 respectively. This is principally from Germany, France, Netherlands, and the U.K. The rest of world area which is the mainly the Asia-Pacific that Ryan described, grew 278% in Q3 and 610% in Q4.

Then, like in North America, this strong SSD growth is tempered by the declines in memory. But as you see in the charts, both EMEA and rest of the world nearly tripled their Q4 revenue versus last year.

On a sequential basis from Q3, SSD revenues in Q4 grew 38% in North America, 31% in EMEA, and 105% in rest of world. Within the SSDs, as we discussed on the Road Show, enterprise class products in Q4 grew by about 350% from last year and accounted for nearly 15% of our SSD revenue. High performance and server products were approximately 78% of the Q4 SSD sales and had a growth rate of about 440%.

Consumer grade SSD grew about 135% and were nearly 7% of SSD revenue in Q4 versus about 2% in Q3.

Turning to the details of our financial results. Our GAAP net loss per share for the fourth quarter was $0.27 compared to a loss of $0.31 in last year fourth quarter. Included in today’s financial release is a table which shows the reconciliation of GAAP to non-GAAP measures as well as the related calculations. The reconciliation also reflects non-cash charges in infrequent or unusual adjustments that are not representative of our normal on-going operations.

GAAP gross margins were 16.6% for the fourth quarter, but after adjustments for the impact of unusual DRAM-related rebates and inventory reserves, non-GAAP gross margins were 16.8% versus 9.8% a year ago.

Without the negative impact of the DRAM products, the margins were nearly 19% compared to nearly 22% in Q3. This decrease was mostly due to higher purchasing costs as our record sales level exceeded existing credit lines with the direct suppliers and we were forced to source through brokers.

Our operating expenses were 11.2 million on a GAAP basis and 10.7 million on a non-GAAP basis after adjustments for cost associated with stock-based compensation, intangible amortization in the Indilinx acquisition. This 10.7 million compared to 6.9 million of non-GAAP costs to the year-ago quarter.

Within OpEx, R&D costs increased 30% sequentially and 91% from last year. This reflects the commitment to technology leadership, which you heard from Ryan. Sales and marketing increased 64% from last year but decreased sequentially after the higher levels in Q3 for certain marketing programs.

G&A and operations increased by 29% from last year reflecting some economy of scale versus a doubling of revenues.

The acquisition of Indilinx will add approximately $1.5 million of expenses per quarter of which the majority will be R&D related, which underscores the strategic nature and further helps our development efforts. With the adjustment I described, we reported a non-GAAP operating profit of 128,000 in the fourth quarter compared to a loss of 3.8 million in the year-ago fourth quarter. That 128,000 non-GAAP profit was net of an estimated 1.7 million operating loss on the memory business due to low margins, direct cross and an allocation of non-overhead costs.

The implied memory – non-memory operating profit of 1.8 million is up from the same 1.1 million calculated in Q3.

Our GAAP financing costs were higher than last year due the overall – higher overall debt levels and the higher mix of international sales which carry a higher financing cost than domestic.

During the quarter we successfully negotiated a new $25 million credit facility with Silicon Valley Bank to replace our previous factory arrangements. As part of this change, we terminated the contract with FGI, who handled the international portion and we incurred a $170,000 termination charge. This has been removed for the non-GAAP presentation.

In Q4 we increased the valuation allowance to 100% for our investment in VCI Net, which we had spun out in Q3 of fiscal 2010 to enable some external people to focus on the [inaudible] product while we focused on our growing SSD products.

We are planned funding a potential IPO has been delayed so to be conservative, we wrote it off resulting in a non-cash charge of about $1 million, which has also been removed from the non-GAAP presentation.

The fair value adjusted of warrants issued with our first quarter equity financing resulted in a 6.7 million non-cash loss, principally due to a higher stock price which makes the warrants more valuable. The theoretical non-cash adjustment is removed as part of the non-GAAP presentation.

GAAP net loss for the quarter was 9.3 million compared to a loss of 6.5 million in last year’s fourth quarter. On a non-GAAP basis, net loss was about 770,000 or $0.02 per share compared to a loss of 4.3 million or $0.20 per share last year. Our adjusted non-GAAP EBITDA was a positive 430,000 versus a loss of 3.5 million last year.

Turning to the Q4 balance sheet, all of our key metrics improved. Cash was 17.5 million, which left an additional capital rate in the late October private placement. You’ll also note 1.3 million of restricted cash, which was used in Q4 for standby letters of credit to help us secure some initial credit lines with direct suppliers.

I think this helps portray the impact of the lack of working capital and how valuable the recent $100 million offering is to us.

Factoring out the relevant non-GAAP adjustments, our receivable days increased to 43 versus 48 last quarter. Inventory days of 40 were about the same as Q3 and payable days decreased to 66 versus 77, which helps our vendor relations as we seek for those higher credit limits due to our revenue growth rates.

Our CapEx for Q4 was 805,000 or double the 386,000 spent in Q3. Nearly 700,00 of the Q4 investment was related to factory expansion with SMT machines and other related items. As you heard from Ryan, we plan to continue this type of investment level over the next couple quarters.

To help finance our growth, our bank debt rose to 20 million from 15.4 million in Q3. But it has been fully repaid with the recent fundraising, so we are now debt free.

For our shares outstanding, with the Indilinx acquisition and the fundraising, we now have approximately 51.4 million shares outstanding and nearly 9 million shares subject to warrants and options.

Turning to guidance, on March 28, we indicated in our initial revenue guidance for fiscal year 2012 to be in the range of 300 million to 330 million. We also indicated that due to the Indilinx acquisition, we expected our gross margins would increase by 2 to 4 percentage points by the end of the year as we integrate Indilinx’s controllers into a greater range of OCZ products as well as the sales of controller products to third parties.

We are also cognizant that since then we now have more funds available for our use. While we expect that this should provide some upside opportunities in the second half of the year, we reiterate our current guidance and plan to provide an update as part of the fiscal 2012’s Q1 results. That allows time to more thoroughly assess the opportunities of the acquisition and the financing.

That concludes my formal remarks. At this point, we’d like to open up the call for questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from Rich Kugele from Needham and Company.

Rich Kugele – Needham and Company

Thank you. Good afternoon, gentlemen. I have a few questions if you’ll indulge me for a moment, and then I’ll just come back in the queue later if there’s more.

First, in terms of the gross margin, without the impact of the DRAM business in the fiscal first quarter, would you expect gross margins at least directionally to trend up or down versus the fiscal fourth quarter?

Rich Kugele – Needham and Company

Ryan Peterson

I think we’re not giving specific guidance on Q1, but overall with the fundraising, we are expecting margins to be directionally up.

Rich Kugele – Needham and Company

Okay, that’s helpful. Can you comment then, I guess a little bit more on the Bello Drive announcement, specifically how we should view the product relative to your C-drive, PCI solutions as well as how it fits within other competitor offerings? And then I guess, just directionally, how to expect a mix between the two? I know you talked about there being potentially one customer for Bello later, but any thoughts on that would be helpful.

Ryan Peterson

Basically, this targeted, people who require a software mode array solution. What we had had when we originally introduced the V-drive as one of our primary selling features was in fact that it did not require any host-side software. As it turns out, a number of customers actually prefer the products to run in host-side software so we’ve enstabled the VCA stack and have a product that essentially is used as a rate controller with [inaudible] behind it.

In regards to OEM opportunities with the Velo drive, it has in fact been a product that we’ve had for several months. It is pending qualification. In fact, I do believe we mentioned we’re in qualification currently with a very large data center and that business could prospectively be the majority of our PCIe SSG revenue through fiscal ’13. So some sizable OEM opportunities.

Rich Kugele – Needham and Company

Okay. Can you talk a little bit about demand supple, especially post-earthquake, how just conceptually increases in prices or changes in prices impact your business and your ability to offset it?

Ryan Peterson

I think in general as, you know, NAND flash prices rise and have risen since the Japan quake, what we’ve seen is we’re able to pass on the cost to a large extent. Also keep in mind that we are moving to new flash nodes as often as they come out. So supply issues tend to be related to new flash, maybe not being available because it’s not in mass production yet. If that makes sense all. Did that answer your question properly?

Rich Kugele – Needham and Company

Yeah. Then I guess in terms of pricing, you’re able to pass along these prices, or do you expect as your business progresses and gets more OEM or major customer wins that that would change? How do we think about that?

Ryan Peterson

I would suspect that we would be able to pass on prices and any long-term OEM contract where it’s not a locked-in-price, we’ll be able to contract obviously supply of NAND flash for those products. If it’s a moving price [inaudible], which generally is in the best interest of the OEM, as NAND flash prices have historically only gone one direction, we get a reset from time to time and any short-term increases can be offset. If that makes sense.

Rich Kugele – Needham and Company

Yes. And then I guess competition wise, you know, this question obviously comes up a lot from our clients. Can you just talk about who you see most often and in what segments?

Ryan Peterson

Sure. Specifically, and some of our competitors that we see in – for example, the server segments, would be a smart module or we would view them as our primary competition in the server segment. [Inaudible] is also a small private company called Client who we see, this is a SaaS 6-gigabyte products. Those Spec, who’s primarily kept to the fiber channel market until recently has released a SaaS 6-gigabyte-a-second SSD. So we do see them competing more in the enterprise storage side of things. I think the field in terms of the PCIe side of things, the whole field is [inaudible]. Of course, there are always folks that are talking about entering the PCIe market, so we’ll have to see if any products come to fruition. But in general, it’s the same folks we’ve seen until you get down to the laptop market, which of course in the laptop market we’ve seen entries from WD, we’ve seen Intel, Micron, all playing in that market.

Rich Kugele – Needham and Company

Okay. Just one last one for me and then I’ll go back into the queue. I’ll apologize up front. Although, really all our clients know the events from your distant past, I think it’s come up. Can you just elaborate a little bit on your background, what was referenced in the prospective and any other filings for the benefit of the broader audience?

Ryan Peterson

Sure, well, I guess thanks for the question. The information about my past is public information. It’s available to anybody. It’s, of course, more than a decade ago. It’s previously been disclosed in OCZ documents, filings, though there’s no legal obligation to do so. So as an example, during our public offering, we had met with a number of investors who actually wanted to know a little bit more about it and we proactively discussed it with them, to whatever extent they wanted to. I’m always open to discuss that with the large institutional investors.

Now, on a personal note, I have to say that, and maybe it goes without saying, that I’m not proud of some of the choices I made when I was a younger kid, and when I’m asked to speak to troubled youth about my past mistakes, I try to be as frank as possible with them about the price I had to pay for my actions and it’s done with the sincere hope that I can inspire them to improve their own lives.

That being said, I can assure you that I really wouldn’t be the guy I am today had I not made those mistakes. And though I know that with OCZ we’ve just begun, I can’t help but feel a sense of pride with the company that we’ve built up here. And with the hundreds of phenomenal employees that we have.

So I guess that’s virtually all I have to say about this subject. Does that answer your question?

Rich Kugele – Needham and Company

Yes, thank you.

Ryan Petersen

Any other questions?

Rich Kugele – Needham and Company

No, I’ll just go back in the queue if I’ve got anything else. Thank you.

Ryan Petersen

All right, thank you.

Operator

Thank you, our next question comes from the line of Aaron Rakers of Stiefel Nicolaus.

Aaron Rakers – Stiefel Nicolaus

Yeah, thanks guys. Sorry about the background noise here. So a couple questions as well.

First question for me, Ryan, you gave a list of obviously incremental opportunities on both direct customers as well as OEMs. The one that seemed to stick out of me is I believe you had mentioned a single source opportunity at a large storage platform provider.

First of all, do you really mean that as a single source win? And secondarily, would you characterize that opportunity as tier one opportunity that to materialize late this year?

Ryan Peterson

I would. The single source, as in we are the single source for that specific product from the vendor. They use, of course, other SSP vendors for other products. And I would characterize them as a tier one.

Aaron Rakers – Stiefel Nicolaus

Okay, perfect, and correct me if I’m wrong Ryan. As far as when you looked at your guidance you provided back on March 28th, how much of that guidance was predicated on new design win ramps materializing through this year or not for that matter?

Ryan Peterson

Sorry to be clear, we basically when we give guidance are not guiding into new design wins to a large extent since we don’t know what a business will materialize based on this design win until we see orders or we have really a forecast from the client that gives an exact order amount, blanket PO’s, those type of things. We do not forecast based on those orders.

Hence, our comments earlier are comments earlier that we do need to take time to take into the account of finance.

Aaron Rakers – Stiefel Nicolaus

And then the last couple questions for me, when I look at the adjusted gross margin trying to exclude the discontinued memory business and I’m coming up with a number somewhere in the kind of 9.4, 9.5% range, is that correct. And if so, with that, basically the memory business gone, how do we think about the trajectory of that gross margin? Are you adding 100 basis point incrementally on a sequential basis here as we move forward? What’s the inflection points or the real triggers we should be looking for?

Ryan Peterson

So the question is, what is the margin with and without memory in the fourth quarter, is that right?

Aaron Rakers – Stiefel Nicolaus

Correct, gross margin.

Ryan Peterson

So I think that it’s, Art, I’m sorry, but I believe it’s significantly higher than 9%.

Aaron Rakers – Stiefel Nicolaus

Yeah, I’m not sure. I said 19.4.

RyanPeterson

Okay, got you. But we would expect then our expectation is that the memory on a go forth basis, what’s just gone, I think that’s an incremental maybe a few hundred basis points.

Arthur Knapp

Aaron, I think what we said on the road shows as Art obviously – is that we would kind of expect to see a steady progression of the margin. We weren’t trying to have people expect to see us flip a switch, but we would expect to see a steady progression.

Aaron Rakers – Stiefel Nicolaus

Okay, and then final question for me and I think it tied into this discussion, is can you update us where you’re at today on supply arrangements with regard to direct or authorized relationships relative to still buying through the distribution or third-party channels? And how we should expect that to change post the capital race.

Ryan Petersen

Generally, I think not a lot of changes. It’s been a few weeks since we raised the money. Now ultimately, we have however had a number of preliminary meetings to increase our purchasing directly through the big fabs, like for example, Micron, Intel, Toshiba, who we’ve historically dealt with. I would expect that for this to properly pay out, it will take three months before we start to see a significant portion of our business coming from these fabs though I’m trying to set: the expectation correctly there for a bid early.

And then ultimately as we continue to get bigger and become a more important purchaser of flash, we should be able to obviously see additional cost savings.

Aaron Rakers – Stiefel Nicolaus

Great, thanks.

Ryan Petersen

Just a little bit color on that, what’s frustrating is I have a press release in my hand talking about a $94 million raise, but the credit department people of these entities want to see the actual financials, which are out today. So that’s why the process happens with flipping a switch like I said before.

Aaron Rakers – Stiefel Nicolaus

Right, fair, I’ll get back in the queue guys, thank you.

Ryan Petersen

Thank you.

Operator

Our next question comes from the line of Alex Kirk from Sterne Agee.

Alex Kirk – Sterne Agee

Thanks for taking the question. Good afternoon guys.

Ryan Petersen

Hi, Alex.

Alex Kirk – Sterne Agee

Art, could you – if you were to look back at the gross margin in Q3 and Q4, the memory and – have you done analysis around what percentage of the third party brokers you were in Q3 and what they were in Q4. And if you were trying to normalize it in Q4 versus what you have in Q3, how many basis points did you lose you think of the SSD margins?

Arthur Knapp

It’s about a 3% point difference, so 300 basis points. And we think that’s entirely due to having – when we have analysts talking about a $40 million quarter and we did $58, I don’t have the (inaudible) lines for that. You saw during the quarter, I have to put $1.3 million in LC, high up cash to get some LC’s to pick up some initial credit lines.

So that all said, we are monitoring and we’ll update you on the call in the first quarter as to how we’re moving up the food chain so to speak with buying more direct as I can get these financials into their hands. And the credit people can allow that higher limits, we’ll see that percentage go up. When we have to go through brokers when we exceed our credit limits, we pay the price for it.

Alex Kirk – Sterne Agee

So just to be specific here, Art, what percentage in Q4 went through third party brokers versus Q3?

Arthur Knapp

Through third party brokers, it’s in the 70% range, 70 to 80%.

Alex Kirk – Sterne Agee

And what was that in Q3 do you think?

Arthur Knapp

Q3 was probably in the 60% range.

Alex Kirk – Sterne Agee

Okay, and as you move through May and August quarters here, is the goal to get that below 50% or what’s sort of the timing around that?

Ryan Petersen

If I could step up for a second here, I think generally it’s hard to give a good prediction when that will happen. But our long term model or even our short term models frankly is to be 70% direct from the fab. The obviously using some out distributors makes sense for the business. It does not and will never make sense to pay multiple or significantly higher prices for flash . And so really using the broker channel or the third party brokers really only overflow is what makes sense. So to a large extent, I guess that is how much do we overshoot our allocation from the fabs.

Right now, we don’t get enough allocation.

Alex Kirk – Sterne Agee

So Art, just to clarify 300 basis points were lost this quarter versus what you would have had if you had the same percent mix versus Q3?

Arthur Knapp

Right.

Alex Kirk – Sterne Agee

Okay. Ryan, just to follow up on Aaron’s question about the enterprise class storage wind, was that for a specific project? Was that for a specific system? Can you give a little bit more color from where you think or what the use case is for that wind?

Ryan Peterson

Sure, it’s being deployed. The use case or these products are being deployed to serve streaming content over the Internet in a large data center.

Alex Kirk – Sterne Agee

Okay, and last question for me, Ryan, you mentioned Everest, is that the renamed Thunderbolt product from Indilinx?

Ryan Peterson

That is in fact the renamed thunderbolt product.

Alex Kirk – Sterne Agee

So that product is being released this month?

Ryan Peterson

Yes.

Alex Kirk – Sterne Agee

And what percentage of you think your SSD mix say by the end of the August quarter could be supplied out of Everest versus the lower end SATA force controllers? Have you thought about it in those terms?

Ryan Peterson

I think that it would be hard to say at this early date. So again, this comes down to where we need to be guiding. And really, that’s determined by how quickly we can integrate Indilinx. So give us till the quarter and we’ll give some more comments on it.

Alex Kirk – Sterne Agee

I appreciate it guys.

Operator

Thank you. Our next question comes from Christian Schwab of Craig-Hallum Capital.

Christian Schwab – Craig-Hallum Capital

Great, thanks so much for taking my question. Just a quick housekeeping question, what do you expect this year count to Q1 to be given the timing of the financing?

Arthur Knapp

I think we’re fully diluted now.

Christian Schwab – Craig-Hallum Capital

51.4, right?

Arthur Knapp

So the basic would be about 44.5 and if you do some fully diluted, I’ve been telling people we probably add 3.5 depending on your share price whether it’s 8, 10, or 12. But we would expect the first quarter to be between $44 and $45 million.

Christian Schwab – Craig-Hallum Capital

Perfect. Great, and then regarding the doubling of capacity in the next 90 days, can you give us an idea either on units or solid state drive revenue what that would equate to as far as a potential range of revenue on a quarterly basis that you’re building for?

Arthur Knapp

It would be fair to say, what we have talked about in the past is that at full utilization, we would have abruptly $40 million per month of capacity to build SSDs. That’s of course a theoretical number, so you never can run at 100% utilization. So you might as well cut 30%, 40% off the top of that. Now so we’ll double that from those numbers.

Christian Schwab – Craig-Hallum Capital

Perfect, that’s very helpful. And then, our long-term non-GAAP gross margin goal 28 to 32 operating income of 13% to 17%, I assume we’re going to need 70% direct sourcing from the fab on NAND and that. What type of, probably a consistent mix based on server and enterprises you have today give or take and probably a few Indilinx chips used in there, what would be a rough quarterly revenue goal that you guys have looked at to attain that bottle?

Ryan Petersen

I think that the quarterly revenue goal would really – it’s not based on any specific volume for example. So it’s more based on just purchasing correctly and having more of a steady state business without the hyper grow. So hence, it being a two to three year model.

Christian Schwab – Craig-Hallum Capital

Okay, so a two to three year model growth not growing at the rate sequentially that we’re talking about and moving from 70% to 80% third party to direct.

Ryan Petersen

Right, because any time we’re growing 50% sequentially or 40% sequentially quarter after quarter, we’re certainly not as efficient at this point.

Christian Schwab – Craig Hallum Capital

Fabulous, that helps. And my last question, just as far as Q1 guidance Art for quarterly OpEx, should we just take the $1.5 million plus the 10.7 and then some new hire growth and kind of be thinking $12.5 to $13 million and that probably grows modestly sequentially throughout 12. Is that appropriate way of thinking about that?

Arthur Knapp

We’re not at this point trying to give any guidance, but I would point out that the $1.5 million is a full quarter. And the Indilinx acquisition closed in late March, so you’d have two months of that in the first quarter.

Christian Schwab – Craig Hallum Capital

Right, and then but kind of assuming going into August, I know we don’t want to talk about August, but just to make sure that we’re all on the same page, kind of start with kind of roughly at $10.5 million and add a little bit from there would probably be fair?

Arthur Knapp

Again, you’re making it a little difficult. We’re saying we’re not trying to guide. What I was trying to signal was increase spending with Indilinx. And then you’ve seen the increase in R&D where the percentage yield you’ll see on the statements goes from $3.6 to $3.9 in Q3 to Q4. So you can imagine that is trending higher as we carry out technology leadership.

I’m not trying to be evasive. It’s just we indicated we’ll comment more in Q1, so I’m trying to give you what guidance is appropriate.

Christian Schwab – Craig Hallum Capital

No, I completely understand. And then my last question I guess is on Indilinx chips. Do you have a stated target goal for percentage of chips that you want to secure using internal versus external chips when you’re out, two years out, three years out?

Arthur Knapp

No, we don’t generally talk about it. Obviously, it’s hard to tell. So I guess it’s dependent on a number of things including our sales mix, but obviously there’s a substantial cost savings if we use non-controllers.

Christian Schwab – Craig Hallum Capital

Perfect, no other questions. Thanks.

Operator

Thank you, our next question comes from the line of Richard Shannon from Northland Capital.

Richard Shannon – Northland Capital

Hi, guys. I jumped on the call late, so I apologize if some of these have been repeated or you mentioned in your prepared remarks, but I’m curious about the tier one OEM that’s been unnamed so far by you announced in the month of December, how that business trended in February. And in general, qualitative expectations so far for the make order.

Ryan Petersen

We trended quite well being that there was no revenue in the previous quarters. It’s the first quarter of revenue with them. So we do expect them to obviously continue to grow over the year.

Richard Shannon – Northland Capital

Okay, fair enough, and then I think I caught some comments from you, Ryan, in your prepared remarks about the Helios. I don’t know if you mentioned the timeframe by which you expect to start qualifications and the maybe the earliest or more reasonable timeframe to expect potential revenues from those products.

Ryan Peterson

I would generally expect revenue from Helios. We did launch Helios in January. So we know for tier two, we count on four to six months. For tier ones, you count on nine months. So if you want to look out in that timeframe, they’re certainly doing well, the Helios. Anything that’s VCA related and the SAS 6, you’ve done quite well on qualification of them. Though obviously, nothing is going to be done at this early stage. We do intend to ship a Helios family of our product at a lower speed grade to the channel, which will support other smaller clients that might want to enable that in their servers and their [inaudible] . But we are saving the Helios of course for large tier [inaudible]. Does that make sense at all?

Richard Shannon – Northland Capital

Okay, so would you reasonably expect on Devena Two that probably no expectation of revenues in this current fiscal year then.

Ryan Petersen

Well, some, but obviously Deneva Two will be, but typically, we have some products based in our family in the channel. So to what degree we get small tier threes, some of our current clients that may have had early engineering samples may call towards the latter of Q4 timeframe. But nothing substantial this year. Devena Two, obviously with any OEM related product in the enterprise segment, it takes quite a bit of time to qualify that.

Richard Shannon – Northland Capital

Sure, understood. Ryan, if you look kind of in your crystal ball looking in calendar 12 or whatever timeframe beyond that if you care to, if you look at your SSD business between that detached via PC express versus the other storage oriented protocols, actually the VO drive announcement here sounds like you’re very upbeat about that. You mentioned a couple of opportunities there I think. Any guess as to where that split of SSD revenue goes between interfaces in 2012 or beyond? Whatever timeframe you prefer to discuss on that, it would be great.

Ryan Peterson

It’s hard to say, but I will tell you that about half of our enterprise revenue in Q4 was PCIE. And it’s not all enterprise, but to give you just a small bit of data that will give you some kind of future visibility, enterprise is where we’re trying to grow. Our focus is clearly on producing the PCIE products available. As you can tell, we’ve released the Velo drive even though it was a non-standard approach to really try to get as much market share as we can there. The market’s tiny, but it’s also predicted to be one of the fastest growing segments as direct enterprise uses. So I’ve got to say, less competition, a strong market. We have a strong offering there. So I would say that currently that I feel more strongly about our PCIE success.

Richard Shannon – Northland Capital

Okay, great. I think that’s all the questions I have. Congratulations, guys.

Operator

Thank you, our next question is a follow-up from Mr. Aaron Rakers of Stiefel Nicolaus.

Aaron Rakers – Stiefel Nicolaus

Yeah, thanks guys. Two quick questions for me. First question on, you know, the Vertex 3 product. You know, I think a lot of others have asked me about the lead times of those products. Can you talk a little bit about NAND flash supply there and some of the newer generation’s 25-nanometer stuff and availability. And in that context, how much of maybe demand that you’re currently, you know, you feel like you’re under, you know, under meeting or is left under-met given the lead time on those products right now?

Ryan Petersen

I can. I mean, to be as blunt as possible about Vertex 3, we’ve seen an enormous demand, maybe 3X durability to ship for Vertex 3. We expect that issue to basically – so we overshot our allocation for NAND flash. Now, to be clear, we had a pretty high allocation in NAND flash to start with on those. So we just didn’t expect demand to be that much higher than what our allocation was. And this is for the new [inaudible]. So to basically look at the [inaudible], that goes into a full ramp with Micron and Intel in June. So we would expect that we’ll see a considerable upside on Vertex 3 sales really in June.

Aaron Rakers – Stiefel Nicolaus

Okay, great. That’s helpful. And then the final question for me is on Indilinx, you know, I think you’ve talked a lot about the controller integration aspect, obviously a key focal point. But you’ve also obviously told us that you’d expect to sell controllers into third party or other SSD provider opportunities. Can you talk a little bit about how we should expect that to ramp? Any framework of how you’re looking at that opportunity and how we should think about modeling that over the next several quarters?

Ryan Petersen

Well, part of the reason that we are waiting to update some guidance had a lot to do with controller sales. We’ve had a number of questions from key investors. So we have had success with design wins on the next generation of product, but to a large extent we need to take our time to adequately look at what those opportunities are on a go-forward basis and then come back with some very specific guidance in the future. Again, not trying to be evasive, but we need to determine what we’re going to do. We have, you know, obviously picked up some clients on that right out of the gate. We have zero SSD controller revenue in our guidance.

Aaron Rakers – Stiefel Nicolaus

Good. Thanks, Ryan.

Operator

Thank you. Our next question is a follow up from Rich Kugele of Needham and Company

Rich Kugele - Needham and Company

I know the call’s running long, so I just want to be quick. In terms of new products replacing old, I know that when you go and you do a search online you look at Newegg or Amazon, you know, you can get many of your historical products that are still out there. How do you view that going forward? Is that going to be still your approach continuing to ship everything or can you migrate like Apple does where it’s an almost forced migration up to the next product line?

Ryan Petersen

Well, I mean, for the retail channel, we can do whatever we would like, though generally we try to meet customer’s needs on that segment. That’s a small segment for high-performance SSD sales. So when we turn our eyes to the OEM and the server segment, it’s not wise typically to discontinue a product that is only a year old and has just become qualified into a number of OEMs. So we have to – I mean, like the Deneva series for example, which is really an enterprise version of Vertex. We’re going to have that product around for some time. We’ve had a number of [inaudible] with it that have just come through. Some of those might not even ramp until halfway through this year.

Rich Kugele - Needham and Company

Okay, and then just because I couldn’t write it all fast enough, can you go through which three wins are incremental, that you decided – the one with the large telco and then the storage one, and then the VeloDrive one. Are those the three?

Ryan Petersen

Those are all incremental. All of the OEMs that we listed, now we have had time to really assess the impact of that business.

Rich Kugele - Needham and Company

Okay.

Ryan Petersen

They’re all incremental business.

Rich Kugele - Needham and Company

And of those three, one is shipping at some level today and should ramp through the year and the rest are more second half?

Ryan Petersen

I think the majority of them are ramping in the second half, but all of them are shipping in some small quantity today at least.

Rich Kugele - Needham and Company

Okay, all right. Great. Thank you very much.

Operator

Thank you. And I’m showing no further questions in the queue at this time. I’d like to turn the call back to Mr. Petersen for any closing remarks.

Ryan Petersen

Thank you, everybody. I just wanted to close by saying that we’re pleased with our achievements during the course of the fiscal year and transforming the company into a leading provider of solid state disk drives, acquiring the controller ID, the funding, have all really contributed to us feeling favorable about our position as we continue to roll out next-generation products in the coming year. So with that, I will thank you again for joining us and I look forward to talking to you again in the next quarter.

Operator

Ladies and gentlemen, thank you for attending today’s conference. This does conclude the program. You may now all disconnect. Have a great day.

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