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Xyratex, (NASDAQ:XRTX)

Q2 2011 Earnings Call, Jun 30, 2011

June 30, 2011 4:30 pm ET

Executives

Steve Barber - Chief Executive officer, Acting Networked Storage Solutions General Manager and Director

Richard Pearce - Chief Financial officer, Acting Storage Infrasructure General Manager and Director

Brad Driver - Investor Relations

Analysts

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

Jung Pak - BMO Capital Markets

Glenn Hanus - Needham & Company, LLC, Research Division

Shebly Seyrafi - FBN Securities, Inc., Research Division

Operator

Good day, ladies and gentlemen and welcome to the second quarter 2011 Xyratex Earnings Conference Call. My name is Melanie, and I'll be your coordinator today. [Operator Instructions] As a reminder, today's call is being recorded. 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 Fiscal Second 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 and business activities. These statements are subject to risks and uncertainties that may cause actual results and events to differ materially. These risks and uncertainties are detailed in Xyratex 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 the 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 second quarter. Please note that all numbers are in accordance with GAAP unless stated otherwise.

Total revenue was $338.5 million, down 25.7% as compared to the second quarter of last year, and down 6.1% from our prior fiscal quarter. Sales of our Networked Storage Solutions products were $301.2 million or 89% of total revenue. This is a decrease of $42.7 million or 12.4% compared to the second quarter of last year, and down 9.9% compared with $334.2 million in our prior fiscal quarter. The decrease in revenue primarily reflects the proportional product volume shift to Jabil, per our contract with NetApp, which we have discussed in previous earnings calls.

Sales of our Storage Infrastructure products were $37.4 million or 11% of total revenue, down $74.6 million compared to the second quarter of last year and up 42.1% over our prior fiscal quarter. The decrease in revenue as compared to the second quarter of last year, primarily reflects rates and expected demand last year as a result of catch up and slower-than-expected demand this year, as a result of the pending acquisitions by our 2 largest customers.

Gross margins was 12.9% for the quarter compared to 18.1% in the same period a year ago and 13.7% in our prior fiscal quarter. This decrease, compared to last year, is due to the lower proportions of SI revenues and lower SI gross margins.

The gross margin for our Networked Storage Solutions product was 14.9%. This compares to 12.8% last year and 14.2% last quarter, above our prior guidance. The increased margins, primarily reflects product mix and we expect the margins to remain in this range through the end of this year. The gross margin for the Storage Infrastructure product was negative 2.7% compared to 34.6% last year and 9.7% last quarter.

The shortfall in margins compared to our historic average annualized margins of 30% was the result of 3 main factors. Approximately $5 million of additional provisions reduced the margin by 13.5%, fixed costs relative to lower revenues reduced margins by approximately 10% and the remaining shortfall related to product mix, including early-stage products that are still in the higher cost introductory phase.

Turning to non-GAAP expenses, our operating expenses totaled $46.3 million compared to $43.6 million last quarter and $34.4 million last year. The higher-than-expected expenses included restructuring costs and incremental variable product development costs. Expenses should remain relatively flat to slightly down through the end of this year, as a result of a reduction in costs in the SI business, offset by increased investment in NSS, primarily related to the recently announced NSS ClusterStor product. On a non-GAAP basis, net loss was $1.9 million or $0.06 per diluted share compared to a net income of $46.8 million a year ago and net income of $7.5 million in the prior quarter.

Turning our attention now to the balance sheet, cash and cash equivalents at the end of the quarter was $126.9 million compared to $98.2 million at the end of Q1. Cash flow from operations was $42.3 million in the quarter. Inventories decreased by $23.8 million to $153.1 million through the quarter. Inventory turns was 7.8 compared to 7.1 for the previous quarter. This reflects stable customer forecasts.

Accounts receivable decreased by $14.6 million in the quarter to $177.2 million. Days sales outstanding were 47 in the quarter compared to 48 in the previous quarter. We spent $5.3 million in the quarter under our share buyback program, purchasing 551,000 shares at an average price of $9.62. Headcount at the end of the May quarter was 2,112 permanent employees. A reduction of 3% or 58 employees.

In summary, this was a very challenging quarter for the company in many different ways. The markets we serve remain highly competitive and uncertain, which is limiting our visibility, particularly in our SI business. NSS continues to perform pretty well, as our current customers continue to see strong demand for their products, which we supply. In light of the uncertain times, we are committed to improving our profitability and maintaining our focus on operating cash generation.

Now before I turn it over to Steve for his comments, I'd like to provide you with our business outlook for the fiscal third quarter 2011 ending August 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 risk and uncertainty. 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 third quarter of 2011, we are projecting total revenue to be in the range of $336 million to $376 million, down 22% to 13% as compared to last year and down 1% to up 11% compared to 2Q. This is represented by revenue for Networked Storage Solutions of $316 million to $346 million and from Storage Infrastructure of $20 million to $30 million.

For Q3, gross margin is expected to be 14.5% to 15%. We are estimating non-GAAP earnings per share to be between $0.10 and $0.28. Non-GAAP earnings per share excludes non-cash equity compensation and amortization of intangible assets. The number of shares outstanding at the end of Q3 on a weighted average treasury method is expected to be $31 million, subject to any service share buyback in the quarter. Our cash position at the end of Q3 is expected to be approximately $120 million and trending in excess of $140 million at the end of the fiscal year, subject to share buyback activity in the quarter.

I'll now hand it over to Steve for his comments.

Steve Barber

Thank you, Richard. I'm pleased with the performance of the NSS businesses in the second quarter. The enterprise external storage market remains strong with OEM partners gaining share, and we executed well overall in meeting their needs. In addition, our recently announced ClusterStor 3000 product launch, is receiving very positive customer reaction, and enables us, through our OEM partners to expand our accessible markets into the high Performance Computing growth sector.

In complete contrast, our SI business is being significantly impacted in the near term, as a result of the disk drive sector actively delaying increasing production capacity and hence, capital equipment investments, due to 2 primary macro factors: The delay to later this year of the announced industry consolidation, pending regulatory review and the continuing softness in notebook demand.

As Richard has already covered, the impact to our SI business, as a result of the above dynamics in the current distraught market, combined with increased competition in a much reduced capital equivalent market this year, has had a significant negative impact on our overall business in the quarter and our expectations for the remainder of the year. This has required us to take a number of one-off provisions against material we purchased, in anticipation of demand earlier this year.

In addition, once we took actions to reduce headcount and expense run rate in the SI business during the quarter, we consciously sought to protect our key product development investments, in next-generation disk drive process technology necessary to support the increasing performance demand of the industry. We believe that our investments in new products this year will position us well to benefit for the anticipated need by the industry to add significant production capacity in 2012.

The decision on May 30, by the EU Regulatory Authorities, to delay their decision on the proposed acquisition of Hitachi GST and Samsung's Disk Drive business, will, in our opinion, increased the uncertainty in the industry and further delay the addition of production capacity. As a result, we will need to take further expense actions in the near term, and commence a detailed analysis of all areas, to identify those where we are able to delay investments and reduce our expense run rate going to 4Q.

I'll now review our 2 businesses separately, starting with Networked Storage Solutions. Our fiscal second quarter revenue of $301.2 million, which were at the lower end of our expectations for the quarter. However, we do not view this as an indication of any slowing in demand, but rather, a number of minor specific customers earnings in the quarter including demand rebalancing and new product transitions. A number of our customers are well underway with new feature and function releases, new product development, as well as developing enhanced and expanded sales initiatives. Across our customer base, demand forecast remains strong, and support our full year guidance that we provided for this division in January. While there are expected changes within the mix, overall, we remain confident in our 2011 outlook and the longer term strength of the business.

On the transitioning businesses, and as assumed within our FY '11 plan, our NetApp business top line revenue has reduced compared to 2010, in line with the agreement terms we have explained previously. For this year, we are providing a minimum of 75% of NetApp demand with the design royalty received for the balance of demand fulfilled by NetApp's CM partner. And EMC Data Domain business remains strong in the near term, but as previously stated, it's outlook to reduce towards yearend, as the product line is anticipated to be in-sourced by EMC.

On this growth business relationship, our initiative with IBM continues to grow, with their XIV and V7000 product ranges. We're working closely with HP, following the three-part acquisition as they integrate product range, and we align our fulfillment processes with HP's expectations. Similarly, we're working with Dell to integrate the Component business within their processes. We're seeing new and exciting opportunities with several Tier I accounts. And we're actively engaged with a number of new emerging customers, taking innovative storage solutions to market.

Yesterday, we announced 2 new customers that are leveraging our OneStor storage enclosures and integrated application platforms.

Both SEPATON and Solera Networks are examples of emerging markets with Xyratex to provide enterprise quality platform, and help to differentiate the overall solution. In addition, we're delighted to be the integrated application platform partner to StorSimple. We have recently received a number of industry recognition awards. All these new customers are great examples of OEMs, that offer a range of solutions based on our flexible OneStor architecture. This architecture enables our customers to leverage our storage enclosures for their JBOD requirements and integrated server functionality into their solutions, without needing another development effort.

We're seeing an ever-increasing market demand for storage capacity and our customers continue to show great interest into Xyratex's product portfolio and roadmap. As I mentioned last quarter, we're seeing an increase in the percentage of integrated application platform that our OEMs are leveraging in their solutions portfolio. These products leverage industry-leading convergence of server and storage technologies, all in 1 enclosure.

Enabling our OEM customers to easily port their data management application to provide a fully integrated appliance to the end-user customers.

In our fiscal second quarter, we shipped 897.2 petabytes of external storage. It was only at 10.3% decline over the prior quarter and a 9.1% growth over year-ago. Based on recently published data on the total petabytes shipped in calendar 1Q '11. We estimated that Xyratex once again maintains it's position as the leading player in the market, supplying a 19.1% of capacity in the current quarter.

In addition, as we received from our recent announcement and product launch at the International Supercomputing Conference, we are very excited with the launch of our high-performance computer platform, the ClusterStor 3000. This represents the outcome of a significant investment program by the company over the last 18 months to leverage our core capability as an OEM storage systems provider to address the need of high-growth markets, while critically, not competing with our OEM customers. The high-performance computing or HPC sector, represents a $3 billion data storage market, growing at 10.1% per annum, according to recent industry report.

ClusterStor 3000 incorporates a number of significant firsts for the company, and inter-relate benefits to the HPC environment. The near performance scalability, the ease of installation to management and enhanced storage system reliability at scale. The key to ClusterStor 3000 is its unique scale-out storage architecture, to start with the consolidation of Lustre servers, RAID controllers and disk enclosures, which is offered as 3 separate components in traditional systems, into a single storage appliance, the SSU.

SSU is the new fundamental Lustre file system building block that has been perfectly balanced to deliver a linear performance and capacity scalability as the requirements increase. As performance or capacity needs change, users can simply add another SSU to the storage sector and begin leveraging the increased performance and capacity immediately.

ClusterStor Manager provides a single interface to configure and manage a ClusterStor-storage cluster. ClusterStor Manager is distributed and tightly integrated in our architecture, provides a new class of management ease that has not been seen before in Lustre administration. The linear scanning approach, coupled with simplified management, will enable users to begin leveraging their Lustre storage cluster, in a fraction of the time of a traditional solution. Enhanced reliability features and testing provides 4x industry standards for disk drive reliability in 3 years. And our patented embedded memory protection provides data protection in the event of failure.

As early as February this year as part of our product development process, we installed evaluation systems at both OEM partners and end-users sites. We view the feedback received very positive, as we're able to demonstrate performance capabilities, far exceeding our competitors. Additional customers are eagerly awaiting our upcoming beta system release, so they can complete the integration of their specific applications. The ClusterStor 3000 will be available exclusively through our OEM partners in the fourth quarter this year.

Early feedback from industry, media and analyst firms has been positive. Enterprise Strategy Group commented that the ClusterStor gives Xyratex an offering that can extend to their OEM to expand the addressable market within their customer base, to go after these opportunities.

In support of this market initiative, we worked closely with HPC community, develop a deep understanding of data storage needs and requirements. Lustre is a key part of Xyratex's strategy of HPC market. We're committed to working closely with a network community in order to further the operating systems development and support. With Xyratex's significant Lustre development team, together with its contributions to Lustre communities roadmap for Lustre 2.1, Xyratex is demonstrating it's dedication to ensuring that Lustre continues to evolve to meet the needs of HPC users.

Xyratex is known for enterprise storage expertise, the ability to develop and bring to market innovative new storage technologies and for producing the highest quality storage products. These characteristics, coupled with our deep Lustre file system expertise, will be significant differentiators for us in assisting our OEM customers meet the needs of the HPC environment. We'll be investing in additional customer support capability and capacity through the next quarter as we roll out the beta program with new customers.

Looking forward, we remain focused in identifying further incremental opportunity to grow our business. Both with existing customers, through providing product solutions to adjust adjacent or vertical market product requirements, as well as engaging with a number of high-growth or emerging storage companies, exhibiting innovative or compelling product technology. As you've seen in the last few years, we have successfully grown this business, and significantly diversified our key customer base, providing increased resilience to the business.

With the strength and breadth of our product portfolio, global performance capabilities, competitive cost structure and strong customer relationships, we remain confident in our ability to retain and grow our leadership position in the OEM external storage market. We recognize that we operating in a highly competitive market, which includes the potential risks to our business of customers choosing to import certain products when positioning platforms, or partnering with contract manufacturers to fulfill their demand -- their volume demand. We will continue to focus on demonstrating our technology innovation, time to market advantage and value added service differentiation as major enabler to our customers' business growth.

Overall, against the backdrop of continued strong customer demand, the exciting new emerging customer relationships, and the addition of our new HPC product platform, I'm very pleased with our execution in the last quarter and year-to-date. We remain confident in our ability to grow this business to enabling our OEM customers in the end-user markets.

Moving now to our Storage Infrastructure business. For the second quarter revenues in this business were $37.4 million, an increase over 1Q levels, but remaining relatively low compared to the previous years, and reflective of the current quarter stance by the disk-drive industry, with regard to adding incremental production and capacity. As I mentioned earlier, our SI business is being significantly affected in the near term by macro factors in the disk-drive sector, which has resulted in industry being extremely cautious towards adding incremental production capacity, combined with increased competition in a much-reduced capital equipment market.

We're seeing very limited demand for capital equipment in the near term. We believe the industry is converting existing in-store production capacity from 2.5 inch to 3.5 inch form-factor capabilities, and is utilizing the available capacity to enhance their product mix and selectively meet end-user demand. This trend supports our view that demand for high-capacity 3.5-inch disk drive remains strong, recognizing that the growth of cloud and data storage service offerings, will be predominantly based on data centers filled with storage platforms using high-capacity 3.5-inch disk drives.

2.5-inch form factor drive demand is dominated by mobile notebook applications, where demand has been below the expectations year-to-date. With Xyratex, being the only current provider of 3.5-inch tech systems, we believe we remain well-positioned to benefit from the shift towards increasing 3.5-inch drive demand, albeit against the backdrop of cautiousness by the industry today -- at all, in incremental capacity. It is likely that our additional customers will continue to seek to convert and reutilize existing capital equipment assets, whenever possible before investing in new equipment in the near to medium term.

With overall density slowing -- [indiscernible] growth slowing due to technology challenges facing the industry, we continue to believe that head [ph] and media content within the individual disk drive will increase, as a means to enabling higher-capacity disk drives. As a result, we're continuing our investments in this area, building on the core products and technologies we acquired last year, recognizing however, that we're unlikely to see demand in this area this year.

The further consequence of areal density technology challenges, is a need for improved dynamic performance capability of disk drive, product tests and configuration systems, which will allow disk drive manufacturers to be more efficient. In support of this, we're making major investments in the development of key technology to both upgrade existing installed factory equipment and provide significantly enhanced performance from our Next Generation equipment platform. These systems, in addition, deliver enhanced factory footprint density, reduced power consumption and configuration flexibility, all key requirements for the industry.

Our latest generation of 2.5-inch form factor Optimus system, with enhanced dynamic performance, is currently under engineering evaluation with 1 of our disk-drive customers. In addition, we're on track to provide our new 3.5-inch form factor to the Optimus system, together with productivity and enhanced dynamic performance features for customer qualification in the first quarter of 2012.

During period of delay in CapEx investments, we believe all disk-drive providers are aggressively assessing and qualifying available competitive test platforms, in order to make sorting decisions ahead of installing incremental volume production capacity in 2012. In summary, this is clearly a very challenging year for our SI business and other capital equivalent providers to the disk drive industry, as highlighted in recent earnings calls from peer group companies. In light of the extended period of uncertainty in the market, we will take further actions to reduce our run rate expense over and above those taken in the past quarter. In taking these actions, we will ensure that we do not make short-term decisions that might damage the business in the medium or longer term.

We are a leading provider of processed capital equipment to the disk-drive industry, which is reliant in us investing and delivering ongoing innovations to meet the needs of the industry. We're committed to making this continued investment, as a result of our confidence in the long term growth of the disk drive market. An in turn, the capital equipment market serving the sector.

Our expense actions in the near term may require the slowdown in some of our development areas or potentially exit those where we see limited opportunities. But we will work closely with our customers through this period to understand and set appropriate expectations.

I once again would like to take this opportunity to thank all our employees worldwide, in your efforts in meeting our consumer commitment, driving product shipments and quality, resolving technical issues as they arise and delivering on our product development milestones.

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

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Ananda Baruah with Brean Murray.

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

I guess just a couple of things if I could. The first is on the restructuring that you're alluding to doing. Can you give us, I guess some sense of sort of the timing and the sizing of what it might be? And I realize you said that you're sort of assessing things right now, and I'm sure there's some of that in the current quarter guide. But maybe if you could give us a sense of how we should expect the SI gross margins, to sort of move up from here as we go through the back half of the year, assuming that say revenue stays sort of flattish?

Richard Pearce

As we said in the call, we are assessing [indiscernible] restructuring costs we can take at the moment. As you can see from the script that we have actually reduced our employees during the quarter by 50, some of those were through natural attrition. but some actually from some restructuring we took in the quarter. As we move out into the back half of the year, we're really assessing the opportunities we got at the moment. As Steve mentioned, we have been undertaking a number of platform changes and new platforms in the SI business in the year. And I guess as we entered this year, our expectation was not that the unit volumes were going to fall as severely as they have this year, as well as the uncertainty that we have around the inter-privatization in the market space. So maybe had we had that foresight in advance of the year, we may not have gone into the programs, in quite the same way. However, again, as Steve mentioned, to keep up with the technology, provide the technology that our customers need, we really do need to work on these platforms this year. My expectation is that as we start to finalize on those platforms, that really is towards the back end of the year in the fourth quarter. And where we've invested quite a lot of what I would call variable expenses this year, we will have the opportunity to take that variable expense out, and enter -- with a significantly reduced operating expense in the SI business, as it's related to those variable expenses, really as we go into 2012. So it's going to take us at least 4 months to actually get those changes through and pay those costs out. But we, as I said, we're looking at it and we will be actively undertaking that within the next couple of months.

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

And just a follow up, if I could, on SI. I mean I guess, if we just assume that the deals do close, each of the deals do close in the fourth quarter, how long -- I guess if we assume that's the case, when would you guys expect to begin to get some sense of what the order patterns from Seagate and Western Digital kind of would begin to look like?

Steve Barber

Ananda, Steve here. I think we're in a waiting game right now because of the consolidation question mark, we're delayed. It's difficult to judge how much analysis those 2 major players are undertaking or able to undertake at this time to be able to set total production capacity, post-consolidation assuming it happens. Therefore, I think that would inevitably be some delay going into the year into the new year. Typically, demand for production capacity is generally skewed towards midyear in normal patterns. We could have a strange dynamic this year where there is pent-up demand going into the first half of next year. We have no indications of that yet. But in the light of the extreme cautiousness that we're seeing, I think we -- I guess we wouldn't be too surprised if that was to be the outcome. I generally feel it's too early at this stage to be able to draw any conclusions on that. There's certainly no indication being given to us by those customers as to the scale or timing of incremental production capacity going into 2012. But I think for planning purposes, we would assume typical patterns that we've seen previously, with relatively low demand in the first half, really peaking as we exit the second half going into the third quarter, really in line with the volume the sales drive, which is typically 60% in the second half of the year.

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

And then just lastly, just on SI again, the increase sequentially in SI revenue this quarter. Just what was attributed to? And I guess, what would you kind of consider? I mean are we just looking at maintenance levels right now? And is there just some variability sort of around 25 to 35 for maintenance?

Richard Pearce

We're not really just looking at maintenance levels. So we did have some borders that we are expecting. In fact, some of those were pulled into the second quarter from what our original expectation were in the third quarter. So actually, revenue was both in uptick and in terms of actually where our expectations were. So there is some ongoing requirements there as Steve noted in his call back then, particularly related to the 3.5 inch market where we shipped some systems, as well as where we served the market on the media side of things. We've also seen some orders on that side during the quarter.

Operator

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

Glenn Hanus - Needham & Company, LLC, Research Division

The gross margin here on the SI side, you mentioned a $5 million provision that happened this past quarter. Is there an additional provision coming this quarter, and what do you expect the gross margin on that side of the business to be, and trend through the year?

Steve Barber

I guess as we're just standing, we're filing our accounts now. You wouldn't expect me to say that I'm expecting to serve the provision as we go into next quarter. So I think it's fair to say that as we came into this quarter, we had some uncertain situations regarding revenue to the rest of the year. I guess our expectations now on revenue is for the rest of the year are toward the bottom end of what we were thinking as we enter this quarter. And having a setback now and the forecast that we're seeing going out now at the end of the year, then I believe that we've taken the appropriate provisions, and it is my expectation that we would not be taking any further provisions related to our inventory in the SI business in the next quarter or either of the next quarters. So I think that we've really now assessed it at a prudent level. And as I said, I wouldn't be expecting any further provisions in the next half of the year.

Glenn Hanus - Needham & Company, LLC, Research Division

Okay, and can you comment on the gross margin range you're expecting for this quarter in that business?

Steve Barber

Again, obviously, we provided our guidance within the comments that we made earlier today. So our expectation is that SI revenue will be between $20 million and $30 million in the third quarter. Again relative to fixed costs. The proportion of SI revenue will be lower than it normally is. So I would still be expecting gross margins to be somewhere in the sort of 10% to 15% range. And then as revenues increase as we go into the fourth quarter to what I would say was a more normalized level, we're not giving guidance here for the fourth quarter, but there is consensus out there at the moment and we're relatively comfortable with where that consensus is for the fourth quarter, then we would expect our margins to get up to more normal levels of the 30% or maybe just sub-30% in that period.

Glenn Hanus - Needham & Company, LLC, Research Division

Jumping to the NSS side, you usually provide a little color and rough percentages of the breakout there by customer. Can you update us for this quarter?

Richard Pearce

Yes...

Steve Barber

In the quarter, we shipped 79.45 petabytes on Fibre Channel.

Richard Pearce

I'm sure that question will come up, but NetApp, Glenn was around 48%, Dell this quarter was 24%, but this quarter, we're including the Compellent business where previously, when we provided that obviously, we haven't included the Compellent side of the business. So in the comparisons, one would need to consider that. And IBM was approximately 12%. And that's obviously the NSS revenue only.

Glenn Hanus - Needham & Company, LLC, Research Division

Yes, and then how about, maybe an update on how you're thinking about potential opportunities from the Engenio acquisition and the various new customer, potential new deal kinds of opportunities? Any color you can provide around that?

Richard Pearce

I think it's fair to say, we are engaged in dialogue with a number of parties who are sort of considering their future strategy. I'm certainly not in the position to share with you the details of those. You're well aware, we are partnering with IBM on the V7000 platform, which I guess runs in parallel with their Engenio offering. So IBM truly has options as to where they wish to steer their customers, in either direction. But it's fair to say following the NetApp acquisition, we have seen a number of new inquiries and opportunities arise that we're currently actively engaged in dialogue with both current and new customers.

Glenn Hanus - Needham & Company, LLC, Research Division

You mentioned a favorable gross margin on the NSS side of the business, and that, that might be sustained. Can you give us a little more color on what's driving that and sustaining that?

Richard Pearce

Yes. As I mentioned, it's down to product mix. Yes, I couldn't get more into what particular products or what particular customers that's related to. As I mentioned, my expectation is that we will retain those margins up until the end of this year. That said, as that product mix unfolds and my expectation is that it goes towards where my original expectations were for this year is that we then revert to a more normalized, I think I've given my expectations in previous quarters of between 11.5% and 12.5%. So my expectation is as we go into 2012, that we go back to that type of margin range that we talked about at the beginning of this year.

Glenn Hanus - Needham & Company, LLC, Research Division

And maybe lastly on the ClusterStor 3000, can you comment a little bit on the end-user competitive landscape? I mean, I assumed DDN might be in that mix and at the end-user level, what is the competitive landscape?

Richard Pearce

Yes, I think the expected competition will certainly come from DDN and NetApp with the Engenio product range. We've seen recent announcements which would indicate that NetApp is focusing that technology very specifically at the HPC sector.

Operator

[Operator Instructions] Our next question comes from the line of Jung Pak with BMO Capital Markets.

Jung Pak - BMO Capital Markets

I had a question on the SI business. Previously, you've provided some revenue ranges of 145 to 215. Can you provide any update on that, what you expect for FY '11?

Steve Barber

Yes, it wasn't our intention to start to give guidance for the full year in this quarter. But I think, as I discussed in one of the previous questions, obviously, we are providing guidance for the third quarter and the consensus is currently sitting out there for the fourth quarter in the range of $60 million to $65 million and we're not uncomfortable with the current position that, that consensus sits at.

Jung Pak - BMO Capital Markets

Okay. And before you provided expectations of 5% unit growth for drives around 685, is that the same assumptions you guys are putting on there?

Steve Barber

I think the answer is yes. We can see a lot of speculation right now as to what is happening on the notebook sector, and whether in fact that the supply is below demand. We've seen a number of analyst reports recently speculating that there is additional demand out there. So it's difficult to judge right now, in light of the, I guess, this very, very cautious approach that we're seeing from the drive companies. It's unclear whether they actually are fulfilling that demand expectation or consciously scaling back and selectively using that capacity to meet a particular demand potentially turning away areas where there's a low margin business.

Jung Pak - BMO Capital Markets

Okay. On the SI business, you guys have previously talked about some new customers. Any update with the traction with Toshiba?

Steve Barber

Again, we continue very positive discussions with Toshiba. I think they are behaving similarly, cautiously, currently. And as we've indicated in previous calls, the activity and our development with Toshiba, we do not outlook significant revenues or material revenues in this year. The majority of the activity is going to be focused around qualification and evaluation of adapting our systems to their particular needs. We continue to see Toshiba as a potential customer for us moving into the 2012 time frame.

Jung Pak - BMO Capital Markets

Okay, great. Last one for me is, can you provide what the competitive landscape is for the Media and Head side, and that's it.

Steve Barber

There's a wide variety of very small providers on the Headphone business. Clearly, the major fabrication technology provided by Veeco. But on the Tech side, there is a handful of very, very niche but specialized providers who provide cash technology for the Head. Our acquisition last year enabled us to provide high-speed automation for handling those heads between the various test operations. So we have a footprint in that space, but as I said earlier, whilst we're excited by opportunities and growth we see in components, again, investments in the area and the expansion plans that we had expected for 2011, appeared to be on hold or delayed by the customers, potentially creating a bow wave of demand for that in 2012. On Media, right, or in media testing, we have a footprint in a number of areas. We are providing optimal inspection capabilities at substrate or media levels. We see legacy capacities in that space, unclear whether they are going to react to our [indiscernible] technology or whether they're going to choose to exit this marketplace. And then on the tech side of the business, again on one of the acquisitions we made last year, positions us in a position where we are providing a pretty broad range of capability for basic media testing as well as the core technologies Xyratex has provided for many years in providing server rights technology in various forms for our customers.

Operator

Our next question comes from the line of Shebly Seyrafi with FBN Securities.

Shebly Seyrafi - FBN Securities, Inc., Research Division

So you're talking, Steve, about a pretty nice balance in Q4 if consensus is what you're comfortable with. And I just want know how much visibility do you have into Q4? Do you have orders? Talk about anything you have the gives you comfort with that kind of a number?

Richard Pearce

Yes. Sorry, Shebly, I'll take that one. Yes, we do have a number of orders. And I'm not going to give you the precise coverage that we have at the moment. But we have a good degree of contract on the numbers that we expect in Q4, yes.

Shebly Seyrafi - FBN Securities, Inc., Research Division

And you are expecting even with a $60 million kind of number, which is a lot lower than what you were a year ago, do you have a 30% gross margin or might it be like 20%. Something like that?

Steve Barber

My expectation at this stage is it will be somewhere between 25% to 30% of that level.

Shebly Seyrafi - FBN Securities, Inc., Research Division

25% to 30%, okay. So talking about your Disk business, NetApp, you had the decline, you called for it. Does it keep falling at a more gradual pace? Or -- and then basically, I'm quite interested in your Non-NetApp business especially Dell which grew with Compellent. Do you expect better growth going forward in your Non-NetApp business in the back half?

Richard Pearce

Yes. I mean, I'll take both of those questions I suppose, Shebly. In terms of the NetApp, we have the, as you pointed out, a sequential decline between the first quarter and the second quarter. We don't expect that to continue as we go into 3Q or 4Q. I mean, essentially, when we talked about it a little bit in previous calls in terms of how the NetApp contract works, and that as we came into our fiscal 2011, NetApp had the ability to take a maximum of 25% of the business were going out with the CM. In the first quarter, it actually took actually quite a smaller proportion of that, and as we got into the second quarter then as that product has ramped into their CM, then they've taken a far higher proportion. So that's been the reason for it has come down between 1Q and 2Q. And it's not indicative of NetApp's overall business and therefore, we expect that to become relatively stable as we go through the back half of the year. Then again, as we've been clear within our previous calls, that minimum percentage, which Xyratex holds, reduced sort of 75% or 50% as we go into fiscal 2012 next year. So again, obviously, we would expect a reduction at that time, but not as we go through this year. In terms of the non-NetApp side of the business, as you say, we've seen an increase in Dell overall. Compellent has increased at the same time as the EqualLogic business has stabilized, my expectation is that, that business will remain relatively stable actually as we go through the year. I think we've always viewed IBM as a business which starts to ramp at point during the year. It's been relatively stable 1Q or 2Q. So we would expect that to go up as we go to the back end of the year. A few unknowns in there in terms of the HP business. The caveat to those increases and again Steve mentioned it earlier is that our expectations at the EMC business ramps down towards the back end of the year. We expect it to be relatively strong in 3Q, ramping down in 4Q. So there is a bit mixture in there. We're not giving guidance at the moment 4Q. But, yes, so 3Q we're seeing midpoints, obviously, an uptick by approximately 10% from where we were in the second quarter. Yet at the moment, with the EMC business, we are potentially ramping down in 4Q, my expectations are that potentially 4Q is slightly below 3Q.

Shebly Seyrafi - FBN Securities, Inc., Research Division

Okay. And finally for me, your share repurchase intentions, you just had a pretty good quarter in terms of your free cash flow generation and your net cash has gone up. Why not be more aggressive on your share buyback, especially with the stock having weakened recently?

Richard Pearce

Yes, I mean, obviously, the second quarter was early on in the time that we have announced the repurchase. We have continued to repurchase our shares during the last month. And we will continue to do that. It is our intention to continue the share repurchase program, assuming that the prices are attractive, which we believe that they are at the moment. So we think that we are being relatively aggressive and that within the parameters, the board has agreed that there is a good potential that we will use a large amount of what's been set aside for share repurchases, which, just to remind you, is $50 million as we move towards the end of the year.

Operator

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

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

Steve or Richard, I guess I just wanted to follow up on the Dell comments that you just made. Just about the business being stable in the second half of the year, I just wanted to make sure that there's nothing lost in translation. Dell yesterday was pretty bullish about Compellent. I think they actually talked about growing the pipeline 4x or something in that order of magnitude since the acquisition closed. So seemingly, there's a lot of good momentum there, kind of based on their comments and based on your numbers today. So are you literally saying you expect the business to be sort of stable, meaning flattish in the second half of the year? Or am I reading too much into the comments?

Steve Barber

Ananda, I don't want to preannounce any of my customers' expectations and obviously, the recent information they've put out is very recent. But without getting into the too much specifics, I would expect to see some of the new business that we've with Dell, increasing as we move towards the back end of the year. Some of the earlier businesses which we have with them potentially declining as we go into the back end of the year, depending on the different platforms, et cetera. So just to be clear, my expectations, overall with Dell, I expect our revenue levels to be relatively stable as we go through the back end of the year.

Operator

[Operator Instructions] And gentlemen, I show no further questions at this time. I'd like to turn the call back over to management for any closing remarks. Please proceed.

Brad Driver

Thank you, Melanie. Once again, thank you for joining us this afternoon. We look forward to speaking with you again on our 3Q -- Q3 Earnings Call, which will be scheduled for late September. Also in August, we will be presenting at the Oppenheimer Technology Conference in Boston, at which point we will provide further update to the business environment. So please look for the exact date of those presentations on our Calendar page of our website. As always, you're welcome to call me if you have any additional questions over the course of the quarter. For the time being, have a nice 4th of July weekend. Thanks.

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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