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OCZ Technology Group, Inc. (NASDAQ:OCZ)

F1Q 2012 Earnings Call

July 06, 2011 5:00 p.m. ET

Executives

Bonnie Mott - Investor Relations Manager

Ryan Petersen - CEO

Arthur Knapp - CFO

Analysts

Aaron Rakers - Stifel Nicolaus

Rich Kugele - Needham

Alex Kurtz - Sterne Agee

Christian Schwab - Craig-Hallum Capital

Richard Shannon - Northland Capital

Shebley Seyrafi - FBN Securities

Gary Mobley - Benchmark

Nehal Chokshi - Technology Insights

Mitchell Sacks - Grand Slam

Operator

Good day ladies and gentlemen and thank you for standing by and welcome to the OCZ Technology to host fiscal year 2012 first quarter conference call. At this time all participants are in a listen only mode. Later we'll conduct a question and answer session and instructions will follow at that time. (Operator instructions)

As a reminder, this conference is being recorded. Now I'll turn the program over to Bonnie Mott, Investor Relations Manager of OCZ Technology. Please go ahead.

Bonnie Mott

Good afternoon and welcome everyone. On the call today are Ryan Petersen, CEO, and Arthur 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 July 6, 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 involve risks and uncertainties.

Forward-looking statements on this call are made pursuant to the Safe Harbor provisions of the federal securities laws. Information contained in the forward-looking statement is based on current expectations and is subject to change and actual results may differ materially from forward-looking statements. Such of these factors that could cause actual results to differ are discussed in the reports filed with the SEC

These documents are available on OCZ's Web site, www.ocztechnology.com. With that it is now my pleasure to turn the call over to Ryan Petersen.

Ryan Petersen

Thanks, Bonnie and good day to all of you. We're pleased with our record results during the first quarter as we have achieved several key milestones. Our year over year revenue increased by 115% to $73.8 million, SSD revenue increased year over year by 418% to $69.1 million. Our SSD products represented 94% of our revenue versus 39% of revenue in the first quarter of 2011.

Compared to last quarter, SSD revenue increased about 19% sequentially representing our seventh straight quarter of sequential revenue growth for our SSD products. GAAP gross margins were up 790 basis points to 20% for the first quarter versus 12.1 a year ago and 340 basis points over the 16.6% we reported in Q4. These margin increases were led by higher SSD margins.

Over the past four quarters OCZ has undergone a significant transformation, establishing a solid foundation in the SSD market. And while we're pleased with our rapid progression from being a commodity DRAM player into a solid-state drive technology provider, we are cognizant of the many opportunities that lie before us.

We're focused on our continued evolution as a storage provider and on further leveraging our significant technological advantages, our recent increases in scale, and the improvements in our working capital afforded by our April $93.7 million follow-on, which will allow us to further take advantage of our position as a leader in the growing SSD market.

Key opportunities provided by our increased working capital and scale include greater purchasing power, potentially increased allocation from NAND flash manufacturers. Those are expected to result in increased margins and enable us to more adequately fulfill demand for our products. In March, in a key movement to improve our technological leadership, we acquired strategic partner, Indilinx, in a private - which is a privately-held manufacturer of SSD controllers and firmware.

We expect this acquisition to expand OCZ’s presence in the high margin embedded, hybrid storage and industrial markets while reducing our reliance on third-party controllers and allowing for increased margins. This acquisition is also intended to broaden SSD controller-related IP portfolio. We’ve recently finalized the integration of Indilinx and are expecting our work forces both in Korea and the US to expand.

We’re on schedule for delivery of our next generation Indilinx controllers. As we continue to execute on our strategy of rapidly transitioning the business to be more enterprise and OEM focused, I think it’s important that I describe some of the critical ongoing activities in this regard.

We’ve recently discussed our plans to increase manufacturing capacity and I’m happy to report that we’re on track to bring our new facilities online, which will increase our ability to fulfill demand for our products and better meet the needs of our OEM clients in the second half of fiscal '12.

We’ve been making significant strides in this past quarter to increase our R&D and sales strength, driving our ever-increasing focus on direct to enterprise and OEM sales. We have some of the highest performing enterprise products and are committed to stay the technological and performance leader. We've increased our R&D work resources significantly and continued to add key individuals to directly target enterprise data center and OEM clients.

We believe that this will allow us to continue to grow the business profitably and to drive steady gross margin improvements. The transition to an enterprise focus is not only apparent in our gross margins but also in the recent changes to our client base. For example, it's worth noting that our historically largest client, Newegg, while continuing to grow SSD revenue substantially, no longer represents more than 10% of our revenue.

In addition, we received initial orders from a multitude of new clients for enterprise and server-class SSDs during the first quarter. Despite our historically limited financial resources, we've had considerable success winning both direct to the enterprise and OEM business. Now with the much healthier balance sheet, increased purchasing and manufacturing capabilities and an expanding suite of award-winning enterprise product offerings, we believe that additional client wins and the continued growth of current OEM clients will accelerate this transition.

As the data center and Cloud computing take on increased importance to the evolution of OCZ, we recently expanded our PCIe storage offering to include more software centric solutions.

With that, I would like to take a moment to cover the most important additions to our product portfolio. We recently demonstrated our Z-Drive R4 PCIe SSD running over 1 million 4k random IOPS and 1.5 million sequential IOPS at Computex in Taipei.

This product features our latest Virtualized Controller Architecture and enables maximum performance with expanded enterprise features, it carries mission-critical reliability and is primarily targeted for use in data centers. The Z-Drive R4 SSD couples the performance and reliability of a hardware-driven design and combines it with a software-driven feature set that our second generation Virtualized Controller Architecture virtualization layer enables.

This allows us to deliver a product with the flexibility, data center interoperability and ease of use that our purely software-driven PCIe SSD enables, without the drawbacks such as high CPU utilization, a lack of power fail protection for mission critical applications and a lack of dual-port access for clustering and failover.

As we have seen significant demand for software-enabled PCIe based storage solutions in the data center, we believe that our newest Z-Drive R4 coupled with the recently announced second generation VCA architecture, will help us to gain significant traction in the PCIe market. Further, we believe that our combination of both software and hardware-driven enterprise features deliver the maximum value to our enterprise and data center clients.

Regarding the software specifically, VCA 2.0 is the follow up to our proprietary Virtualized Controller Architecture and presents us to the host as a complete storage subsystem but with an improved and expanded enterprise feature set including things like one virtualization, TRIM support and advanced SMART monitoring capabilities, creating a new storage tier that allows storage architects to better take advantage of PCIe based SSDs in the data center without giving up the hardware-based features enabled in earlier OCZ PCIe SSDs.

Continuing on the PCIe front, we’ve recently launched our RevoDrive 3 PCIe SSD that delivers about 200,000 IOPS under server and workstation work loads in a single card solution. This next generation PCIe SSD utilizes the same VCA 2.0 architecture of the Z-Drive R4. However, with reduced power fail protection and redundancy features disabled, it utilizes lower cost ASIC NANDs and is targeted at the workstation server on NAS markets with prices in the $3-5 per gigabyte range.

We've received numerous awards and accolades for the Revo 3 citing the drive’s exceptional performance and innovation. We have seen positive early indicators of acceptance of PCIe SSDs in the server and NAS segments and we believe this product gives us a high level of differentiation for those segments. Further, we recently introduced what we believe to be the first workstation class hybrid PCIe SSD from the RevoDrive family.

The Revo Hybrid utilizes a large high-speed NAND Flash read/write cache coupled with a high density rotational media in a single direct-attach device. The Revo Hybrid features advanced caching software, which intelligently distributes and manages hot and cold data across the storage elements delivering balanced performance to density ratios for workstation and NAS workloads.

This solution gives clients the best of both worlds from requiring both performance and density with prices in the 40 cent per gigabyte range and speeds of up to 30,000 IOPS or 550 megabyte per second reads and writes. Finally, we unveiled the Arowana Flash Translation Layer from Indilinx, which changes the performance landscape for Indilinx base controllers, while adding increased error correction to support 2x nanometer based MLC NAND.

In conclusion, the company has undergone a significant transformation. OCZ has established a solid foundation in the SSD market and the Company continues to focus on executing its growth strategy to drive enterprise and OEM sales. We are committed to being the technological and performance leader in this market and to building a Company that leverages our differentiated technology, increased scale and improve balance sheet to deliver value to our customers, employees and shareholders. At this point I'll turn things over to Art for a financial overview.

Arthur Knapp

Thanks Ryan. As you indicated, the past four months since year end have been extremely significant for OCZ as we have completed the transformation into the pure play SSD company, raised vital working capital, acquired a key technology component, bolstered our enterprise sales capabilities and built important supply chain relationships.

Ryan covered the basic results. There are detailed financials in the release and some supplemental historical data on our Web site, so I’ll try to just add some additional perspectives and information. While Ryan has previously covered our overall revenue growth, I should bring up a few points regarding this.

For the trailing 12 months, our overall SSD revenues were nearly 190 million with a growth of 308%. Total revenues for the trailing 12 months were 230 million, up 61%. As I've mentioned on the last call the rapid transformation into SSDs for memory skews the geographic results, particularly in North America where year to year SSD growth was 187%, slightly higher than the 161% growth rate achieved in Q4.

However, the overall reported year to year revenue growth was 12% due to less memory revenue. Our international markets continue to show strong growth as we expand our customer relationships and sales capabilities. Within SSDs, consumer grade products decreased to 3% of revenues from 7% in Q4, reflecting less emphasis in this area. Enterprise class products in Q1 grew by about 250% from last year and accounted for nearly 12% of our SSD revenue.

Server and high performance products were approximately 85% of the Q1 SSD sales and had a year to year growth rate of nearly 490%. GAAP gross margins were 20% for the first quarter versus 12.1% a year ago and 16.6% in Q4. As Ryan mentioned, this improvement was driven by higher SSD margins partly due to less consumer mix, partly due to pricing power and partly purchasing efficiencies with the additional capital raised in the April follow-on offering.

We were successful in securing higher credit lines with direct suppliers and our NAND purchases from them approached 50% as we exited the quarter. While this purchase mix increased from the 25% in Q4 was primarily to build inventory levels for certain key components, we also expect future purchases will help increase margins by improving pricing from what we historically have obtained from brokers.

Our operating expenses were $19.1 million on a GAAP basis and $13.7 million on a non-GAAP basis, after adjustments for costs associated with stock based compensation, intangible amortization, and the Indilinx acquisition. This $13.7 million compared to $7.4 million of non-GAAP operating expenses in Q1 last year and $10.7 million in Q4. About 40% of the sequential increase of $3 million related to the Indilinx operating cost.

Within OpEx, R&D cost increased 70% sequentially and 172% from last year. Since year end, we have doubled our engineering staff reflecting a commitment to technology leadership, which you heard from Ryan. Sales and marketing increased 64% from last year, but we have increased sales headcount by 70% since year end to better address enterprise sales opportunities.

G&A and operations increased by 72%, reflecting some economies of scale versus the 115% increase in revenues. We incurred approximately 4.7 million of acquisition related charges for transaction costs and inventory write-downs of older generation Indilinx products as we decided to focus on integrating some of the new, exciting technologies.

Our financing costs decreased by 20% from last year and 60% from Q4 as during the quarter we repaid the entire 20 million of outstanding debt from our 25 million credit facility with Silicon Valley Bank. We also repaid $4 million of certain debt assumed in the Indilinx acquisition and the remaining 924,000 Indilinx debt, which is on the May balance sheet, has been repaid during June.

The fair value adjustment of warrants issued with our initial equity financing in Q1 last year resulted in a 4.2 million non-cash charge, principally due to a higher stock price, which makes the warrants more valuable. This theoretical non-cash adjustment is removed as part of the non-GAAP presentation. GAAP net loss for the quarter was 9.1 million compared to a loss of 4.8 million in last year’s first quarter.

With the acquisition of non-cash related adjustments I described, we reported a non-GAAP operating profit of $1 million in the first quarter compared to a loss of 2.2 million in the year ago first quarter. Our GAAP net loss for the fourth quarter was 20 cents compared to a loss of 19 cents in last year’s first quarter. On a non-GAAP basis we showed net income per share of 1 cent this year versus a loss per share of 11 cents last year.

Included in today’s financial release is a table, which shows a reconciliation of the GAAP to non-GAAP measures as well as related calculations. Turning to the Q1 balance sheet, we see a vastly improved financial picture with the follow-on offering. Cash was 64 million, our inventory levels increased to nearly $35 million and stockholders' equity was nearly $132 million.

The 1.3 million of restricted cash was for standby letters of credit to help us secure initial credit lines with direct suppliers. We added a $62,000 LC in connection with our lease renewal at our corporate headquarters in San Jose, which provides the additional floor space needed to house our expansion. In connection with the Indilinx acquisition, we added approximately $39 million of goodwill and intangible assets to the balance sheet.

Factoring up the relevant non-GAAP adjustments and using average balances, our receivable days increased slightly to 46 versus 43 in Q4. Inventory days were 43 versus 32 as we increased gross inventory levels by $15 million and payable days were 67 versus 64 in Q4, and 78 in the year ago quarter.

Our CapEx for Q1 was $414,000, making a total of approximately $1.2 million invested in the past two quarters, mostly related to factory expansion with SMT machines and other related items. We expect that our equipment-related CapEx investment will continue at these levels as we invest in our continued expansion through fiscal '12.

For our shares outstanding, with the Indilinx acquisition and the fund raising we now have approximately 51.5 million shares outstanding and approximately 9 million shares subject to warrants and options. Diluted shares are estimated to be approximately 56 million for Q2. Turning to guidance, we previously indicated our initial revenue guidance for fiscal year '12 to be in the range of $300-330 million.

We are now raising that guidance to a range of $310- 345 million. As a result of recent product releases and our anticipation of increased market acceptance of our enterprise products, we are also revising components of our long-term, non-GAAP target model. For gross margins, we are raising the prior 28-32% guidance to now be between 30% and 40%, as we anticipate success in capitalizing on our technological leadership, increasing our enterprise SSD mix and achieving cost savings from purchasing power and the Indilinx acquisition.

Then as we achieve success in increasing our enterprise sales, we estimate that supporting the higher enterprise mix levels will also increase our operating costs on a long-term basis to between 18-22% of revenue. Thus, we are currently targeting a long-term operating income range of 15-20%, an increase from the 13-17% we previously provided. That concludes my formal remarks. At this point we’d like to open the call up for your questions. Operator.

Question and Answer Session

Operator

Yes sir. (Operator instructions) Our first questioner in queue is Aaron Rakers with Stifel Nicolaus. Please go ahead.

Aaron Rakers

Yes. Thanks. A couple questions, guys. Number one, looking at the adjustments you've made to the long-term margin assumption, can you update us where PCIe stands as a percentage of your revenue this last quarter and what your long-term model assumes with regard to that contribution to the total revenue looking out longer term?

Ryan Petersen

So I think we’re not disclosing PCIe as a separate line item right now. But obviously from the increased margin target we would expect enterprise class sales to go up, as you know, or as we previously commented, in the enterprise segment or in our enterprise segment, is primarily about 50% of PCIe.

Sorry. Obviously, the 30-40% long-term model takes into account substantial increases in the enterprise mix.

Aaron Rakers

Fair enough. Then just a point of clarification on the supply chain changes that you guys have made going direct with your suppliers on NAND, you said 50% exiting the quarter. Is that correct or what was the contribution for the actual quarter if that was the actual statement?

Ryan Petersen

I think again, we weren't disclosing it exactly but we were obviously, as everybody is well aware, we raised money kind of at the midpoint in the quarter. So we would expect that we'll get to our target on time. Sorry Art, if you want to comment.

Arthur Knapp

This is Art. We had talked before about having a 25% mix previously before the fund raising and trying to have by the time we exit the year, have that grow to 75% or better. So what we're trying to provide is an update just directionally that we are achieving that goal and we're on our way to achieving it.

I described also previously there is still one major supplier that needed to see these numbers before they will increase our credit lines. So some of these things take a little bit of time to work out. But I was very pleased to see the progress we've made since the fund raising.

Aaron Rakers

And then final question and I'll cede the floor on the PCIe opportunity again. Ryan, can you talk a little bit about some of the recent product announcements, how you see yourself effectively competing against the likes of Fusion-IO? And update us on the current status on some of the enterprise opportunities that now might be shipping that you had referenced last quarter. Thank you.

Ryan Petersen

Sure. On the PCIe front we feel that our most recent release really with the Z-Drive R4 positions us very well against the competition. We obviously feel that we've been gaining ground with previous products such as Velo, which has begun shipping to really large data centers or Tier 1 if you will data centers in the quarter.

We would expect that the Velo will continue to grow simultaneously, though it’s at the beginning of a call cycle. We believe that Z-Drive R4 is one of the best performing products in the market, and has the flexibility needed by data centers. So we obviously feel quite good about that product. Go ahead.

Aaron Rakers

Just to be clear, when does that start shipping in volume?

Ryan Petersen

In July.

Aaron Rakers

Okay. Perfect. Thanks Ryan.

Operator

Thank you. Our next questioner in queue is Rich Kugele with Needham. Please go ahead.

Richard Kugele

Thank you. Good afternoon. A couple questions - first, was there any impact to the gross margin line from legacy memory sales at cost or lower?

Arthur Knapp

I think SSD margins were higher than the average, which would indicate that there was some continued impact. Obviously we have fairly good reserves but it’s non-material.

Richard Kugele

Okay. And then in terms of the Indilinx technology, when would you expect to see that shipping in your products again, like the new ones?

Ryan Petersen

The next generation Indilinx controller and OCZ products, I think, is - I don’t think we've changed our timeline. So I do believe we've told people kind of late this calendar year.

Richard Kugele

Okay. And then just lastly, because of the changing mix and your de-emphasizing of the consumer side, how should we look at seasonality over the balance of the year? Should we think of each quarter sequentially up or do you think that there's a hockey stick towards the end?

And then in that vein when you talk about long-term gross margins, are you referring to kind of next 12 months or do you think that it's an even longer period than that?

Ryan Petersen

So first question on seasonality, I think my answer is that typically in business and what we see among our peers and ourselves is really that the first two quarters of the year tend to be slower with the second half really being I think on a historical basis for us well north of 60, sometimes into the 70% of sales range.

Obviously, this has been masked over the past 12 months with the growth that we've had but on the go as we get bigger and as sequential growth rates drop below 50% as they have this quarter, I think, it's going to become more apparent. I’m sorry I missed the second half of your question exactly.

Richard Kugele

And the second half is basically just how do you define long-term for gross margins?

Ryan Petersen

I think we haven't changed our definition from what we've had out on the Street before. So it's kind of the three-year target model.

Richard Kugele

Okay. Thank you very much.

Operator

Thank you sir. Our next questioner in queue is Alex Kurtz with Sterne Agee. Please go ahead.

Alex Kurtz

Thanks guys. Art, just to clarify what you said last quarter versus this quarter from the third-party contribution, are you saying it was 70% last quarter down to 50% this quarter?

Arthur Knapp

The third-party was roughly 75% last quarter and as we exited this quarter it was at about a 50% rate.

Alex Kurtz

Okay. And the goal is to get that to 25% exiting the year?

Arthur Knapp

Correct or less but just - pleased with the results in the two months since the fund raise.

Alex Kurtz

So you talked about one of your suppliers needing to see the print before they changed the structure of the agreement with you guys. I know that you announced at our conference that Toshiba had increased their supply agreement. So is it safe to assume it’s one of the other two?

Arthur Knapp

Correct.

Alex Kurtz

Okay.

Arthur Knapp

And the other one of the two we're also dealing with and setting up some lines but they didn’t need to see the results. Again, these guys just take a little bit of time. You’re dealing with the major players so that’s why we’re just trying to provide direction and we’re very pleased with the progress we’re making.

Alex Kurtz

And Ryan, on the Indilinx side, can you talk to us what kind of products Indilinx controllers are going to be put into exiting this year? Is that going to be in the PCIe side, is that going to be in SAS and SATA side, have you thought that out yet?

Ryan Petersen

Generally our plans are to put Indilinx controllers obviously in as many products as possible just from the margin savings standpoint. Clearly the products that were in their roadmap, pre-OCZ purchasing them, look a little different than they do post-OCZ’s acquisition of Indilinx. So the products that are in fab or had already been taped out when we bought them may be in really kind of the mid-range server products and on some of the low end PCIe.

And then as we release new products, this I think goes back to Mr. Kugele’s question, when are we going to see them in OCZ products? Well, there are obviously some Indilinx controllers in our products now. That mix is growing but ultimately getting to where there is a superior controller that can be used in all OCZ products, we have to look out a little bit in the future.

So across the spectrum really dependent on the product roadmap, so as you may know Everest came out or was recently shown at, which was Indilinx SATA 6 controller, was shown at Computex. And I do believe there is a company that is outside of OCZ that's launching that and they have announced August. So I would guess August timeframe for that.

Alex Kurtz

To clarify, it sounds like Indilinx could be going into some of your PCIe products?

Ryan Petersen

That’s correct.

Alex Kurtz

Okay. And Art, just a couple quick questions and I’ll cede the floor here. Can you talk a little bit about the growth in DSOs quarter over quarter? Can talk about tax assumptions in the model and how we should think about OpEx growth sequentially throughout the rest of the year? Thanks.

Arthur Knapp

So the DSOs ticked up slightly because obviously with the fundraising we were able to do more business in the latter part of the year. So it was really the timing of the bookings but nothing real severe. The tax rates, the funny thing now in California is they have suspended the NOL carryovers if you are beyond 300,000 of taxable income. So while we have about $35 million of NOLs sitting out there for federal purposes, anything above 300,000 of profit will be taxed at 8-1/4% in California.

So you can kind of make your own blending assumptions as to when those NOLs will be eaten through. As far as OpEx, we were trying to provide the guidance of the 18-22%. We were in that range this quarter when you exclude some of the certain of those non-GAAP items. So I think you kind of model that sort of thing and it depends on how rapidly some of the enterprise opportunities happen with the additional support that we'll be putting in to make sure those customers are very happy.

Alex Kurtz

But you guys should remain profitable on an EBIT line for the foreseeable future here, right?

Arthur Knapp

We want to continue the profitability improvement we've been showing the last three quarters, yes.

Alex Kurtz

Thanks guys.

Operator

Thank you sir. Our next questioner in queue is Christian Schwab with Craig-Hallum Capital. Please go ahead.

Christian Schwab

Great. Thank you. On the gross margin front given the increase in gross margin range, can you give us an update on when you potentially would target being at the low end of your previous guidance?

Ryan Petersen

I’m sorry, I’m a bit confused. I didn't follow. I'm sorry.

Christian Schwab

Sorry. When do you guys expect gross margins to recover to improve to the high 20s?

Ryan Petersen

I don’t know that we’re going to give specific guidance on that. Obviously with the big uptick in our long-term model we would expect it to be sooner rather than later.

Christian Schwab

Perfect. And then can you update us on if there were any 10% customers in the quarter?

Ryan Petersen

There were no 10% customers. So Newegg has historically been a 10% customer and is now not. That’s clearly from our growing mix of OEM sales.

Christian Schwab

Perfect. And then would we obviously anticipate more than one OEM to be a 10% customer in the back half of the year? Can you quantify how many you would expect?

Ryan Petersen

It’s hard to say so I’m not going to try and give any specific guidance on that.

Christian Schwab

Okay. Great. No other questions. Thanks.

Operator

Thank you sir. Our next questioner in queue is Richard Shannon with Northland Capital. Your line is now open.

Richard Shannon

Hi guys. I guess a question on the gross margins - you talked about a new range here, 30-40 in the long term. Curious if you could rank relative to your previous guidance rank which of the factors drove it up the most?

I think you talked about a few of them including the integration of Indilinx technology, a flash, more director flash sourcing and mix among others. Which one of those is more important or distinctly more important than the others?

Ryan Petersen

To the long-term model? I’m sorry.

Richard Shannon

Yes, the long-term model.

Ryan Petersen

So the long-term model, as you know, is basically we’re assuming the same cost factors but there is a considerably higher percentage of enterprise sales as with our historic model. We had no change to the percentage of our enterprise sales and assumed very flat growth across the segments. What we're guiding is in fact that we will see considerably higher enterprise sales going forward.

Richard Shannon

Got it. Okay. So it’s mix shift then. Second question Ryan, you had discussed briefly in your prepared comments about the new Z-Drive R4 and about PCI-Express opportunities. I wonder if you could characterize the environment out there. How many different customers that you're talking with that are interested, and if you can kind of provide us some scope as to the size of the opportunity and perhaps something a little about timing there?

Ryan Petersen

So sure - amazingly it seems that we've seen really with the Z-Drive R4 what drove us developing the Z-Drive R4 was that, in fact data centers as opposed to OEMs where we would typically sell, have shown some very serious interest in adopting directly PCIe cards as direct-attach or as devices within clusters as a tier zero storage really compared to ASIC.

So it seems that the opportunity for PCIe is bigger than what we would have previously assumed when looking at third-party analysis as opposed to being or being treated especially with a software-enabled PCIe card. As opposed to being treated as a hard disk replacement, we see data centers replacing that as a sort of caching appliance or really as a tier one storage as a standalone device that is in fact directly attached to the server.

So giving you an idea on how successful that's going to be without really talking about wins that our competitors have had is difficult. Obviously we see the value of putting software features that enable the data center guys kind of a higher level of ease of use. And we feel that our hardware is significantly better than what's available on the market today.

So I think that opportunities may be we will see some adoption relatively quickly as data centers kind of have a shorter call cycle, not really the same 9-18 months of an OEM, but more like a 6-9 month timeframe if that makes sense at all?

Richard Shannon

Yeah it does, right. Any way to quantify the number of opportunities out there? I mean some people might ask if it's 5 or 10 or 25 or 50, or any way that you can characterize that for us?

Ryan Petersen

We have a list of opportunities in the low triple-digits.

Richard Shannon

Okay. And just a couple of more questions from me - you mentioned the roadmap is on track in terms of your next-generation controller. I’m kind of curious about one angle on that in terms of the adoption of TLC memory. Kind of curious about is that going to be used in your next generation controller and what are your OEMs or potential OEM customers looking for, asking for in terms of that technology?

Ryan Petersen

Well, I think as maybe not everybody knows, MLC was a big step forward in the evolution of SSDs and we moved from the single layer cell to the MLC cell. We’ve seen huge kind of market growth based on the cost variance. And the next challenge is obviously is TLC. What we’ve seen is, it is less durable.

And every new real new generation of NAND flash is less durable and has ridiculously high error correction requirement. So I think what we’ve seen or what we’ve been pushing for really for the last two years in terms of product development is to make that next step and be the first to make it. In terms of how the market will develop for TLC, we have seen interest and positive indicators from OEMs.

It is in fact something that needs to be proven as a technology and obviously at this point it’s not on the market yet. So I would hope that in terms of Everest, Everest 2 controllers that we will have TLC support and we'll be on the market later this year albeit in a lower durability focused product, workstation class, maybe low end server use but nothing for the enterprise yet and that we will eventually or the technology will evolve and as it becomes proven get adoption into the enterprise through the next kind of 18 months after that.

Richard Shannon

Okay. Perfect. Great. Then just a last quick question for you, Art. I know you haven’t talked about specific guidance for the August quarter but any way you can characterize cash flows up or down that we should expect this quarter?

Arthur Knapp

Well, I think, the one comment I made was we were continuing to build inventories. So you might see the inventory build continue because we've never been able to have the luxury to have finished goods, plus lineup parts supply.

So I think when you go back to Alex’s question on the profitability that would generate cash flow there. But we will continue to invest in inventory. I think that's probably the only guidance that'd be appropriate at this point.

Richard Shannon

Okay. That’s fair enough guys. Thank you very much.

Operator

Thank you sir. Our next questioner in queue is Shebley Seyrafi with FBN Securities. Your line is now open.

Shebley Seyrafi

Yes. Thank you very much. So your enterprise business looks like that’s where the growth is going to be. It’s going to drive your gross margins incrementally higher versus the Indilinx and by more NAND direct, which were already there.

But your enterprise business declined sequentially. You're talking about it taking off. Can you talk about where you see it going as a percentage of your SSDs? It was now 12%. Do you see it growing to like a quarter of your SSDs over the next year? Any comments on that?

Ryan Petersen

I do believe 25-30% would make sense if you kind of track into where the margins are for sub-segment and look at our LTM. And obviously you have to take into account the other growth in the server segment, for example.

Shebley Seyrafi

Okay. 25-30% over the next year is what you’re saying makes sense. Also, your North American business was weaker than EMEA again. Do you expect that kind of dynamic to change starting with the August quarter for example?

Ryan Petersen

I would guess not because ultimately, if you’re looking at shipment by delivery location it doesn’t necessarily track where the accounts are. For example, Dell or an HP will build in Taiwan. So those might go into APAC so they can build in Czech Republic or Germany.

So I mean until the US becomes a manufacturing base for computer components I don’t expect the US to really be a big driver of sales. What you do see is direct data centers obviously, that are physically located in the US with docks here will be picking up product direct. So enterprise field may be a little more US focused.

Shebley Seyrafi

Okay. And I forget if you mentioned your current capacity. It was 140 units per month before. Can you update on that, how many units you shipped, for example?

Ryan Petersen

I don’t think we’re giving direct guidance on our unit shipments.

Shebley Seyrafi

What about capacity?

Ryan Petersen

I think no also other than what we’ve said before, which is we had made some additional expansions I think, to like 180 per months at 100% utilization, somewhere around there. I don’t have it in front of me. And you know obviously we are investing in additional expansion to support OEMs in the second half. So I think I guided last quarter that we would double our manufacturing capacity again.

Shebley Seyrafi

Okay. And the last one for me - you talked about it a little bit already but I just want some clarity here. The tax rate over the next several years is expected to be zero, right? Then the NOLs really kick in several years from now, right?

Arthur Knapp

Well, the NOLs are available. I think I indicated we have 35 million to shelter federal. And then the state because of the California situation, we’d probably be paying some - if you're profitable over 300,000, you pay some cash taxes. So you basically just have to model when you think the 35 million gets eaten through and then use a 35-40% tax rate if you want. We are also looking at some of the tax strategies to optimize our tax rate for longer term.

Shebley Seyrafi

Okay. Thank you very much.

Operator

Thank you sir. Our next questioner in queue is Gary Mobley with Benchmark. Your line is now open.

Gary Mobley

Hi guys. Well, I wanted to start out by trying to reconcile something. Ryan, in the past you've talked about some of these enterprise deals being worth potentially $80-100 million taking, for example, the PCI-Express business Fusion-IO does with Facebook. It sounds like you have perhaps inched closer to landing one of these large data center deals as evident in your raised gross margin outlook.

But yet you are raising the revenue outlook for the balance of the year, the midpoint by only $10 million roughly. What is going on there? Should I really think of the gross margin realization being more of a 2013 event? Or are you perhaps taking out of the mix some lower margin business offsetting the gains in enterprise?

Ryan Petersen

So in general what we're doing is obviously we've guided our revs up. So I think we feel that there will be growth overall. Consumers aren’t a focus so I don't know there will be losing any of that businesses or there's some run rate in the consumer segment, which sometimes can go into embedded PCs and so on.

But really the big margin change comes from the enterprise or from the data center business. As I think everybody is aware, PCIe SSD products have margins north of 50%. So it doesn’t take a lot to see some traction there and we’re not giving specific guidance in margins for this year.

Gary Mobley

Okay. And in the past you've talked about the benefit of receiving direct NAND purchase agreements. Being potentially 200-400 basis points of incremental gross margin and contribution, and assuming that you've doubled your mix of revenue purchased directly from OEMs, is it logical to think that you should at least get a 150 basis point benefit in the second quarter compared to the first quarter just from that alone in the gross margin?

Arthur Knapp

This is Art. I had made the comment that the current build up was to get parts availability. So we were building inventory and then I’ve said going forward we would expect future purchases to help more with the pricing mechanism and the current purchases. Right now we’re just trying to get parts and build availability.

Ryan Petersen

Yeah. I don’t think you’re doing the math wrong. Just ultimately you have to keep in mind we got the money during a portion of the quarter. We still are not at terms with all of our vendors yet but you aren't doing the math incorrectly. So the math is in fact correct.

Gary Mobley

Okay. And are you facing any capacity constraints and, i.e., revenue constraints in the second quarter and particularly on the enterprise side of the business?

Ryan Petersen

Well, Thinkflash is still in shortage. So it has been in shortage since last quarter. Though it is loosening up, I’m not sure who covers some of the fabs here but obviously, as Thinkflash becomes more available our high end enterprise products can ship more readily.

Gary Mobley

All right. Thank you guys.

Operator

Thank you. (Operator instructions) We do have a question from Nehal Chokshi with Technology Insights. Your line is open.

Nehal Chokshi

Yes, thanks guys. Did you provide a breakdown like you did last quarter, the SSDs by sub-category, i.e., the enterprise, the high-performance computing, and the consumer? Can you just do that again real quickly?

Ryan Petersen

Sure. Art, do you have it?

Arthur Knapp

Yeah, I think we said enterprise was about 12%, the consumer was 3% and the server high performance was 85% of the SSD revenue.

Nehal Chokshi

Great. Thanks for that. You mentioned that you did some key component strategic buys. Could you talk a little bit more about what sort of key component is there?

Ryan Petersen

He means NAND flash.

Nehal Chokshi

NAND flash, okay, not controllers or anything like that. Then your implied guidance for the remainder of the fiscal year is 254 million and if you take the Q1 consensus numbers, the implied guidance before that was $247 million.

So, you're having a nice raise here of $7 million on the next nine months and I’m just wondering I presume that's largely all SSDs. But within this segment is that all enterprise SSDs or is that spread across the three segments here?

Ryan Petersen

I don’t think we're guiding that specifically.

Nehal Chokshi

Okay. Then lastly, with your new operating model when we reconcile the incremental change on the low-end versus the high-end, at the low end you're implying there is effectively no incremental OpEx.

And at the high-end incremental change you're implying there is about 500 basis points of potential incremental OpEx. Is this the right way of thinking about it or is there a different way we should be thinking about this incremental change in the long-term operating model?

Arthur Knapp

Is the question is that - sorry, is the question that like the enterprise levels have a higher operating expense than the low-end? I'm sorry.

Nehal Chokshi

No. The question is that your new long-term operating model has your GMs going up by 200 basis points and your operating margins going up by 200 basis points. And so that implies no incremental OpEx. Why is that?

Arthur Knapp

The range on the OpEx has increased and that’s primarily due to higher R&D spend. And the margin model went from 28-32% to 30-40%. So it seems like you’re measuring the high or low point versus the low point as opposed to measuring the two midpoints. So you might want to look at the midpoints.

Nehal Chokshi

Okay. We should look at midpoints and not really low-to-low and high-to-high. All right, got that. Then just real quickly, you’ve had this inventory, the special inventory charge related to the Indilinx acquisition. What inventory was that actually that got charged from and why is that?

Ryan Petersen

Those were consumer-grade controllers that were basically useless to OCZ on a go-forward basis as we have no focus on the consumer segment.

Operator

Thank you. Our next questioner in queue is Mitchell Sacks with Grand Slam. Please go ahead.

Mitchell Sacks

Hey guys. I wanted to just follow-up on a question regarding the bid activity. I think earlier you had mentioned that the number of enterprise customers you’re looking at I think, it was triple digits. Could you just sort of walk through sort of the market size and the opportunity as you see it over the next couple of years, and how you sort of intend to go after it?

Ryan Petersen

Sure. Yeah, do you mean specifically in regards to PCIe or in general?

Mitchell Sacks

Well, in general, yes and PCIe specifically.

Ryan Petersen

So in PCIe specifically, I think that the difference in our approach from our historic approach which has been and continues to be a focus on selling into tier one OEMs, selling into OEM specific segment OEMs and really targeting the OEM accounts, who then sell through the product to the end user is a very effective strategy.

But what we've found is that with PCIe products because they are in fact more competitive with a storage system than they are with a hard disc drive, we’ve had to move to a more direct to the data center model. And frankly, that's been enabled by our software. What we also see though is that as it becomes un-hinged from the SSD market, it seems to be a much greater market opportunity.

So to size it, I mean, we do know of opportunities in the $200-400 million range and several opportunities of that size with large or some of the world's largest data centers for PCIe SSD. So there is quite a bit of business out there. Really the change for us is adding the software and ultimately then adding a direct sales force to sell directly to those clients, which is why you see in our long-term target model not only a substantial increase in gross margins but some incremental expense related to selling to those enterprises or to the data centers directly. Did that answer your question?

Mitchell Sacks

Yes it does. Thank you.

Operator

Thank you. And at this time I am showing no additional questioners in the queue. I'd like to turn the program back over to Ryan Petersen for any closing remarks.

Ryan Petersen

Well, I thank everybody for coming and I just wanted to say in conclusion that we're proud that we’ve achieved these milestones and undergone a significant transformation over the past 12 months. We're committed to continuing to leverage our technological and performance leaderships in the market and building value for our shareholders. With that I will bid you adieu.

Operator

Thank you, sir. Ladies and gentlemen, this does conclude today's program. Thank you for your participation and have a wonderful day. Attendees, you may disconnect at this time.

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