Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Brad Driver -

Richard Pearce - Chief Financial Officer and Director

Steve Barber - Chief Executive Officer and Director

Analysts

Glenn Hanus - Needham & Company, LLC, Research Division

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

Keith F. Bachman - BMO Capital Markets U.S.

Unknown Analyst

Kenneth Miller

Xyratex (XRTX) Q1 2012 Earnings Call March 29, 2012 4:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2012 Xyratex Earnings Conference Call. My name is Derek, and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to the Vice President of Investor Relations, Mr. Brad Driver. You may proceed.

Brad Driver

Thank you, Derek 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 First Quarter 2012 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's filings with the Securities and Exchange Commission, including the company's 20-F, dated February 24, 2012.

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.

Before I turn it over to Richard, I would like to make you aware that following the direction we outlined in our last call to take advantage of the increasing technology synergies within the company to better serve the business opportunities we see, we've taken the decision to consolidate our organizational governance and operate as a single entity as opposed to our historical dual divisional structure.

As a result, we will now be reporting under a single financial structure. We will continue to provide supplemental segment analysis for our Enterprise Data Storage Solutions, formerly referred to as Networked Storage Solutions, and our Hard Disk Drive Capital Equipment product, formerly referred to as Storage Infrastructure. And we'll refer to these statements -- refer to these segments as we discuss the overall business.

I would now like to turn the call over to Richard to review the financial details of the quarter.

Richard Pearce

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

Total revenue was $295.7 million, down 18% as compared to the first quarter of last year and down 24% from our prior fiscal quarter. Revenue was at the lower end of our expectations, primarily as a result of disk drive supply constraints in respect of our Enterprise Data Storage Solutions products.

Sales of our Enterprise Data Storage Solutions products were $272.1 million or 92% of total revenue. This is a decrease of 19% compared to the first quarter of last year and a decrease of 23% compared to our prior fiscal quarter. Sales of our capital equipment products were $23.6 million or 8% of total revenue, down 10% compared to the first quarter of last year and down 33% compared to our prior fiscal quarter.

Gross margin was 17.9% for the quarter compared to 13.7% in the same period a year ago and 17.7% in our prior fiscal quarter. Gross margins were slightly higher than expected due to product mix. The gross margin for our Enterprise Data Storage Solutions products was 17.3% compared to 14.2% last year and 17.7% last quarter. In addition to product mix, the increase from the prior year was impacted by the sale of specific products without hard disk drives, as Steve would explain later.

The gross margin for our capital equipment products was 25.5% compared to 9.7% last year and 18% last quarter. The prior-year margin was impacted by higher fixed cost base and inventory provisions.

Non-GAAP operating expenses in the quarter were $39.6 million compared to $43.5 million in Q1 of last year and $44.3 million last quarter, reflecting the restructuring actions we implemented toward the end of last year and the deferral of some specific product development expense into Q2. On a non-GAAP basis, net income was $11.4 million or $0.40 per diluted share compared to net income of $7.5 million a year ago and net income of $20.8 million in the prior quarter.

Turning our attention now to the balance sheet. Cash and cash equivalents at the end of the quarter was $155.8 million compared to $132.6 million at the end of Q4 and $90.8 million at the end of fiscal year 2010. Cash flow generated from operations was $34.2 million in the quarter.

Inventories decreased by $11.7 million to $152.5 million in the quarter. Inventory turns were 6.5 compared to 7.9 for the previous quarter. Accounts receivable decreased by $48.6 million in the quarter to $152.1 million. Days sales outstanding were 46 compared to 47 in the previous quarter. Headcount at the end of February quarter was 1,950 permanent employees, approximately flat over the past quarter.

Now before I turn this over to Steve for his comments, I would like to provide you with our business outlook for our fiscal second quarter 2012 ending May 31. Our business outlook is based on current business expectations. It should be noted that there are 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, we recommend that each investor review the risk factors outlined in our Form 20-F filing.

For the second quarter of 2012, we are projecting total revenue to be in the range of $297 million to $357 million, down 12% to up 6% as compared to last year, and up 1% to 21% compared to the prior quarter. For Q2, gross margins is expected to be 15.5% to 16.5%.

We are estimating non-GAAP earnings per share to be between $0.16 and $0.43. Non-GAAP earnings per share excludes noncash equity compensation and amortization of intangible assets. The number of shares outstanding at the end of Q2 on a weighted average treasury method is expected to be 29 million. Our cash position at the end of Q2 is expected to be approximately $140 million, reducing slightly from current levels due to an increase in working capital to support the ramp in capital equipment revenues.

The company announced and paid its third dividend in the quarter, with a cash dividend set at $0.065 a share, and today announced its second gross dividend of $0.075 a share payable April 26. The company intends to incrementally increase the dividend per share per quarter until such time when the annual yield is approximately 2.5% to 3%, at which point the board will review its dividend strategy.

In summary, I believe we did a good job of managing the challenges we experienced during the quarter while maintaining a focus on expenditure, resulting in very good net earnings. The demand environment remains good, although we continue to anticipate moderate disk drive constraints during this quarter. I believe the overall supply situation is improving and our team is doing a good job of staying in front of the major issues as they occur.

Additionally, I believe the reorganization that Brad referred to earlier will be beneficial to our operations and research and development efforts and enable us to better meet the technology requirements and demands of our customers, as well as position us to succeed in new markets that we are entering.

I'd now like to hand over to Steve for his comments.

Steve Barber

Thank you, Richard. Before I comment on our performance in the quarter, I'd like to expand on our corporate reorganization that we're in the process of implementing. We're integrating the Storage Infrastructure and Network Storage Solutions businesses to facilitate for further technology innovation and to leverage many aspects of how we do business to better support our customers. I believe this will enable us to improve our efficiency and effectiveness across all of our product lines and business development efforts.

Xyratex is uniquely positioned in the OEM data storage market, with significant expertise across the continuum of data storage elements from disk drive heads and media through disk drive and enterprise storage platforms to high-performance computing data storage solutions. Our expertise enables us to design the highest quality data storage platforms by incorporating advanced design elements in our systems to meet the demands of next-generation disk drive technologies as they're introduced into the market.

I believe Xyratex is equally well positioned to provide our capital equipment customers with solutions that incorporate demand from the end-user application environment. I'm confident that our new structure will help facilitate a better use of our resources and improve our ability to meet the needs of our customers in the markets we serve.

Moving on, I'd like to cover the key messages in our call today. We performed well given some challenging supply chain issues, managed our expenses well and remained focused on executing on many of our strategic areas.

With the 2 industry acquisitions by Seagate and Western Digital now complete, I believe the industry will experience more mid- to long-term stability as each move forward with integration efforts. We anticipate ongoing disk drive supply constraints that impacted some of our revenue opportunities in the quarter and continued to work closely with our suppliers and customers to ensure minimal disruption going forward. I do believe the situation is improving albeit at a slow rate.

As a result of the impact of the flood in Thailand, specifically the disruption to the consistent and reliable supply of disk drives, we are seeing potential changes in supply models, which I'll expand on shortly. We continue to secure new design wins and are actively engaged in a number of meaningful new products and new customer partnerships, driving future growth of the business. Overall, I remain confident we can achieve our financial plan for the year.

As Richard mentioned in his comments in our financial results, our revenues in the quarter and ability to meet customer demand were impacted by the current disk drive supply constraints that we cited as a potential risk back in January. I was pleased with how we managed this challenging situation as it could otherwise have been more disruptive to our customers and as a result impactful to our financial results.

Additionally, we also saw a shift by one of our major customers. We have specific products they have now elected to manage their disk drive supply and integration internally, and we provide systems to them without disk drives. This clearly results in reducing our revenues but increases the gross margins to our Enterprise Data Storage products. Such a move is understandable in an environment with supply constraints, where our customers are challenged as to which product performs to allocate scarce disk drive supply.

In support of this change in the product fulfillment model, we have developed innovative techniques within our manufacturing and system test processes to ensure the quality of our products ahead of the disk drives being integrated by our OEM customer.

Currently, most of our customers leverage the test and certification capabilities of Xyratex to provide a more robust solution for the end-user customers. We believe the value derived from these patented test processes will continue to provide significant differentiations for Xyratex and our customers.

The situation regarding disk drive supplier remains fluid at this time, with certain drive suppliers moving away from historical customer inventory hub supply models to direct supply models against customer forecasts. As these supply model changes develop, we will mitigate any potential impacts to our business going forward.

With these changing supply models, it is clear that the industry faces challenges and accurately matching demand planning for disk drives with actual end-user model mix demand. We therefore see an opportunity for us to assist in optimizing the utilization of available disk drive supply by providing reconfiguration capability for disk drives based on our capital equipment solutions and product system test expertise within our mutual OEM customers' integration centers.

With our expertise and breadth of disk drive production test solutions and storage systems test capability, we believe we are uniquely positioned in the market to enable the industry transition to this potentially new disk drive supply model.

For the quarter, our revenue for the capital equipment side of our business was in line with our expectations, while gross margins were slightly above our plan. Today, we're escalating all areas of our activities needed to support and assist in the recovery of equipment damaged by the floods in Thailand and are taking all possible steps to accelerate delivery of new disk drive and component process systems urgently required by our customers. We were limited by competitive lead time for some products, which limited our ability to provide systems in the first quarter but are currently scheduled for installation in this quarter.

Our near-term demand remains strong as the industry works to recover the production capacity lost to the flood. We believe in the medium term that the industry will seek to match increases in disk drive production capacity with both the pace of recovery and component supply and with market demand. And as has been communicated by some disk drive providers, they're entering into long-term supply agreements with their major customers, providing them with long-term demand visibility through committed orders and in return, providing certainty of disk drive supply for their customers.

We believe this will enable the disk drive industry to forecast demand with more certainly and in turn, enable it to plan CapEx investments more accurately matching demand with production and supply. These are mix [ph] we believe will be an environment of somewhat cautious CapEx investments through this year, in line with our observations that we outlined in our January earnings call.

While it is with some relief that we have certainties surrounding the Western Digital acquisition of Hitachi GST has now been removed, a new uncertainty has emerged as to how these organizations will operate in compliance with the regulatory requirement of keeping the 2 businesses effectively separated over the next 2 years. We will continue to work closely with both customers to ensure our development priorities and supply capabilities are aligned with their respective capital equipment needs.

In addition to our activities to assist with the recovery of damaged equipment and supply of replacement equipment in the near term, we are seeing demand for incremental and new production systems across the disk drive sector with a number of installations scheduled for this quarter. As part of this, we'll be installing in volume our next-generation dedicated 3.5 inch disk drive form factor test solution, the Optimus 3500 this quarter. This platform provides our customers with enhanced features to improve production test yields and factory equipment utilization.

Demand for high-capacity, long test time 3.5 inch form factor disk drives is expected by industry analysts to increase significantly over the next few years as the growth in cloud data centers expands. Coupled with this, enterprise data storage architectures are increasingly utilizing a combination of solid state flash memory for high-performance data access and highest possible capacity 3.5 inch disk drives for data storage. As the only independent provider of 3.5 inch disk drive test process technology, we believe we have a significant time to market advantage to benefit from the growth in demand for high-capacity 3.5 inch disk drives.

In support of recent new business opportunities in the disk drive and disk drive component market, we're expanding our current field service capability beyond Singapore, Malaysia, Thailand, China and Japan with a new facility in the Philippines later this year. These teams are focused on working closely with our disk drive customers in optimizing utilization of our process equipment in meeting the specific needs of each factory operation, enhancing process yields and reducing operational costs for our customers.

In the Enterprise Data Storage market, we continue to make very good progress in the high-performance computing, or HVAC, market with additional partnership agreements with major computing technology providers expected later this year.

The ClusterStor 3000 is increasingly being recognized as a class-leading, highly scalable solution for this high-growth market. Our efforts are currently focused on our first announced OEM partner, Cray, in delivering the Blue Waters project, one of the most powerful supercomputers in the world for the National Center for Supercomputing Applications, or NCSA.

In addition, we're deploying customer store evaluation systems for our OEM partners into oil and gas and research laboratory end-user applications. We're excited by the opportunities we see in this market and by the positive customer response we received to date.

We continue to invest significantly in our product road map for the sector and recently announced the opening of a new center of excellence for storage software development based in the Kitchener-Waterloo region of Ontario, Canada. Focused primarily on ClusterStor system, cloud infrastructure and management software development. This team will consolidate and lead our efforts in the development of next-generation ClusterStor system capabilities and advanced application framework with intuitive management tools for Lustre-based ClusterStor high-performance computing storage solutions.

Leveraging our technology relevance within the ClusterStor 3000 platform, last week, we formally launched our OneStor 2584 storage solution, a 5U 84 drive product and the industry's highest density enterprise-class data storage platform.

This product, available as an expansion storage solution or the high-density application platform, complete with high availability controller technology, is capable of scaling to over 250 terabytes of storage in 5U rack space. We're well advanced in product evaluation with a number of current and new OEM customers seeking to utilize this platform as a basis for the next generation high-density solutions.

In addition, we are actively engaged with new OEM customers. We're evaluating the OneStor family of solutions for their emerging needs. We expect to announce new OEM partnerships for both the OneStor application platform and the OneStor storage enclosure later this year.

I'm encouraged by the number of new business opportunities we see across the business. We are actively engaged with 2 global partners, one new to Xyratex, in developing new storage platforms as we're partnering with a number of innovative emerging companies in the sector.

Earlier this week, we're delighted to announce our partnership with Pure Storage, an exciting flash-based enterprise storage company. Pure Storage is a great example of an emerging company that we strategically partner with to bring innovative technology to market. By leveraging our family of OneStor application platforms and storage enclosures as the basis of their flash storage solution, Pure Storage was able to focus their development resources on their core offering while relying on Xyratex to execute on the data storage aspects. As we've demonstrated with previous emerging technology partnerships, this approach has proven to be beneficial to both companies.

Finally, we're executing on our long-term strategy to provide incremental value within our solutions. As part of the strategy, we're actively developing solution architectures to address new opportunities within the public cloud infrastructure market that leverage our core technology expertise in data storage solution design, cloud system expertise and management. These solutions are aimed at meeting the scalability, manageability and reliability needs of the public cloud, providing best-in-class price performance, while providing the cloud provider with the ability to scale the solution as demand grows.

Key design elements include lowering the energy footprint, providing performance at scale and enabling a viable cost per end user. Our architecture aims to incorporate innovations with all layers of the stack, from the base hardware to the software, all of which play to the technical strength and heritage of the company. We're targeting to launch the platform in 2013.

The 451 Group has estimated the total public cloud infrastructure market is approximately $4.5 billion, and we believe we can realistically address around 5% of this market with our technology and go-to-market strategy. As a result, we believe that in the coming years, with good execution, this could be a significant business opportunity for us. We're leveraging the appliance model we developed with ClusterStor 3000 having significant value to innovative software and integration of this software with the rest of the cloud ecosystem. We believe this approach will allow us to deliver additional margin contribution to the overall business.

In summary, we're excited by the numerous opportunities available to us in the coming years. Digital data creation and storage growth continues unabated by macroeconomic factors, and Xyratex is increasingly recognized as a significant provider of technology and enabling solutions to multiple sectors of the market. We're a trusted partner to many of the world's global brands in the data storage eco chain, and we remain focused on enabling their and our business success through the position of product-leading innovation and cost-competitive solutions.

Once again, I would like to thank all our employees worldwide for your ongoing efforts in meeting our customer commitments, executing your customer requirements, resolving the technical challenges and delivering on our product development milestones. Thank you for your continued support, commitment and innovation as we work to enable our customer's success in this high-growth market of data storage.

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 is coming from the line of Glenn Hanus from Needham.

Glenn Hanus - Needham & Company, LLC, Research Division

All right. So I'll start with a couple of the financial questions. Could you maybe break out -- well to start, could you give us the breakout on the OEMs for the percent of the business on the Network Storage Solutions side?

Richard Pearce

Yes, Glenn. We've kind of now gone on to the name of Enterprise Data Storage Solutions, but as we said in the comments, we still break that down in our press release into the 2 segments. So what I'll report here, the numbers within those 2 segments as we quite normally do. So of the revenue in the quarter within that segment, which was $272 million in total, NetApp represented approximately 46% of that, Dell represented 26%, IBM represented 17%; and then EMC and HP are both just under the 5% level.

Glenn Hanus - Needham & Company, LLC, Research Division

Okay. Great. And then in terms of your guidance, could you break out between the businesses, how to think about revenues and gross margins for each business?

Richard Pearce

Yes, I mean just -- yes, just giving approximates within those, Glenn, rather than I guess more formal as I guess we used to supply. And my expectation is within the capital equipment side of the business that will be in around the $40 million to $50 million range in 2Q. And on the Data Storage Solutions business, around $257 million to $307 million, I guess, that's in line with the overall guidance which has been provided. From a margin standpoint, I think consistent with previous comments that we've made, my expectations for the year in the storage solutions was a range of 14% to 16% we've given originally. I said that we expect it to be at the high end of that. Obviously, we stated in our comments the margins in the quarter at 17.3% were a little bit above our expectations, but I do expect it to be around about that 16% level as we go into 2Q. And on the capital equipment business, expect to be around about 20% level in Q2.

Glenn Hanus - Needham & Company, LLC, Research Division

20%. You really -- I'm looking at 25% this quarter. I was only expecting about 18% or so for the quarter. So can you just talk to the upside you saw this quarter, and what's the outlook going forward on gross margins for SI then?

Richard Pearce

Yes, I mean, it's very much dependent on the product mix that we have in there. And I think a large proportion, even though obviously it's not a particularly huge number, but in Q1 a larger proportion of the equipment revenues were spares, particularly helping out in areas that the flood has affected on certain parts. And they command a slightly higher margin as you can imagine on spares. Whereas as we move into Q2, more systems and again, I think as we've talked about in previous quarters, one particularly -- a new system that we brought into the marketplace have accelerated that system the 3500 into Q2, when in normal circumstances it wouldn't have been ready for Q2 but because of the floods and the desire to replace old equipment with new, we've accelerated that. But we are in the early stages, and as with many products in their early stages, getting a lower margin from that product in those early stages when the volumes are relatively low. And we're still working on getting the original costs down and I guess engineering some of the costs out of that product.

Glenn Hanus - Needham & Company, LLC, Research Division

And then you're still looking for gross margins in SI to kind of return to the mid-20s range over the next 4 or 5 quarters or so?

Richard Pearce

Yes. I think -- again, referring back to previous calls, I'd look to the back half of the year between 20% and 25%. And I guess that's represented in the consensus it stands today and that's my expectation. And then going back up to the 25% to 30% as we move into 2013 is my current expectations.

Glenn Hanus - Needham & Company, LLC, Research Division

Okay. One -- maybe one last more discussion kind of question. Can you talk about with the restructuring, give us a little more color how you're seeing sort of synergies between the 2 sides, where you were able to cut costs and how your -- why is this the right time to bring the 2 businesses together and how that leads to more productivity going forward?

Steve Barber

Okay. Steve here. The 2 key areas which are really driving it and we're now discovering a number of areas -- other initial areas. But the 2 key really relates to, I'm going to call it, dynamic performance of disk drives, managing the vibration of thermal requirements of the disk drive is equally and in fact now becoming more demanding in both sides of our business, managing vibration, managing thermal environment for those. And historically, those 2 activities have been managed at a capital equipment level or at a storage system level. And what we're realizing is there's a lot of synergy to bring together and expertise in both sides to benefit both sets of products. The other side, really looking the other way, is as our enterprise storage systems are moving more towards rack level products, ClusterStor 3000 being I guess first of those, it's very clear that the legacy expertise within our capital equipment business, which has been focused on rack scale systems, power distribution, cooling, installation, et cetera, is proving extremely valuable for our learning curve on rack-based storage systems. So the technology benefits are already paying significant dividends in our business. We're seeing a lot of real innovation that's helping both sides of our businesses moving forward as with earlier. But beneath that, we're starting to see a number of process areas where the way activities are taking one area of the business versus the other can be directly helpful to the other part of the business. So we're expecting to see a number of improvements with regards to time to markets, true innovation of our technology, but there's also rather bringing together these 2 areas of the businesses.

Glenn Hanus - Needham & Company, LLC, Research Division

And were there some synergies or some things you're doing on the sales and marketing side between the 2 businesses? Or was this just on the R&D side?

Steve Barber

I think we are in the early stages in the sales and marketing side. I think they're very different customer sets, but the relationship we have with both sides is actually very similar. We provide highly customized solutions for our customers based on core building blocks. And that's close relationship side of working entirely applicable to both sides of the businesses. I think the area where we need to think very carefully is more about customer support, field support, supporting equipment inside disk drive factories is somewhat unique versus the support we provide to the storage system customer. So there are some areas where I think we will clearly maintain relatively separate, very focused areas of the business. But with sales and marketing overall standpoint, I think there are benefits to be played by bringing those teams much closer together.

Glenn Hanus - Needham & Company, LLC, Research Division

All right. And lastly, OpEx, could you give us an update on how we should think about OpEx over the next 3 or 4 quarters?

Richard Pearce

Yes. I mean very much consistent with where we thought we will be at the last quarter, I think, referring to this quarter. In fact, we did have some lower expenses in this quarter through a deferral of some specific product development expenses. But that was only kind of $1 million to $1.5 million. So where I think previously I guess within relatively narrow ranges, but we were looking at expenses in the second quarter being somewhere in the $41 million to $44 million region. My expectation is now that it's going to be in the $43 million to $46 million level and that they will remain relatively stable then throughout the rest of the year. So very much in line, I think, with the numbers that are already out there.

Operator

Your next question is coming from the line of Ananda Baruah from Brean Murray.

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

Just like to get your thoughts on, I guess, NSS industry demand trends. And I guess any linearity you saw through the quarter and what you're thinking is for kind of going into the second half into the next quarter, into the middle of the year?

Steve Barber

This is Steve here. I think pretty much as we expected. The deltas you saw on our revenues as indicated in the prepared script really focused around drive supply. I don't think we are seeing any change in overall demand trends. But as I'd say, we left some demand unfulfilled in the quarter, as well as seeing a revenue delta because all of us moving towards a shipping systems without drives to one customer who was looking to integrate drives themselves. So overall, while the revenue did look slightly down in the quarter, the underlying number of units shift and the demand we're seeing, pretty much as expected and remains, I would say, pretty strong across the range of customers we serve.

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

Which -- I guess on the drive side, which drives are more constrained right now as opposed to less constrained? Meaning fiber channel sets data.

Steve Barber

It's very specific model types. I'm happy to follow up to you with more details if that's an area you want some more insight. Certainly, high-capacity drives but also some of the higher-performance but very particular model types. So depending on the model mix that our customers are looking for, we are seeing tightness around very specific models. So it's not a general statement. It's really around I guess having a very accurately planned demand on a model-type basis going forward. This is the legacy supply models where there was inventory in the hubs that was buffers around the overall channel or the overall sector that we could call out. None of that exists today. So any minor changes, in particular model mixes, is creating holes in -- or gaps in supply in the near term.

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

What's your best guess on when that pressure gets resolves? Is it 2Q? Is it 3Q?

Steve Barber

I can only speak to comments we're seeing from industry analysts. I think there's a general view that the overall capacity starts to match demand at some point in the third quarter. I think in reality, we're still going to be impacted by particular specific model constraints on a week-by-week basis that will carry on through the course of this year. Clearly, we're seeing from our capital equipment side that we're playing a role in assisting the industry recover and increasing installed base. But as I've said in my comments, I don't think the industry is looking to replace and refill the buffers that existed previously. I think they are moving more towards the direct supply model, in many cases and scale and capacity very much in line with specific end-user demand. I believe in some cases, some customers to these long-term agreements where they will have very -- they have clarity as to what products they're shipping literally by model type and quantity within each quarter.

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

And I believe you made a comment on the last quarter call that there is a -- you expected about $50 million, call it, make-up spending or recovery make-up spending. Is that still the ballpark of what you're expecting?

Richard Pearce

Yes, and I think when we talked about last time, we said we'll see that over the second quarter and third quarter. I think there will be a slightly skewed towards the third quarter. And some of that just in terms of lead times and particularly on these new products and how quickly we can get it actually out there and functioning in the factories. But yes, that's still a good number, and the numbers which are out there today, we feel comfortable with.

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

Okay. Great. And I guess just last one for me for now. More of a clarification. Did I hear you correctly that the HPC opportunity, do you think you can address this 5% of the $4.5 billion market?

Steve Barber

I was referring there to the cloud infrastructure markets, but a number of reports recently are trying to scale the size of that infrastructure sector. So I didn't comment on the HPC space specifically. It's more addressed on the emerging cloud infrastructure market that we're looking to address in 2013.

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

Got it. That's helpful. And then just one follow-up on HPC, can you give us some sort of framework on how to think about -- at least how we can think about how you guys are thinking about the HPC opportunity over the next, I don't know, 12 to 36 months? Quantifiably, how are you viewing the market, things like that?

Steve Barber

At this stage, very positively. We are all, I guess, somewhat cautious since we are new to the sector. I think the feedback we're receiving from customers that we are engaged with today are validating the product has been extremely positive. The technology is simply recognized as a leading-edge technology and is creating a lot of interest. From our standpoint, we'll make sure that we pace ourselves, we don't overextend and potentially fail immediate customer expectations. But the momentum we're gaining through the course of this year, I think, will put us in a very strong position going in say '13 and '14.

Operator

Your next question is coming from the line of Keith Bachman from Bank of Montréal.

Keith F. Bachman - BMO Capital Markets U.S.

Could you speak to any share shift issues either that occurred in this quarter or next quarter in each of the various business areas? In particular, what I mean is on the drive equipment. Did you see -- what did you see or what do you anticipate seeing near-term Teradyne? And then secondly, was the NetApp business, was there any unusual share shifts there? Or did it proceed as you anticipated and previously described?

Richard Pearce

Yes, I mean on the NetApp side of things, really it was in line with our expectations there. I think as everyone or majority of people who follow us are aware, the proportion of the primary product that we supply to NetApp our proportion of that business at a minimum level reduced during the quarter from the 75% to a 50% level. We probably didn't go right down to the bottom of that range in the quarter as they transitioned across to their third-party provider, but pretty much in lock in and it will be somewhere between 50% and 60% that we had in that quarter. So therefore, we expect it to be relatively consistent and as you move into the second quarter. So conscious that it's obviously NetApp year end in that period. So nothing on toward there. As far as the HDD Capital Equipment business, unfortunately, we haven't got any significant knowledge of what Teradyne may or may not have in terms of their order base there. I guess from our perspective, we received the orders that we expected, that we talked about from the Thailand flooding, so we're relatively comfortable with our position in there. Obviously, quite a large proportion of the business that we've got is related on the 3.5-inch side. So I haven't got too much more data on the 2.5 inch, or how Teradyne may be doing, but I guess we'll wait till they report in the next month or so.

Keith F. Bachman - BMO Capital Markets U.S.

Okay. And Steve, is there any color you'd like to provide us on just even broad parameters on what you think the HDD revenues can look like for this fiscal year, kind of going out to the end of the year?

Steve Barber

You said HPC revenues?

Keith F. Bachman - BMO Capital Markets U.S.

Sorry. HDD, hard drive revenues, excuse me.

Steve Barber

Yes, I mean I think, yes, the numbers which are out there today in terms of consensus around the $190 million, I think yes, Keith, your numbers which you put back out there again last week or so around about $200 million, yes we feel comfortable with those numbers. Yes, there is discussions that we're having with a number of customers about potential opportunities at the back end of the year. But at this stage, I wouldn't want to stretch those numbers from where they are.

Keith F. Bachman - BMO Capital Markets U.S.

Okay. Well my last question, I'm going to keep my questions under double digits, it seems like if I go back to reflect on your last conference call, it seems like hard drives were a little tighter than you anticipated. It seems like you're raising it, as more of an issue today than I would have anticipated given that some time has elapsed and many folks were indeed talking about some more relaxed supply constraints. But I just want to hear your comments there. Because if I just listened to your comments, it seems like things didn't free up as much as you thought and indeed got worse during the quarter. Am I reading that incorrectly?

Steve Barber

No, no. I think you're probably reading a little more into it. We gave a pretty wide range for revenue guidance in the sector specifically in the last quarter because of that uncertainty. I think as we netted out and we have a pretty good job at securing the majority of the drives that our customers needed, I think it's fair to say we do operate in a somewhat volatile model mix environment. Our customer base finds it challenging to accurately forecast specific model types capacity points that they will ship -- actually ship in the quarter. And I think it's fair to say that provided we are able to accurately forecast, I would say broadly supply is better today than we had anticipated coming into the quarter. The issue comes about volatility of end-user demand and our ability to respond that because as I said on my earlier comments, there simply are no buffers around anymore. There's no free float of any drives. They're all allocated to particular customers. And the shortfalls we saw were really related to various model types for particular customers during the quarter, coupled with, as I've said, one of our customers, one of our major customers, elected to effectively take all of their drive demand across all of their products, Xyratex-based products and other in house-based products and integrate those drives themselves in order to avoid a situation where they have drive held up in finished good systems but without mismatch between product a, shipping or having demand for and product b, where all the driver are sitting. So that was probably the more significant factor with regard to our revenue in the quarter than actually not having the drives to meet demand.

Operator

Your next question is coming from the line of Paul Mansky [ph].

Unknown Analyst

And you may have touched on this. I dropped off the call for about 2 minutes. But going back to your earlier comments relative to one of your OEM partners procuring drive capacity themselves, taking it off your hands, did you quantify the impact that, that will have relative to either your Q2 guidance? Or did it impact at all any revenue levels in Q1 at all?

Richard Pearce

Yes, I mean I think in terms of the levels in the specific quarter, I would say approximately $15 million to $20 million of revenue which we didn't get in Q1. And I guess given that our guidance for Q2, versus what the market previously estimated, then our expectations would be that it will be a pretty similar amount in Q2. So that solely was not the effect of some of the reduction in revenue in Q1 as we did have some constraints as Steve talked about in addition to the specific products on this customer going diskless. But yes, around about $15 million to $20 million. And now we don't -- as things -- as we anticipate and hope that the situation on drives get better into 3Q, we could see a reversal of that situation in terms of those products.

Unknown Analyst

Does that change your purchasing power going forward?

Richard Pearce

I mean it's not that significant really if you look at our overall disk drive purchasing, so I would say no in the near term on that.

Unknown Analyst

Okay. And then last for me, relative to the kind of that full year bogey, gross margin bogey for the enterprise solutions side of the business. Obviously, you upsided your prior bogey this quarter. We kind of look at guidance as we've taken into account, obviously, if you're shipping less disk, the margin profile on that business should look better. And yet we're still talking 14% to 16% albeit at the higher end of the range. Am I missing another part of that equation that we should be factoring in there?

Richard Pearce

I mean I think we've talked in previous calls, Paul, and it's good to hear you again. But yes, some of our sort of legacy businesses, which are providing higher margins at the like of EMC as a customer, which is we've explained the majority of that business has sort of transitioned over to an EMC platform. We did have some in Q1. We're going to have slightly less in Q2. So that I guess impacts the margins to a degree as one of some of the Dow ecologic business, which is a similar situation. So whilst you see slightly better margins because of this diskless situation, yes, they are impacted by those. So I feel relatively comfortable but yes, we will be at the top of that sort of bogey number, the 16% range in Q2 is probably going out to the rest of the year. But yes, I guess that's the dynamics between -- if it was just -- it's not only that we would see them pick up, but we have at least these sort of items balancing that to a degree.

Operator

Your next question is coming from the line of Kenneth Miller from Nokomis Capital.

Kenneth Miller

I think my question is partially been answered by the movement of customer -- of the customer who's now procuring disks directly. But maybe you talk a little bit about your expectations for Networked Storage Solutions revenue in the back half of the year. Have the shortages created pent-up demand you think will -- cause a snap back in the second half of the year? Are we looking at it kind of down mid-teens type year in the Network Storage Solutions revenue?

Richard Pearce

I mean we do expect the revenues to increase slightly as we go into the back of the year in line with the guidance we gave out at the moment. But I guess if we go back to our prior comments here, if I look at the midpoint of consensus, we're kind of down $15 million in Q1 and that's kind of explained by the diskless units. So we don't expect that to catch up because that's out there, and we fulfilled that. And as Steve said, the units were pretty much on as we expected. Again, as we move into Q2, we're expecting a similar level and probably -- again, a similar level away from the numbers that were already out there. So I'm not expecting a huge pent-up demand because of that situation. But that said, in terms of the other opportunities and some of the HPC business that we see, which again, as we talked about on previous calls, we're only expecting to see revenues in the back half of the year, then as per the numbers that are out there today, we are expecting to see a tick up in Q3 and Q4, but I wouldn't expect it to be a huge change because of this reduction in disks in the first half of the year. And where we are in Q2 versus '11 on a total, yes, I'd say low teens, if anything in terms of a revenue year-on-year. Again, pretty much in line with the numbers that out there today.

Operator

At this time, I'm showing no further questions in queue. I would like to turn the call back over to Mr. Brad Driver for any closing remarks.

Brad Driver

All right. Thank you, Derek. Once again, I'd like to thank you for joining us this afternoon. We look forward to speaking with you again on our Q2 earnings call, which should be scheduled for late June.

Also, on May 23, we'll be at the Barclays Technology Conference in New York, and on June 4, we'll be at the Brean Murray Conference in New York. As always, you're welcome to call me if you have any additional questions over the course of the quarter. For now, have a good weekend.

Operator

Ladies and gentlemen, that concludes today's conference. We thank you for your participation. You may now disconnect. Have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Xyratex's CEO Discusses Q1 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts