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STEC, Inc. (NASDAQ:STEC)

Q4 2007 Earnings Call

March 5, 2008 4:45 pm ET

Executives

Mitch Gellman – Vice President, Investor Relations

Manouch Moshayedi - Chairman of the Board, Chief Executive Officer

Dan Moses - Chief Financial Officer, Executive Vice President, Director

Analysts

V. Rakeesh

Rich Cojo

Daniel Gelbtuch

Richard Shannon

Sal Kameldon

Bryan Algers

Doug Reed

Rich Cooglie

Jill Marceloni

Owen Hishman

Operator

Good afternoon. My name is Tomeka, and I will be your conference operator today. At this time I would like to welcome everyone to the STEC Quarter 4 and full year 2007 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session (Operator Instructions).

Thank you. I will turn the call over to Mitch Gellman, Vice President of Investor Relations. Please go ahead, sir.

Mitch Gellman

Thanks, Tomeka. Welcome, everybody. Good afternoon, and thanks again for joining us today for our Q4 and full year 2007 earnings conference call. I’d just like to give you a quick update. Our next conference presentation will be April 2nd. That’ll be at the B. Reilly & Co. annual investor conference in Las Vegas at the Palms Casino Resort and again we’re presenting on Wednesday, April 2nd. Now joining me for today’s call out Chairman and CEO, Manouch Moshayed, and our Chief Financial Officer and Director, Dan Moses.

Various comments about the company’s future expectations, plans and prospects made during today’s earnings conference call, including the question and answer session constitute forward-looking statements within the meaning of section 27A of the Securities Act of 1933 as amended, and section 21E of the Securities Act of 1934 as amended, and are based on management’s current expectations. These forward-looking statements entail various significant risks and uncertainties that could cause our actual results to differ materially from those expressed in such forward-looking statements. The risks and uncertainties are detailed under risk factors in followings with the securities and exchange commission made from time to time by us, including our annual report on form 10-K, our quarterly reports on form 10-Q, and our current reports on form 8-K, including the form 8-K filed earlier today for this news release. The filings are available under the category SEC filings in the Investor Relations section at our website, which is www.stec-inc.com. Forward-looking statements in this teleconference are generally identified by words such as beliefs, anticipates, expects, intend, may, will, and other similar expressions; however, these words are not the only way we identified forward-looking statements. In addition, any statements that refer to expectations, projections or characterizations of future events or circumstances are forward-looking statements. Listeners are cautioned not to place a new reliance on these forward-looking statements, which represents our views only as of today. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change and; therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to today.

Thank you very much again for joining us and now I’d like to turn the call over to Dan Moses, our CFO.

Dan Moses

Thank you, Mitch, and welcome everyone. We believe that we’re at a very exciting time in our company’s history. In the past year, we’ve entered three new SSD product lines, ZeusIOPS for enterprise storage, MACH8IOPS for enterprise servers, and MACH8 for laptop computers. In January of 2008, we announced the adoption of our ZeusIOPS line of SSDs by one of the world’s largest enterprise storage manufacturers for integration into their high performance systems. We expect production level to ramp for this customer in future quarters. In addition, we are in the qualification process with our MACH8IOPS and MACH8 using MOC product lines with some of the world’s largest server and lap OEMs and we are receiving tremendously positive feedback from these OEMs about these products.

By the end of 2008, we expect each of these three new product lines to make significant contributions to our revenues, which could have a dramatic impact on our operating profit. In addition, we have completed construction of our 200,000 square foot facility in Malaysia, which we believe will reduce our average production and administrative costs in the future. Further, we expect our global tax restructuring project to be fully implemented by the end of the first quarter of 2008. As the Malaysia facility begins to ramp up to significant production volumes, we expect that the completion of this global tax restructuring project result in a significant impact in reducing our effective tax rate in 2009 and 2010 and beyond, which could significantly improve our earnings per share.

For the fourth quarter of 2008 on a continuing operations basis, revenues by product line were as follows: Flash memory was $32.7 million dollars or 62% of our total revenues, which was an increase from $27.8 million dollars in the third quarter of 2007. DRAM memory was $18.6 million dollars or 35% of total revenues, which was an increase from $14.2 million dollars in the third quarter of 2007, and service revenue was $1.7 million or 3% of total revenue. International sales comprise 19% of our total revenues in the fourth quarter of 2007.

Our average sales price for non-service revenue increased from $30 dollars per unit in the third quarter of 2007 to $37 dollars per unit in the fourth quarter due to a product mix change towards higher capacity products. Our average shipment density for our memory or non-service products increased from 1.1 gigabytes per unit in the third quarter of 2007 to 1.3 gigabytes in the fourth quarter of 2007. We shipped 1.4 total non-service units in both the third and fourth quarters of 2007.

GAAP results included several expense items that we do not expect to recur in our long-term operating model. These items are detailed in our fourth quarter of 2007 earnings release issued shortly ago, earlier today. The following comparisons are based on non-GAAP operating expenses from continuing operations for the third and fourth quarters of 2007. Non-GAAP sales and marketing spending increased from $4.0 million in the third quarter of 2007 to $4.5 million in the fourth quarter of 2007, due primarily to increased commissions due to higher revenue and the addition of new sales personnel.

Non-GAAP general and administrative spending increased from $3.6 million in the third quarter of 2007 to $4.1 million in the fourth quarter of 2007, due primarily to increased support and payroll costs related to systems implementation and to support quality, financial planning and global expansion initiatives.

Non-GAAP research and development increased from $3.6 million dollars in the third quarter of 2007 to $4.1 million dollars in the fourth quarter of 2007, due primarily to the global expansion of our research and development efforts and increased focus in spending on our SSD product development.

Capital expenditures were $6.4 million dollars during the fourth quarter of 2007 and depreciation expense was approximately $1.3 million dollars during the quarter. The capital expenditures related primarily to construction costs for our new Malaysia facility.

We are projecting first quarter of 2008 results to range from revenue of $45 to $47 million dollars with diluted non-GAAP earnings per share ranging from 2 to 3 cents.

Thank you again for joining us today. This concludes our prepared remarks and now Manouch, Mitch, and I would like to open it up for questions.

Question-and-Answer Session

Operator

At this time, if you would like to ask a question, press star 1 on your telephone keypad. We’ll pause for a moment to compile the Q&A roster. Your first question comes from line of V. Rakeesh.

V. Rakeesh

Hi guys. I just want to get a little bit idea on the gross margins. Where do you see margins for calendar ’08 and the tax rate here. I know you probably get a benefit from tax rate from the finance facility on tax rate for next year, but how do you see margins and tax rates here for this year?

Dan Moses

It’s going to depend on mix. We’ve got three new exciting product lines and the one thing that we do have great visibility on is that we are in front of some very large customers and qualification processes going very well, but it’s difficult when you look out through the entire year to see how quickly they ramp up and at what rate. So it’s difficult to say by the end of the year what mix, you know, what’s going to be the mix of the high margin SSD products. It’s difficult to project margins. We’re expecting SSD to become the newer SSD product to become a significant portion of our mix by the end of the year and if that’s the case we would expect margins to be increasing once we get toward the end of the year, but I think it’s a little difficult to actually pinpoint a number at this early stage in the launch of these products.

Manouch Moshayedi

It’ll damage and it’s going to depend on the mix as all of our new product lines, the SSV line, which carries a higher margin than our DUM business. We fully expect our DUM to be a smaller percentage of our sales going forward; therefore, the low margin business is going to diminish as a percentage of the total revenue. So we fully expect our margins to grow quarter to quarter.

V. Rakeesh

So you said five to ten enterprise SSD in ’07, was it mostly in Q4?

Manouch Moshayedi

Yeah, we did total of I think of $11 million dollars in 2007 and I think up to Q4 we had done somewhere around $4 million dollars.

Dan Moses

We probably had about $7 in Q4.

V. Rakeesh

As you look, let’s say if you look toward the end of ’08, what could SSD…can you give a bracket? Can SSD be 15 like Q4 of ’08? Probably 15%...?

Dan Moses

I think it was 15% last quarter or so. Could be, for sure, well not quite 15%, but $7 million out of $53 million, so it was approaching that already last quarter. So of course it could higher than that, but again it’s very difficult to project where we’re going to be even in quarter, two, three quarters out, but we’re very optimistic about how it will look

Manouch Moshayedi

We are planning for success of this type of a product line in SSDs and today we are the leader in the market in SSDs and we continue to invest in our R&D to stay above the rest of the competition out there. So definitely we are thinking that other [inaudible] are going to grow bigger.

V. Rakeesh

Can you give a little bit idea on the company landscape on SSD? You guys are the first to market here. How do you see progressing through the year?

Manouch Moshayedi

Well, I’m sure all of the major players today are providing Flash components will be competitors in this market, whether or not their focus is going to be on the lower end, mid end, or the high end. That’s still questionable; however, we think that we still have at least a couple of quarters head start on everybody else and we are getting to see and talk to the biggest OEMs on the service side and the laptop side. So we feel pretty confident that we’ll be the first and when the large production of these SSDs come into the market. So whatever happens in the future, we are planning for success and we hope that we can stay as one of the vendors to the big EOMs. On the ZeusIOP product line, we still don’t see any competitor coming close to having a product, so that might be something that people might be planning for late 2009, but as of this point, we are not seeing anyone coming close to the performance of that product.

Dan Moses

And also, even if they were to come out with a product that was in the same class of our product, it took us with our biggest customer that produced IOPS, it took us about seven or eight months of daily engineering calls to optimize firmware. It’s not a plug and place solution to optimize these products in the system. So this is something that somebody can introduce something, but it’s still going to take a significant amount of collaborative effort between that company and their potential customers to be able to get it to work in their system.

V. Rakeesh

One last question, given that the enterprise is kind of a growing market, is it going to stay flat…?

Manouch Moshayedi

By the first half of this year, I would say all of the parts that we sent out in 2007, samples, are going to be put into systems and sent out to end user customers. So I would say that probably starting second quarter or end of second quarter we’re going to start seeing production level type of activities of SSD customers. On the laptop side and the service side, we would think that production would start somewhere around third to fourth quarter of this year.

V. Rakeesh

Thank you.

Manouch Moshayedi

Thank you very much.

Operator

Your next question comes from the line of Rich Cojo.

Rich Cojo

A few questions. First, on MACH8 for the server side, can you give us a sense on what you think really the addressable market is among the server customers? Since it is largely targeting the high transactional data environment, what we should really thinking with the total market opportunity, regardless of whatever year we’re referring to.

Manouch Moshayedi

Well, right now we are talking to several customers on the high end server side for the market IOPS for that line and I would say that each one of them, their requirements or what they’re doing today is in the hundreds of thousands of units a year. So it’s a pretty large product line on the market, IOPS side of things. On the MACH8 MOC for the laptops, it’s going to run into hundreds of thousands of units per quarter when we get to go to production with some major laptop manufacturers.

Rich Cojo

Which actually leads me to my second question, what do you think that the sweet spot of the market is for a laptop SSD? Some of the data today suggests that as desktops are replaced by laptops, the average capacity continues to move higher and so just wondering where the best opportunity is for SSDs to play in laptops?

Manouch Moshayedi

I would say the beginning of this year would be 64 gig drives, but I would say probably the beginning of next year will be 128 gig. Right now, we are qualifying both 64 and 128 gigs, so it would be somewhere in the middle of it, but I think we’re going to integrate into 120 gig as the products of MOC components continue to come down.

Rich Cojo

Okay, lastly on the ZeusIOPS, initially I believe your goal was a $50 million type number for ’08 with 40 of that or so roughly coming from one major customer that’s already announced the product line. Do you still anticipate that as being the right way to think of ’08 or any updates there?

Manouch Moshayedi

We are still very optimistic about ’08 with major production in the second half of this year. We are seeing a huge amount of reception from the major storage guys and everyone is absolutely in love with that product line. So we don’t see anything that will upset the numbers that we’ve already put out on the ZeusIOPS. We think that as we go through the year and [inaudible] prices might also drop a little bit, we will also see bigger and bigger integration of SSDs into the very high end storage systems.

Rich Cojo

Thank you very much.

Manouch Moshayedi

Thanks a lot, Rich.

Operator

Your next question comes from the line of Daniel Gelbtuch.

Manouch Moshayedi

Hi Daniel. Daniel Gelbtuch.

Daniel Gelbtuch

Hi. It’s okay. It’s been butchered in the past many times. I wanted to get just the previous question. What kind of activity are you seeing on the SSD enterprise server and for regular server, our enterprise storage and regular server? Should we expect to see another [inaudible] OEM on the enterprise side?

Manouch Moshayedi

We hope so. We hope that within the next quarter and a half, we’ll be able to announce major customers coming online on the server side of things. We are right now in discussions with all of the major players who are selling enterprise servers into the market. We have the highest IOPS and highest performing drive out there. Plus because of our 14 years of experience in SSDs, I would say that we probably understand more about the whole SSD performance and Flash performance than anyone else out there. So I think our customers definitely appreciate what we bring to the table and at this point we’re the only ones playing in that market still until either has come up with the same type of product line. So we’re very hopeful on that.

Daniel Gelbtuch

So there wouldn’t be anything incremental from your perspective on the competitive front?

Manouch Moshayedi

Well not at this rate; however, I would say that by the…we have seen in announcements from the major Flash manufactures that are coming out with similar types of products as the MACH8IOPS, somewhere the end of this year. So we’ll have to wait and see whether or not that actually comes true.

Daniel Gelbtuch

Now last question, are you still comfortable with your guidance for ZeusIOPS that you gave previously. There’s been some discussion by some of the other analysts out there that that number is going to be dramatically lower than what you guided to.

Manouch Moshayedi

I don’t think that the analyst report was correct, but we are still very confident about the numbers we put out. Maybe people are not calculating the same type of things that we are seeing and they don’t have access to the same information as we do. We think that we are still in line to do the numbers that we had already put out. We see tremendous amount of excitement out of the stories customers about SSDs as a whole and integrating Flash into the systems. That is across the board from all of the major players in the storage markets. So ZeusIOPS is the highest performing drive that’s out there. In this market where everyone is trying to conserve cash and capital, we are seeing good amount of end user customers come forward to our customer and want this product simply because on a go-forward basis, it save them somewhere around 90% of cost of ownership. So even in a slowdown economy, people will see our ZeusIOPS as a sving type of a product rather than expenditure.

Daniel Gelbtuch

I got you. Well, I appreciate it. Thank you very much.

Manouch Moshayedi

Thanks a lot.

Operator

Your next question comes from Richard Shannon.

Richard Shannon

Can you hear me? Okay, great. I guess first question on your guidance for the first quarter, Dan, I wonder if you could discuss some of your implied numbers for gross margins and OP-EX and what, if any, excluded costs that you’ve excluded in past quarters do you expect to see in first quarter as well?

Dan Moses

We eluded the trending from the past six months of non-GAAP and I’d have to pull my model to give you more detail, but give me a second and I’ll pull it up here.

Manouch Moshayedi

Any other questions?

Richard Shannon

Curious as you go throughout the year and you start to see a ramp up in your SSD products, does that squeeze out and allow you to be more selective on your DRAM products to any extent? Do you see that this year, do you see it next year, or not at all?

Manouch Moshayedi

If you look at our DRAM customer base, these are very large customers we’ve had for many, many years and we’re not going to cut out that product line to these major customers. So we’re going to keep on going forward. We’re going to push forward with the DRAM also; however, because we’ve got such a huge concentration on SSD and we’re talking to such major customers, we believe that our SSD business and as a whole our Flash business will grow much more rapidly than our DRAM; therefore, as a percentage of revenue our forecast is that our DRAM will drop to less than 30% of total revenue by the end of this year.

Dan Moses

I’ve got my model up, so basically with kind of seeing decline in revenues, is we’d expect a nominal drop in margins. So expect somewhere between a half and a point drop in gross margins just because of the lower revenue base and spreading out kind of a fixed production cost over the less units in revenue. As far as operating expenses, expect sales and marketing to be relatively flat, maybe slightly down, because of the lower revenue base. Then we’re expecting some continued growth in R&D and G&A as we’re trying to support all this transition stuff that’s going on. So you might see a little bit of a creep up again in R&D and G&A. R&D, our plan by design is to continue to try to add additional engineers and stay ahead of the technology curve. So the R&D I would model continued growth in that, every quarter. G&A, I think we get to a point where we flatten out.

Richard Shannon

In the revenue composition, do you expect Flash to be relatively flat or will that decline as well?

Manouch Moshayedi

No it’ll be basically the same percentages I would say.

Richard Shannon

And Manouch, did I hear you say earlier in response to a question that you’re working with essentially all of the major OEMs and servers with your MACH8?

Manouch Moshayedi

Yeah, MACH8IOPS, yes.

Richard Shannon

And are you working with what you would call the major ones in the laptop area as well?

Manouch Moshayedi

Yes, on the MACH8 and OC.

Richard Shannon

Last question for you, Manouch. You talked in the past quarters about creating some type of partnership to get some preferential and well priced Flash memory. Can you give us an update on what’s going on there right now?

Manouch Moshayedi

The discussions are still ongoing and they’re taking a little bit longer than I’d expected, but when you are talking to major [inaudible] guys, that’s what you’re going to get. I think we’re still going to have at least a couple more quarters to go before we conclude something.

Richard Shannon

Is there any particular road block that’s in the way there or is it just taking more time?

Manouch Moshayedi

Just taking more time.

Richard Shannon

Thanks a lot, guys.

Manouch Moshayedi

Thank you, Richard.

Operator

Your next question is from Sal Kameldon.

Sal Kameldon

The $7 million number for the SSD business in Q4, was that all ZeusIOPS?

Manouch Moshayedi

Yes.

Sal Kameldon

Okay, and did that include any stocking orders from the large OEM you announced in the quarter?

Manouch Moshayedi

Stocking orders, I don’t know what that means.

Sal Kameldon

Orders that were not for sampling purposes. Orders that were going to get shipped.

Manouch Moshayedi

As I mentioned, our customers are still in evaluation time period, so I think production will be coming out at the end of this quarter sometime. So we’ll probably see production of these components go out during the quarters as we move forward. So second and third quarter will be obviously a lot higher than what you’ve seen in the past.

Sal Kameldon

So if the $7 million in Zeus drives in Q4 is backed out of the $32.7 million number for Flash and aggregate, it looks like you did $25 in Flash revenue and if you do the same thing for September in back Zeus, it was also $25 million, so it looks like the core business excluding Zeus was kind of flattish in a quarter that’s usually seasonably stronger there. So we read anything into that?

Manouch Moshayedi

No, prices took a huge hike in the third quarter of last year and then they flattened back down again in the fourth quarter. So I would say that you probably saw higher volumes in the fourth quarter than you got in the third quarter. So I would say that we still had a growth advantage on that one.

Sal Kameldon

So higher volumes basically offsetting lower SSDs in the core business?

Manouch Moshayedi

I think so.

Sal Kameldon

How do you see your business trending with your current large networking customer in ’08 and I think you guys have touched upon what your position was going to be with that customer in the past and just wondering if you can give us an update on that and how you see that trending.

Manouch Moshayedi

As far as I know, our customers are extremely happy with our performance and they keep on staying with us and we really appreciate their loyalty to us and we do everything that we can in our power to stay competitive and give them the best technology out there and we’ve been performing for the past 18 years and we keep on doing the same thing. I think we are all planning for growth in that area also.

Sal Kameldon

Okay, so for the model, we can model year-over-year growth in ’08 relative to ’07 for the core business, excluding ZeusIOPS?

Manouch Moshayedi

I would think so. Yes.

Sal Kameldon

Then just a little more clarity on the guidance for Q1, what kind of revenue mix are you projecting relative to Q4?

Manouch Moshayedi

Same percentages as you saw from Q4. Dan mentioned somewhere around 35% year…and 65% or 64% Flash, a couple of percentage points in service revenue.

Sal Kameldon

Okay great, and last question, any 10% customers?

Manouch Moshayedi

Same as before.

Dan Moses

Se have a K coming out next week, mid to late next week.

Sal Kameldon

Thanks.

Manouch Moshayedi

Thank you.

Operator

Your next question is from Gordon Johnson.

Manouch Moshayedi

Hello, Gordon, how are you?

Gordon Johnson

Manouch, how are you, sir? Thanks for taking the question and congrats on the winning to EMC. I think that’s a big win for you guys. I guess a lot of my questions have been answered. One question I did have is on the operating margins, it seems like the facility in Malaysia that’s ramping kind of impacted those numbers a bit. How do we look at that moving forward? Is that going to have an impact on the first quarter and should we start to model for the benefit of that facility in the third and fourth quarter?

Manouch Moshayedi

No I would say that our Malaysia facility will kick in in earnest somewhere around third quarter of this year. So for now, we are setting up machinery, we’re producing some parts out of Malaysia; however, not enough to impact the overall sales, but I would say somewhere around third quarter will be the time where we’ve got all the machines fired up in Malaysia and contributing in a major way to withhold revenue.

Gordon Johnson

Dan, it looks like the tax rate this quarter from a non-GAAP perspective was a bit higher than we were expecting. How should we look at modeling that moving forward?

Dan Moses

Are you going with GAAP numbers or non-GAAP numbers?

Gordon Johnson

Non-GAAP.

Dan Moses

Okay so non-GAAP we basically have been taking the effective tax rate down to 37%, which has been our historical tax rate. What’s happening is, I don’t know if you want all the details of it. I can give you all the details offline, but basically we’re in a setup period where there will be, you know, when Malaysia starts to ramp up in full, we’ll see the significant drop in tax rate, but in order to set up to get it to that point, you end up with a short-term period where the effective tax rate is higher. So that’s what we’re seeing and that’s why we’re performing at 37%, but I would think that we’re hoping as early as maybe Q4, if not Q4 this year, Q1 next year, we should start to see our rate drop below our historical rate of 37% and it’s going to depend a little bit on the mix how quickly it drops, but we think long-term, I think 20% is easily reachable in the long-term plan for us, but I would probably leave it flat at 37% this year and then as we start to get more business we can maybe give you more guidance on how quickly it’s going to start to drop.

Gordon Johnson

On the gross margin line, I noticed some questions have been asked there, but it seems like there may be some slight pressure there and I wanted to get your insights on, Manouch, are you seeing any pressure specifically at CISCO in your CF Flash card business from a pricing standpoint?

Manouch Moshayedi

I can’t comment on particular customers; however, the overall mix of last quarter was pretty good and you said that we had margin pressure; however, actually our margins went up .6%. So there wasn’t any from third quarter to fourth quarter. As I’ve answered before, as our SSD business grows, we fully expect our total gross margin will grow with it also.

Gordon Johnson

I guess I was talking about the guidance. It seems like you guys are saying margins will be down slightly.

Dan Moses

That was just because of the lower revenue base. You got to still spread your fixed production. You know, your machines don’t go away if you’re building less units. They still have to spread some of your kind of short-term fixed production labor and overhead cost over a smaller revenue base. That typically will put a little bit of pressure on the margins, but probably not too significantly.

Gordon Johnson

Lastly, when we look at the systems that EMC is going to be ramping here, it seems like towards the end of March, the DMX4 systems, can you guys give us some kind of view of how many I guess terabytes we should expect on each system?

Manouch Moshayedi

As I mentioned, we can’t comment on any other customers. Confidential information.

Gordon Johnson

Thanks a lot, guys.

Operator

Your next question is from Bryan Alger.

Bryan Alger

Thanks for taking the questions. Congrats on a good quarter. A number of questions. First was regards to the performing calculation. I’m a little bit new to how you guys are approaching things and I just want to understand the logic behind not including the startup cost tied to Malaysia or the startup cost in winning EOM business. When obviously going forward, we’re going to recognize the benefits of those expenses.

Dan Moses

The theory is that we’re going through a short-term transition period. I mean we’re not going to be starting up a new manufacturing facility anytime hopefully ever again after all the work that’s gone into it now. So this is a one-time period where we’ve got over a hundred people in Malaysia who are learning and training and really not contributing to the success of the overall company today. They certainly will be here shortly in a few quarters. If you look at all these extra costs incurred today, once they start to contribute it wouldn’t be, kind of comparing apples to apples to look at when they have idle people not contributing to it. A year from now, when they’re doing a significant share of our production and other functions, we will be gaining the benefit of that. Right now, we’re not getting any benefits. We look at it as kind of non-recurring startup. The other one, right now it’s kind of a historic time for us in that we’re really launching three new high end technology product lines, which is probably never been in this type of situation in the past. So there are certain startup costs affiliated with that we would expect. We typically wouldn’t be launching three major product lines at one time. What we’re trying to do is pull out the things that we don’t expect will be a normal recurrence in the future.

Bryan Alger

So it’s not like we’re trying to drive toward cash-based earnings or anything like that…more ongoing comparison.

Dan Moses

Yeah, we’re going through a lot of transition. We sold our consumer division last year. We had arbitration, significant arbitration costs related to that. We’re ramping up this big Malaysia facility, you know, a lot of things. We’re changing our tax structure, which will help us. All these things are going to be helping us I think significantly long-term, but we’re trying to make it a fair presentation once things kind of settle in. So when you look back and compare next year’s numbers to this year’s numbers, you’re going to have a pretty even comparison when everything is kind of up and running where it should be.

Bryan Alger

Fair enough. I want to come back to the question that everybody is kind of dancing around. Manouch, it’s public information with the configuration of the DMX4 and how much Flash it contains and how much it can scale up to. You guys have also given us some ASPs with regards to what to expect. Your various configurations to generate on those is IOPS. Do you believe that there’s going to be demand in 2008 for well over half a petabyte of solid state drivers in 2008. If so, where is that coming from? What’s the evidence you have for that, because clearly we can all understand the gross margin levers that comes into your business model and how much earnings growth we can see if we can count on those solid state drive numbers, but without solid state, it’s clear that your core business is start to declining and under margin pressure, which makes one wonder how should we value the company and how much confidence we have in the earnings growth.

Manouch Moshayedi

First of all, on the core business, our core business is not dropping. The number of units that we’re shipping is growing to our core customers. The price of Flash is coming down and we have to drop our prices based on price of Flash on a year-to-year basis and a quarter-to-quarter basis. We’re definitely still planning for growth of our core business this year by 20% or so, 20 to 25%; however, we feel that our SSD business is something that’s has got huge growth in front of it. On the ZeusIOPS, we are saying major companies look at that product an see where they can integrate it into their systems and then the way that they would present it to their customers. It would show the customer that they can actually save money by going and buying a product that has got ZeusIOPS in it rather than a hard drive. We can deliver an IOP about 95% cheaper than a hard drive can using our ZeusIOPS even though it is very high priced today. So I can’t give you the specific numbers, specific customers and numbers and what their usages are, but I can just tell you that today we’re talking to all of the major storage companies and even though one was earlier to market than everybody else, everybody else is looking at this thing and saying—hey, you know what? This actually makes sense and maybe beginning of next year they will come with our business. The fourth quarter of this year they might come to this business. So it’s going to take an amount of time for those people to integrate the ZeusIOPS into their system also, but we are definitely still very, very confident about the numbers that we put out, which was 10,000 drives at an average cost of $5,000. So we are not retreating from that number. So if you guys have got a different number from different customers, from all I’ve seen to this point, analysis that I’ve seen, that’s ever publicized…I haven’t seen anything that is compelling enough for me to even comment on yet.

Gordon Johnson

Fair enough. One last follow-up for Dan just quickly on the cash side of things. You got some Cap X going on. You obviously have some one time expenses as you’re bringing up Malaysia. What do you expect the cash to be exiting the first quarter?

Dan Moses

Probably I think we’re spending, we have some new machines coming into the Malaysia facility. We were operating out of a smaller 25,000 square foot facility. So I would say we’ve probably got about another $6 to $8 million of equipment that’s coming, maybe $10 million, maybe maximum coming off into the Malaysia facility through maybe April timeframe. So you might have another drain of maybe another $10 million, hopefully some of that’s offset by some profits, but that should be pretty much, that should set us up for the foreseeable future over there. We’ll have tremendous amount of capacity once we spend that.

Manouch Moshayedi

Fourth quarter and this quarter, we purchased over $2 million shares at an average cost of 70 to 74. So $15.5 million dollars have been spent on buying back shares at this point. Some of our cash has gone to that. So end of this quarter, somewhere around $75 million.

Bryan Alger

Guys, thanks for taking all my questions. Appreciate the direct answers.

Operator

Your next question is from Doug Reed.

Doug Reed

A couple of quick questions. First Micron and Intel released a high-speed chip about four or five weeks ago. Just wondering if that’s something that FTC is interested in sampling and if they are sampling and if there would be new products based on that product?

Manouch Moshayedi

A chip? What do you mean by chip? Flash chip?

Doug Reed

Yeah…five times faster than a standard…

Manouch Moshayedi

Right now we’ve got only one or two vendors out there with chip function and SSDs. We’re sticking with those for the foreseeable future until we can get other parts into our systems.

Doug Reed

Okay. Then looking at the financial statements. R&D on non-GAAp basis looks like they capped up about almost $ .9 million and sales and marketing capped up about $ .7 million. I’m not sure if you talked about that specifically.

Dan Moses

I gave some in the script. R&D by plan, we’re constantly trying to add R&D. We’re an R&D driven company at this point in time, so we’re looking for talent in our related field constantly. So our plan is to continually add head count. So by nature, we expect R&D to grow every single quarter. Sales and marketing, some of that is new hires. We’re hiring new sales people to help us handle all of our customer opportunities. We’ve actually have added two new sales VPs and we have a total of four now in the last few months. So there’s a lot of opportunity that we’re juggling and managing. So we’ve added some head count and in addition with a higher revenue base, you’re going to have some higher commissions as a result.

Doug Reed

So you would expect those to scale with revenue as it has in this past quarter, in essence?

Dan Moses

Yes, sales and marketing will kind of move up and down if there’s revenue fluxations, up or down, but R&D typically will grow every quarter.

Doug Reed

This last question is for Manouch. Some hard disk manufacturers CMX4 as creating a new tier of tier zero and that it doesn’t really affect tier one hard disk drives. Is that what you guys are seeing as well or something different?

Manouch Moshayedi

I think obviously data storage as a whole category is growing. So I would say hard disk drive manufacturers are seeing growth, but the growth that’s coming from just putting stale data on the hottest drives in the future. So maybe you put all your data and you’ll never look at in a hard drive; however, everything that you will touch and feel on a daily basis, it will be on SSD. That is our belief. We’ve seen that already from customers who are very excited about our SSDs and that is what they’re planning. So yes, at the beginning stages we will see that at only the front end of all the systems, but these guys are kidding themselves if they think the best [inaudible] is going to stay. I would say that from laptops to servers to all of the big storage systems, everything will be affected by the SSD.

Doug Reed

Thank you very much.

Operator

Your next question is from Rich Cooglie.

Rich Cooglie

Thank you. Just a couple last questions here on the Malaysian facility and how it plays in. In particular, what do you expect to manufacture first and then when should we expect all the manufacturing has been transferred over to the facility?

Manouch Moshayedi

We’re not planning at any time in the near future or future future to move all of our manufacturing to Malaysia. Our Malaysian facility will take up majority of our growth and majority of whatever they’re producing today; however, the first addition will be on the compact Flash type of product line and then once we have solidified the ZeusIOPS and SSDs in terms of building them and testing them, then we’ll start to transition, but I wouldn’t expect building in Malaysia yet for the next three or four quarters.

Doug Reed

Okay, and then just lastly on ZeusIOPs and some of your major wins there. Those customers tend to be quite demanding from a pricing perspective, in particular on volume purchases. Do you anticipate having to, as you move further into the year, you get a little bit more volume under your belt on that side, having to give up some of those margin gains in price reductions? Has any of that mapped out today or is this something more that we’ll see in’09?

Manouch Moshayedi

We don’t think we’re going to have margin pressure as a result of efficiencies of bringing into the manufacturing and the cost of the components…the ZeusIOPS as a whole and then the Flash components themselves coming down in price. That’s why we have modeled the average price of our ZeusIOPS to be in the $5,000 dollar range rather than a $10,000 range last year. So there is a 50% drop in price on last year to this year, modeling about 10,000 units being sold this year.

Doug Reed

But we shouldn’t be seeing that type of a decline for ’09?

Manouch Moshayedi

For ’09? That all depends on from that point what happens to the Flash, you know, from all looks of it, yes. From the way that we are hearing everybody is building new Flash frontlines and ability of Flash and since SSD will be using mostly the SLC type of Flash, we would assume that everyone’s percentage of SLC manufacturing will go up as we move forward in 2008.

Doug Reed

Okay. Thank you very much.

Operator

Your next question is a follow-up from Richard Shannon.

Richard Shannon

One quick question. Manouch, you’ve talked about the particular length of time that you had worked with the MC on the firmware. I’m curious as to how many other storage vendors that you are currently in some sort of firmware development work with?

Manouch Moshayedi

Richard, we cannot say anything about a customer and mention the customer as a whole, but it will take about a year for our ZeusIOPS to get qualified as any customer as a whole.

Richard Shannon

But you can’t mention the number of customers?

Manouch Moshayedi

All of the major customers are in storage. You can just go ahead and put that in Google and the names will pop up, but it’s all of the major storage guys out there who do storage products.

Operator

Your next question comes from the line of Jill Marceloni.

Manouch Moshayedi

Jill Marceloni, how are you?

Jill Marceloni

Regarding Q1, do you see Zeus growing versus Q4 or do you think it’ll take a seasonal decline in Q1?

Manouch Moshayedi

We’re not sure yet in Q1 versus Q4. So we wouldn’t be able to tell you exactly what’s going to happen to ZeusIOPS if we’re going to ship more or less this quarter. So can’t be that specific about it, but I would say that we are looking at ZeusIOPS as something that we will see grow, a significant growth at the end of second quarter and then going into fourth quarter, because all of the parts that you’ve shipped have gone into systems and things like that that they still have to be shipped to customers and get production units out of orders from customers at that point.

Jill Marceloni

So it sounds like given that we’re sort of already in March that it could be pretty back-end loaded for the quarter I guess. In that we’re already in March, the March quarter, it sounds like the Zeus sales could be fairly back end loaded for the quarter and then begin to ramp into Q2 in the remainder of the year.

Manouch Moshayedi

Yeah, I would say that we shipped quite a good amount of ZeusIOPS in Q4. So Q1 will be back end loaded going into Q2 and basically all kinds of major production in Q3, Q4 of this year.

Jill Marceloni

Great. Thanks again, guys, and good luck on 2008.

Manouch Moshayedi

Thank you, Jill.

Operator

Your next question is from Owen Hishman.

Owen Hishman

Hi, how are you? Good. You mentioned all products have been in the qualification system. Have those systems finished qualification so to speak so there’s no technological risk at this point?

Manouch Moshayedi

I don’t think there was that many yet sold in end units, so we are expecting those to be sold in the next quarter or two quarters. So hopefully we get positive feedback, which we fully expect, and we will be able to get very good production numbers going into Q3 and Q4 as we have planned.

Owen Hishman

Just again, my question was vented on whether there’s any technological risks at this point in terms of having what the customer wants. In other words, are we going through all the cost casing?

Manouch Moshayedi

No, I don’t think so.

Dan Moses

I don’t think the customer would feel comfortable to announce they had any worries. If there was any technological issues, I wouldn’t notice that.

Manouch Moshayedi

No, we haven’t seen anything.

Owen Hishman

At this point, actually getting orders from the end customers. They said they’re actually in the field selling at this point?

Manouch Moshayedi

Again, I can’t comment on my customers’ marketing and sales parameters and strategies. So you got to go ask them.

Owen Hishman

Thank you.

Manouch Moshayedi

Thank you very much.

Operator

At this time, there are no further questions.

Manouch Moshayedi

Thank you very much. Thank you for joining us today.

Operator

This concludes today’s conference. You may now disconnect.

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