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Fusion-io, Inc. (NYSE:FIO)

F1Q13 (Qtr End 09/30/2012) Earnings Call

October 24, 2012 5:00 pm ET

Executives

Nancy Fazioli - Investor Relations

David Flynn - Co-Founder, Chief Executive Officer and President

Dennis Wolf - Chief Financial Officer and Executive Vice President

Analyst

Brent Bracelin - Pacific Crest Securities

Katy Huberty - Morgan Stanley

Aaron Rakers - Stifel Nicolaus

Mark Moskowitz - JPMorgan

Amit Daryanani - RBC Capital Markets

Bill Shope - Goldman Sachs

Edward Parker - Lazard

Kulbinder Garcha - Credit Suisse

Ben Reitzes - Barclays

Alex Kurtz - Sterne Agee

Srini Nandury - Summit Research

Andrew Nowinski - Piper Jaffray

Brian Freed - Wunderlich Securities

Roxane Googin - Global Investment Research

Operator

Welcome to the Fusion-io first quarter 2013 earnings call. (Operator Instructions) I would now like to turn the call over to Nancy Fazioli, Investor Relations.

Nancy Fazioli

Thank you, Anthony. Good afternoon, everyone, and welcome to Fusion-io's fiscal first quarter and 2013 earnings conference call. On the call today are Fusion-io's CEO, David Flynn; and CFO, Dennis Wolf.

Please note that a replay of this call will be available on the Investor Relations page of our website at fusionio.com within a few hours and will be available for at least a week from the time of this call. Unauthorized recording of this call is not permitted.

During today's call, we will be referencing both GAAP and non-GAAP financial measures and wish to note that a copy of the press release and financial tables, which include a GAAP to non-GAAP reconciliations and other supplemental financial information, is available on the Investor Relations page of our website. Some of the statements we will make during this call constitute forward-looking statements within the meaning of the federal securities laws.

Accordingly, we wish to caution you that such statements are just predictions based on current expectations and assumptions regarding future events and business performance, and involve risks and uncertainties that could cause actual results to differ materially. We refer you to the registration statements and reports that we file with the U.S. Securities and Exchange Commission, which are available on our website and identify important factors that could cause the actual results to differ materially from those contained in our projections and other forward-looking statements. Fusion-io undertakes no obligation to update any forward-looking statements to actual results or changes in the company's expectations.

Before taking questions, Dennis will explain on our results and then David will close with some prepared remarks. With that, I'll turn the call over to Dennis.

Dennis Wolf

All right, thank you, Nancy, and good afternoon everyone. Thanks for joining us today. For the fist fiscal quarter, Fusion-io reported record revenue of $118.1 million, an increase of 11% sequentially, which also represents an increase of 59% year-over-year. We delivered non-GAAP net income of $14.9 million, a 52% sequential increase in profit.

We are pleased by the strong top and bottom line results, which we believe evident strong business fundamentals in a macroeconomic environment that by all accounts appears to be growing more tepid. We continue to believe, we have a compelling opportunity in this market environment, given that our products generate a significant return on investment for our customers. We help them do more with less in their data centers, which is an area where few companies can afford to under invest.

In additions suite now allows us to be competitive at both spectrums of the market, in the hyperscale market as well as is in the enterprise market that seeks to leverage existing storage investments. And our partnerships enable us to expand our go-to-market footprint. We believe those are the positive forces in place for fiscal 2013.

I'll now go into more detail on our results and then elaborate on our outlook for the second quarter and fiscal year. Then let me first inform you that all financial results will be discussed on a non-GAAP basis unless otherwise indicated.

Turning first to revenue. $118 million in the quarter represents 55% year-over-year growth in our core business. Core revenue continued to increase in Q1, growing 3% sequentially, as we prioritize shipments to key customers. We saw strength EMEA and A-Pac driven by partners HP, IBM and Dell, and our public sector business was also the strongest past quarter.

Partnerships with CISCO and NetApp are still in the early stages. We expect them to be meaningful contributors to revenue in the second half of the year. Facebook and Apple represented approximately 56% of total revenue, higher than we had forecasted due to deployment schedules.

This represented an 18% sequential increase for Q1. Many of our end-user customers choose to fulfill our product through HP. As a result HP also exceeded 10% of revenue this quarter. In aggregate HP, Facebook and Apple represented 70% of revenue compared to 72% of revenue in the prior quarter.

Turning now to gross margin, in the first quarter our gross margin was 59.5%, exceeding the high end of our target range. The sequential improvement was a result of product mix favoring higher configuration products as well as NAND cost improvements.

Our NAND flash supply chain which continues to be healthy has been a recent focus for investors. As we had noted, we used multiple NAND flash suppliers with whom we place large strategic orders.

In addition to having long term supply arrangements, our proactive approach helps to buffer us from short term volatility in the NAND flash market. In fact, while the stock market for NAND has shortly increased in price recently, our cost to NAND in this fiscal year is expected to remain stable.

Longer term, we believe that our NAND cost will continue to trend down particularly with qualifying new suppliers and the move to new lithographies.

Moving now to operating expense. Our expenses totaled $47.2 million for the quarter, down 5% or $2.2 million from the prior quarter, which included fiscal fourth quarter sales accelerators. Due to stronger than expect a top line execution, our operating margin was 19.5% this quarter.

Sales and marketing expenses were $22.9 million or 19% of revenue in fiscal Q1, a decrease of $1.7 million from the prior quarter. The decrease was primarily due to variable sales compensation. We continue to add to our sales force, which included approximately 180 quarter-carrying sales reps by the end of the quarter.

R&D expenses were $16.5 million or 14% of revenue, an increase of $1.5 million from the prior quarter, primarily due to continued build out of the engineering team.

G&A expenses were $7.9 million or 7% of revenue, a decrease of $1.9 million over the prior quarter, primarily due to variable compensation. Net income in Q1 was $14.9 million or $0.14 per share. This compares to fourth quarter net income of $15.1 million or $0.15 per share.

I'm going to now move to the cash flow statements, beginning with operating cash flow. Our operating activities provided $28.7 million of cash during the first quarter.

Purchases of property and equipment and leaseholds improvements in the fiscal first quarter were $5.2 million, roughly on track with our expectations for $20 million to $25 million in capital expenditures for the year.

I'm now going to turn to the balance sheet beginning with cash. Our cash and equivalents were $353.9 million, up $32.7 million sequentially.

Deferred revenue in the first quarter was $34.5 million, up $5.6 million sequentially. The growth in deferred revenue is attributable to the sale of support and maintenance services. Accounts receivable stood at $65.7 million this quarter, an increase of $9 million from the prior quarter due to later quarter timing of shipments to key customers.

Net DSOs were 54 days, up from 52 days last quarter. As we noted previously, we expect DSOs to remain in the low 50s in the near term.

Total inventory at the end of the first quarter increased to $67.2 million, an increase of $7.7 million sequentially. And turning to headcount, we ended the quarter with total headcount of 733 people, up 64 employees from the prior quarter.

Let me now turn to guidance. For the fiscal second quarter of 2013, we expect revenue to be essentially flat sequentially, as context, we fulfilled approximately $10 million in the first quarter to a key customer that we had originally expected to fall into the second quarter.

Gross margin is expected to be in our target range of 56% to 58% depending upon mix. Our operating margin is expected to be approximately 10%. And we expect diluted shares outstanding to be approximately $112 million. For the full fiscal year 2013 guidance, we remain unchanged.

So to summarize, we started the year strong. We had exceeded all of our financial expectations.

I now turn the call over to David.

David Flynn

Thank you, Dennis, and thank you everyone for joining us today. As Dennis noted, we are very pleased with our results this quarter and the continued traction we are see in our business.

We continue to be excited about the opportunity before us. The era of software-defined storage has now arrived. Today the storage system can miniaturize and embedded within the server, using software to offload the complexity that previously required expensive proprietary systems.

As we have said from day one, our focus is to get customers the power of sand that fits in the palm of their hand. With this power our customers can now used open server platforms to accelerate applications that drive business value across the enterprise. We believe it really boils down to the fundamental concept that when open systems compete with closed ones, open wins. We have seen this pattern repeat itself over and over again in the technology industry.

Fusion-io is open in its support for the customers' choice of server platform and backend storage system. We are pleased to be able to support basically every major server vendor including HP and CISCO blade server systems, with special form factors of our products. No one else does this.

With our ioTurbine, Direct Cache and ION data accelerator software products, we are pleased to be able to improve the capabilities of their storage platforms including HP's 3PAR, IBM's D series, Dell's Compellent and NetApp's ONTAP.

Our products and go-to-market strategy are designed to compliment our partners existing server and storage businesses. By contrast closed products like the proprietary flash appliance offered by Violin memory are not designed to compliment, but instead attempt to replace.

We recognize that traditional storage will continue to play an important role in most data centers. To be able to keep up with the explosion in the quantity of data that we're seeing today, and the need for immediate access, primary data will increasingly be forced to reside in the server, where it is instantly available, because it is not just about big data it is also about fast data.

This view is supported by what we are seeing from our customers. I'd like to highlight a few customer successes that demonstrate this in practice.

In Q1, we had six end-user customers place orders in excess of $1 million, with three new additions to the list. Several are public sector customers, including the foreign government, first-time customer that rose to this level in just one quarter.

Another to reach this level in the quarter was one of the world's largest media companies that we referenced in Q4 as an early adopter of our ION data accelerator solutions.

Their original use of our technology was for Documentum. Now, they have found additional use cases, including reducing media trans-coding time from hours to mere minutes, while also moving to a virtualized infrastructure.

We are pleased to see these customers expand their deployments into additional use cases, and believe there is significant further potential within this accounts.

Telecommunications, both domestically and internationally has become a strong industry focus for us. Of particular note was deployment in Q1, with the China Mobile, the largest mobile operator in the world.

Our server acceleration products allowed them to scale registered users from 130 million to 370 million, without changing their existing overall business architecture, while at the same time reducing cost by over 75%.

The team at China Mobile was so excited about the success of this deployment, that they highlighted it in full detail in this month's China, a new Telecommunication's Journal. The author noted in the article, that Fusion-io products are the state-of-the-are technology in the IT sector. Our footprint within China mobiles infrastructure is still an nascent, which is true for this vertical as a whole as well as other industry verticals that are only now starting to realize the benefits of broader adoptions.

Retail is another important market vertical for us. This quarter we had the opportunity to work with SIS Republic, a leading provider of loss prevention solutions for the world's largest retailers. We now help them protect more than 1 billion transactions per day across 22,000 stores worldwide. With Fusion's ION data accelerator software, SIS Republic can process more data more quickly with the right combination of performance, infrastructure flexibility and cost effectiveness, ultimately improving real-time fraud detection that directly helps their customers' bottomline.

Financial services remains one of our key verticals. Our data acceleration solutions are particularly applicable to this market, given the real-time nature of their businesses and broader adoption of virtualization. As an example, a large international bank recently experienced a 5x performance improvement with the use of our ioTurbine software.

We believe recent software enhancements will accelerate our customer adoption within this segment and others, including support for a broader set of guest operating systems with the addition of Linux, increased VM density per cluster, simplified installation process and better support for large scale environments. To date, adoption of ioTurbine has been most rapid among small-to-medium size businesses though our channel. We expect to see adoption broaden in large scale environments with these enhancements.

Healthcares and other industry have to deal with ever increasing quantities of data that must be delivered nearly instantly. The Bradford and Airedale NHS Trust, a branch of the U.K. Government's National Health Services has deployed Fusion-io in their virtual desktop environment. They have achieved an amazing 300 virtual desktops per physical server, while simultaneously reducing log-in time from 10 minutes to under a single minute. This is an exciting example of the innovations made possible with our technology in VDI environments.

Web-scale and those providing cloud services are uniquely positioned to benefit from big data. So it's not surprising that these hyperscale companies are early adopters of open software and open hardware platforms, that allows them to cost effectively leveraged big data at scale.

As we have seen from some of our customers in this segment, such as Facebook and salesforce.com, flash is becoming a crucial element in their infrastructure. Our open architecture to deploying flash is a key advantage for Fusion-io. Our ability to continue to aggressively capture market and respond to this market's unique needs is key to our long-term growth. The growth in server shipments in this market, diverse all other verticals combined. We continue to evolve our product offerings and our go-to-market strategy to better address this opportunity more directly with more dedicated resources.

One of the key differentiators for Fusion-io is that our technology allows us to use a wide variety of NAND, including low-quality commodity NAND. With our controller technology, we do a better job than even the NAND manufacturers at using the lowest cost, lowest grade NAND, to create the highest performing most reliable products.

You may recall that we were using MLC NAND years before anyone else. And it's not clear even now that anyone else is reliably able to deploy MLC-based products at scale. The economic benefits of NAND flash grow more compelling overtime with each shift to a new lithography and lower cost point.

We are uniquely able to capitalize on these developments without significant disruption, thanks to our software systems capability. Our sustainable advantage has been our ability to make cheaper NAND into more capable products than any of the competition. This technology leadership combined with our ability to sell full software defined storage solutions directly to end-user customer builds trust with these customers and our partners around the globe.

As an example, one of the world's largest consumers of SAN storage, a leader in the travel reservations business, went from testing ION data accelerator to deploying it in full production in a mission critical environment, in just one quarter. The reason they had the confidence to do this is that they had already been using ioMemory as direct attached storage within their servers. All they had to do is add the ION software to these servers to get the benefits of SAN storage. We took this business from EMC. In cases like this, we estimate that for every dollar spent on Fusion-io, customers save $5 to $10 of legacy storage spend.

To close, Q1 was a strong start to fiscal 2013. We are pleased to see the market increasingly come to appreciate the value-add of our systems level software. To drive continued growth, our key goals for the year include developing new key customers, especially in the hyperscale market, extending our technology leadership with continued innovation and leveraging ongoing investments in our go-to-market strategy through strong partnerships and a world-class direct sales team.

Thank you for your time and interest. We'll now turn the time over to you. Operator, we're ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Brent Bracelin of Pacific Crest Securities.

Brent Bracelin - Pacific Crest Securities

Really had a quick question on the quarter-end and the guide on the quarter itself. I think the core you mentioned was up 3% sequentially at the benefit of $10 million pull-in this quarter. Did you see any sort of impact because of macro concerns or any delayed decisions or lengthening sale cycles that we're sharing with other enterprise storage companies that impact to the core business?

And as you think about the guidance to square with the guide less than $10 million pull-in that implied a pretty material increase in the core business sequentially. So what's the pipeline and visibility into an acceleration in the quarter to get to the guidance you gave for December?

Dennis Wolf - Chief Financial Officer

I think what I'm going to do is actually speak to outlook in general and core and key customers in specifics. Our outlook remains as we said on the call, it remains unchanged. And there are some really positive forces in our growth drivers that enable us to think that: one is as David was talking about our new products, we have more new products now than we've ever had; our go-to-market strategy is actually expanded; we have partners; we have channels; we're deepening our geographies; we have our alliance program; our TAP program; we have the federal sector that's doing very well; we also continue to have a very strong VAR channel; and we're building out the SDK's channel, where now we have approximately 300 IFC's.

Now, having said that, I will tell you that there are of course some pressure points around visibility. The macro environment is a little more attentive than it was six months ago. And our customers do in essence provide a little bit less visibility in the market. So while we know we're not immune to whatever the macro environment is up to, our solutions are more compelling in a tightening market scenario. And as David was saying, we are able to really reduce cost by 5x to 10x from traditional storage. So we feel optimistic about that.

As far as core is concerned, the number for core of 3% growth this quarter is not indicative of core strength. We have a very strong pipeline. It's actually stronger than it has ever been. And it's especially as we refine our products in our go-to-market strategies that is specific to hyperscale. We're seeing some evidence of that, as we expand our focus into hyperscale. Some of those larger names that you'd like to see, we have better visibility on in the second half of the year.

Operator

Our next question comes from Katy Huberty of Morgan Stanley.

Katy Huberty - Morgan Stanley

Just following on that discussion, if not for the $10 million deal this quarter, you would have just met revenue expectations. And this is the first quarter that you haven't raised for your guidance, so just curious whether the macro pressures and anything else are limiting your ability. If you think over the next several quarters to show upside versus expectation or is there a pipeline and some visibility, you mentioned the second half that present opportunities for you to go out and beat expectations like you have over the past 18 months?

David Flynn

Visibility is more difficult in this kind of an environment. And so our customers provide a little less tale, long tale if you will, as to what their deployment schedules are. That doesn't make us unrealistic to the second half, which we think is bolstered by the fact that the pipeline is stronger than it's ever been, and that we are moving to hyperscale is actually taking form.

Realize that this quarter we would have in fact met guidance and next quarter we would also meet guidance, if not for the switch of the $10 million into the current quarter. That's the visibility that we have.

Operator

Our next question comes from Aaron Rakers of Stifel Nicolaus.

Aaron Rakers - Stifel Nicolaus

I just want to clarify, first, the comment you just made. If you haven't had that large customer, that $10 million deal, you mentioned you prioritized deals at the core business. Would that have just moved into the core business line, given it wouldn't have?

Dennis Wolf

No, maybe it was the key customer and it was the deployment itself, which would have otherwise been in the second quarter.

David Flynn

So by pulling that customer into this quarter, like you've possibly seen in the past, it delays some of the core business. So what we're pointing out is that, the 3% growth is not indicative of the strength of the core business, because that customer deployment got pulled forward to this quarter and took a priority sequence in shipments. Hopefully that clarifies.

Dennis Wolf

And getting on the pipeline, it's pretty strong and pipeline really means core.

Operator

Our next question comes from Mark Moskowitz of JPMorgan.

Mark Moskowitz - JPMorgan

One is the deferred revenue growth that was I think pretty impressive, is that starting to suggest that you're staring see a breakout in terms of the mix of your customers, we are staring to get greater penetration into more enterprise accounts versus some of these depocketed Apple's and Facebook's, where they can kind of take care of things on their own? And then the second question is more competitively speaking with IBM's acquisition of TMS this past summer, does that change the relationship at all or the competitive landscape, especially with IBM?

Dennis Wolf

So it's hard to provide revenues. It is support and service. And it continues to primarily be the key account. There are opportunities for us to expand in support and services as we move forward with some of these larger accounts that we're talking about potentially for the second half of the year.

David Flynn

But it's kind of the exact opposite of the way you phrased it. It is the hyperscale accounts that we deal with directly that pay us support. The enterprise business is largely supported by our OEM partnerships. With the exception of software as software comes online, because it has a more direct relationship to the end-users, even in the enterprise space we are providing the frontline support for that. So as we move to selling those solutions in the enterprise, it will show up more on that support line.

The second question about TMS, Texas Memory Systems was purchased by IBM's Storage Division for their memory appliance. We work with their server division on the flash within the server. And we think it's rather backwards looking to be focusing on a proprietary flash appliance versus how to take off the shelf servers and have them perform the same role from within an open platform.

So this actually take say it would be competitor off the market, TMS was attempting to get into the market with PCI Express devices to go into servers. But that's not what they were acquired for and we don't expect that to be a part of their business inside of IBM.

Operator

Our next question will come from Amit Daryanani from RBC Capital Markets.

Amit Daryanani - RBC Capital Markets

Just two quick questions from my side. One, I think you just talked about 180 quota-carrying sales people this quarter. I want to make sure I heard that right, because last quarter that number was 150, and if you could just broadly talk of that number was correct? And then, how long does it take when you get a new AE for them to start becoming productive, is it two to four quarters or longer? And then secondly, could you just maybe talk about the NetApp relationship very specifically, and what sort of revenue expectations you may have built into the fiscal '13 guidance with NetApp?

Dennis Wolf

A 180 was right. Those are the quota-carrying sales reps. As far as sales productivity is concerned, Amit, we don't get into that. You all have to come to your own conclusions there, otherwise we'd be forced to have everything depended upon sales productivity models. And when we do our forecast, we use a lot more than sales productivity to try to figure out what the numbers are.

Now, the numbers that we expect in the second half of the year, we expect both NetApp and Cisco to be stronger numbers in the second half of the year than early in the first half of the year. So staring in Q3, those will be much more meaningful.

David Flynn

To date, we've trained over 500 sales people within NetApp, they're extremely eager and rearing to go, because this expands their market addressability, allowing NAS to go more into the performance strong hold, where SAN use to have sway. So we're very excited about the relationship, but don't expect it to be material until on the second half.

Operator

Our next question comes from Bill Shope of Goldman Sachs.

Bill Shope - Goldman Sachs

You mentioned, your increased ability to penetrate traditional enterprise accounts, can you give us some more color on what types of apps you're seeing the most success with so far? And particularly in this quarter, how you expect that to trend as we progress to 2013?

David Flynn

Well, database has been and continues to be sort of the strong hold there. With our new product offerings, we can address databases deployed in many different ways. For example, ION allows us to address Oracle RAC environments more directly, since they expect for share storage.

And with ioTurbine, we can now take databases and move them into virtual environments, which is one of the things folks have wanted to do, is to take these data intensive applications that could not survive the penalties of being in a virtual environment, and now they can actually run faster as virtualized. The database is clearly one of them and the additional product offerings around software give us that flexibility to address a broader diversity of database environments.

There are other application areas that we find ourselves in, such as virtual desktops, that is a new market. People are trying to figure out the recipe for help to architect those environments. And so there is still baking that, which makes it a great opportunity to get in and the numbers are phenomenal, as you've heard on the call, with being able to put many, many times more desktops per machine and having much, much better response time from it. So we're seeing that as well.

But this is really a very horizontal solution, anything that consumes large quantities of data fast, can benefit from it. And things that don't are the ones you virtualize, and then you use this so that you can put more of them in higher density. So we see things ranging across the gambit.

Operator

(Operator Instructions) Our next question comes from Edward Parker of Lazard.

Edward Parker - Lazard

Dennis, could you just maybe clarify just one more time going back to your core business and talking about prioritization going to some key customers. Could you help quantify, what core would have been, have there not been prioritization going on, if you get a better picture of what true demand was in the quarter, I'm assuming it wasn't $10 million?

Dennis Wolf

Ed, the key accounts if you will, were about $10 million. So if you figured the math out that the first quarter has that $10 million in it, if you subtract out, there you get a sense of what core would be as a proportion. The reality is that in any events we have to put that in priority sequence. So the true demand for core is what we are kind of our articulating as far as the fact that we haven't changed our guidance.

David Flynn

If you look, the same effect happened last year, and we went through it at that point too. If you go back and look at numbers on the base growth versus strategic and you can see kind of the pattern there, when we have to pull-in large deployment deals. So we can't really do the what-if, because it didn't play out that way, but you can look at how it has played out in the past.

David Flynn

And it's articulated in our pipeline, so we know that it's stronger.

Operator

Our next question comes from Kulbinder Garcha of Credit Suisse.

Kulbinder Garcha - Credit Suisse

Just a few questions. First of all, just on the pulling of this major account. I guess, David, I was under the impression there were multiple strategic customers that were going to spend a major deployment in the second and third fiscal quarter this year. So I believe there should be some growth in the other strategic customer that didn't get pulled-in all. Did I misunderstand that? The second question I have is just on ioTurbine, is there any revenue contribution expected next quarter from that, I thought the timing for that was the December quarter previously?

David Flynn

So taking in reverse order ioTurbine is now generating revenue is in the ramp process. I don't know if that answers your question specifically. We don't break it out differently, because we sell as a full solution and it has to drag along of the hardware, which may actually come from a different fulfillment path, pulling through OEMs, whereas the ioTurbine maybe sold direct. Maybe you could repeat that first question around the strategic, so I'm not quite sure I got it.

Kulbinder Garcha - Credit Suisse

One of the key customers pulled forward $10 million of spend into the first fiscal quarter. I was under the impression that you're going to see multiple strategic customers start major deployment starting in the next quarter. I think starting Q2 for the fiscal year. So I would have thought there should be some uptick there at least that would soften this pulling effect that you're talking about, which gives you a lot of sequential growth or did I misunderstand the last quarter I guess?

Dennis Wolf

We expect that some of those larger key accounts are going to form in the second half of the year. When we've talked about the key customers on the last call, it was an assumption around two key customers that we do have, and it's coming out exactly as we had it expected, which is that our key customers in the first half of the year were representing about 50% of total.

In the second half of the year, regarding just those key customers, it's little too early to tell, because the visibility that we get now with the environment is a little different. But at the same time if that happened, we're getting better visibility on some of those assets that you're talking about for the second half of the year.

Operator

Our next question comes from Ben Reitzes with Barclays.

Ben Reitzes - Barclays

I wanted to clarify the operating margin guidance with 19.5% in the first quarter and then with what you're looking at for the full year, don't we have to go to 10% for the next three quarter. So do I have that right? And how do we get there, and what do we push down? And what kind of expenses do we have to take to get the margin there on higher revenue each quarter really after the second quarter?

Dennis Wolf

Ben, as the math would work with their original assumption that we made for the year is roughly 12% operating margin, we anticipate that will be within that range.

The expenses are inline with where we would like them to be. The investments that we're going to make will continue to be in sales and R&. We think that we have a very powerful opportunity here and we're investing in that opportunity. And we believe that the return for the investors at that rate is a good rate in light of the amount of share capability we have in the market.

Operator

Our next question comes from Alex Kurtz of Sterne Agee.

Alex Kurtz - Sterne Agee

This $10 million deal was from one of your two traditionally large customers, is that right?

Dennis Wolf

Yes.

Alex Kurtz - Sterne Agee

David, just two easy questions for you, the Violin announcement from HP in last couple of days, can you comment about that. Is that the opportunity you can go after? And also Google, I know that they have traditionally done a lot of stuff in-house. I know that you're guys are calling them. Any kind of change there, any kind of change of mindset around how they use branded products, that would be great?

David Flynn

So taking the first question first, yes, really relationship with Violin within HP has been strained for a longtime and we've been the beneficiary of that. They hadn't really made a very good partner, because their products are more in conflict with HPs existing portfolio.

And we take steps to make sure that our sales team is incented to work well with our partners. They actually make more when product comes through these partners. So there has always been a tension there within Violin.

Yes, this does present an opportunity, and not just at HP but within the channel and otherwise because our solution is an open solution that allows the customer the choice of their server. We're not selling a franking box, or some proprietary thing with a bunch of that FPGAs and stuff, and that we're able to use a Tear 1 server..

The second question around Google, wouldn't really want to go into too many details, but yes we do see opportunity there. We're calling on them for a reason. We think our technology offer superior ability to use the newest lithography NANDS that has a better price point.

As NAND lithographies gets smaller and smaller and higher and higher density, the IP that it takes to make it reliable is much, much harder. And we have led the field of being able to take low grade NAND and make it into an enterprise reliable product.

Back when in was 50-nanometers and 40-nanometers, even 30-nanometers were relatively easy. Now, down at the 2x and especially going to 1x, it's going to be even more challenging, which means even more opportunity from those who were doing it themselves.

Operator

(Operator Instructions) Our next question comes from Srini Nandury of Summit Research.

Srini Nandury - Summit Research

David, can you discuss SCSI Express and what is the opportunity it presents for you?

David Flynn

So we're excited about SCSI Express. It as well as NVMe are attempts to standardize how to bring PCI Express more directly to the traditional drive base and get rid of the need for intervening storage controllers that allows us the flexibility of having disk drive form factor, yet the PCI Express attached devices, which we do today and have announced and showcase some of those with our sever partners.

So we view it as a great opportunity to add the convince of front face plate access to pluggable drives. Some of that is offset by the fact that with a truly reliable product, you shouldn't need to replace it.

And so from the beginning, where we've taken a position that this should be embedded in the server just like your memory modules and your processor, you shouldn't have to service it.

And many of our large scale, the hyperscale customers benefit from this because they can actually simplify out all of that sheet metal and build something that's an elegant server, very simplified, because it doesn't need to have all the mechanics to make the hot swap ability. But in the enterprise space, that extendibility to go and add more capacity, remove it that can be helpful.

So as we look at how our market separate between the hyperscale where things have fully optimize for just going to tens of thousands of servers versus the enterprise where it's more about adaptability and flexibility with this we see playing out the drive bat accessible PCI Express devices are going to be relevant to that market. But all of it is good, because it gives us the ability to take our technologies into new forms factors.

Operator

Our next question comes from Andrew Nowinski of Piper Jaffray.

Andrew Nowinski - Piper Jaffray

I just wanted to get a little more color on your gross margin. The mix on strategic was clearly higher than expected this quarter, which include that $10 million deal.

Your gross margin was well above the targeted range and so I know NAND cost was at tail end but do the mix of strategic this quarter offset any of that tail end? Is it fair to assume that you should have tail end to gross margins in the December quarter, or else equal given that the strategic should be a lower percentage of the total revenue?

David Flynn

This quarter, Andrew, was a good gross margin story. And I think we've worked our way through all of the gross margin dialogue. What it was just to be clear, it's about whatever the mix would be as well as now it's regarding NAND cost.

During the prepared remarks, I was talking about NAND pricing. Even though the NAND pricing environment has been fluid and up, ours is actually been relatively stable, and we expect long-term that it will go down.

And it's consequence of us thoughtfully looking at the strategic needs that we would have for NAND. That has helped our margin and it enables us to continue to believe that the relevant range is 56% to 58%, up a couple of points, rather on the high end of it when the mix is higher end, and on the lower end of it when it isn't.

Operator

(Operator Instructions) Our next question comes from Brian Freed of Wunderlich Securities.

Brian Freed - Wunderlich Securities

Just on that front, I was hoping you could give just a little bit more color on your pricing arrangements and particularly how it evolved in recent quarter. I am trying to drill down here and see why these recent NAND price increases won't affect your margins, just in the context of how your pricing arrangements have changed?

Dennis Wolf

So because we have such a stable flow of business and the tight relationship with the memory fabs, they respect our ability to use their product, even the stuff that may not be as higher quality.

As a matter of fact here is an anecdotal thing, we had one of our suppliers identified that they had had a stethoscope in some parts that we're compromised and we were able to show that it made no difference. Our design was robust enough to absorb even those parts where others had stuff failing on them.

So this, our competency with using NAND flash has led us to very tight relationship with these memory manufacturers, multiples out of them and the flow of volume those two things have allowed us to lock-in supply agreements. That are very favorable over a longer period of time than what you could get by going to the stock market, which has made us much more immune to the short-term swings that are indicative of memory market.

Operator

Our next question comes from Roxane Googin of Global Investment Research.

Roxane Googin - Global Investment Research

I have two questions. Could you give us generally an idea what the critical path as to your ability to expand supply and concert with quarter end spikes? Is it a material availability or something in the channel that would not allow you to supply all of your demand this quarter?

David Flynn

So Roxane, the first question is that we have the supply on hand. We have strategic purchases on hand. It's just that we have to get certain deployments out at certain points of time. So it really depends upon timing not staging.

Dennis Wolf

And to some extent, we do build order, especially with very, very large deployments and those within the manufacturing pipeline pushback other flow of product.

It's one of the reasons why you see an increased investment of our capital resources in inventory is because we have identified, customers have frankly told us that, having the product immediately available or if not having it immediate available has impacted their ability to purchase more. And we want them to be able to purchase more. So we're making sure that it is readily available. But one thing to note, we are very proud of our manufacturing. Have very high yields and first past yields. So it's quite efficient.

Roxane Googin - Global Investment Research

First of all, do you ever see OCZ or STEC in competitive situation?

David Flynn

Not really. In the enterprise space they don't have a solution for enterprise customers, and have never been there. In the hyperscales space, because those in the hyperscale world like to purchase consumer grade stuff and try to make it work within their environment to save every penny that they can.

There was in the past an interest in the price points that OCG talked about, more often than not though it did not work. It was not reliable enough to really go, but it did tend to frame some of the discussion and that has since evaded since it's clear that those business models were not sustainable.

Operator

We will take our last question from Bill Shope of Goldman Sachs.

Bill Shope - Goldman Sachs

Thanks for letting me have a second question. Just an extension of that prior question on dealing with end of quarter, spikes and what your capacity constraints, outside of just having a large amount of inventory to deal with that, is there a way for you guys to build more capacity at the end of the quarter, not necessary component capacity, but have an ability to do more direct ship custom build order, things of that nature?

I don't know if it's hiring more folks, building all of your manufacturing footprint but are there ways to increase your capacity at the end of the quarter, so you don't get in these types of situation?

David Flynn

There are two things that we are doing specifically to aid this. One of them is to hub our product with our OEM partners. This is offering them a service where we can put more products on their premise without them having to take any risk with it.

And as a result of that, we get the benefit of better visibility into end-user customer demand, and shorten the time lag between when that demand arrives and when they can get product. That also makes us more intertwined with these systems vendor partners versus if they were to look at somebody else's flash parts.

So that is one way is through a hubbing. Additionally, we are moving towards a turn key manufacturing to where our contract manufacturers can take our high volumes skews and produce them without us ever having to touch them. A key part of that has been building the testing framework, so that we can be satisfied with the quality.

So we have built the testing rigs that can go on the premise and go through and perform all of the final manufacturing acceptance tests. Every single product that goes through we gather a full set of database records on it and track those over its lifetime.

And so these information systems are all tied into it. So we're pretty excited about that because it's going to let us take the high volume skews and shift them to a touchless model and have the build to order stuff not interrupted by those volume skews.

Operator

And I would now like to turn it back to Nancy Fazioli for final comments.

Nancy Fazioli

Thank you, Operator. Regarding events for the quarter, please note that Dennis and Gary Orenstein, Senior Vice President, Products will be presenting at the Piper Jaffray TNT conference on Wednesday, November 7.

In addition, David and Dennis will present at the Credit Suisse Annual Technology conference on Tuesday, November 27. Each of these presentations will be webcast and available on the Investor Relations page of Fusion-io's website. Please contact the Investor Relations department with any follow-up questions from this call. You can reach us at ir@fusionio.com.

This concludes our call. Thank you for your participation and support, and good evening.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.

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