Following 2Q14 (Dec) results, many analysts are reiterating a Hold rating. On one hand, the company was able to exceed 2Q14 guidance. However, the company is still unprofitable and is guiding 3Q14 results to include an even greater loss. At this time, the company has no clear path to profitability other than a 35%-40% increase in revenue. Said differently, the company has yet to prove non-Facebook and non- Apple customer growth sufficient to generate a profit. In addition to this, we are not more constructive with our rating because of: 1) the likelihood of more competition from larger, more integrated companies (e.g. memory IDMs, storage system OEMs & HDD companies) and 2) the uncertainty caused by recent management turnover (e.g. more than a half dozen c-level execs) as well as a change in go-to-market strategy (e.g. relying less on direct sales and relying more on OEMs, ISVs and VARs).

The company reported 2Q14 revenue of $94.5 million, up 9.5% q/q (down 22% y/y). Reported revenue compared favorably to guidance of a “up slightly q/q”. A non-GAAP gross margin of 57.6% was down 180bp q/q (down 410bp y/y), but compared favorably to guidance of 52%-54%. The upside to gross margin was a function of having a greater mix of enterprise-related business (vs. hypercale sales which tend to be lower margin). Non-GAAP EPS of $(0.06) compared favorably to our estimate of $(0.08) and consensus of $(0.10).

In terms of customer diversification, the company had 12 customers which generated more than $1.0 million in revenue. This is an improvement from a recent trend of having ~10 >$1.0 million customers. While management did not name >10% customer by name, Facebook was likely more than 10% of revenue once again. Two OEMs were more than 10% of revenue, vs. three last quarter.

Since Shane Robison took over as Chairman and CEO in May 2013, there have been at least six c-level management changes. This said, most vacant positions are now filled. In addition, the company has shifted its go-to-market strategy to include ISVs and OEMs. This shift in strategy is obviously taking time to translate into growth.

Management guided 3Q14 (March) revenue to trend flat to up slightly q/q, nudging our estimate to $95.0 million (vs. prior estimate of $97.0 million & prior consensus of $97.9 million). Based on management’s guidance, we are lowering our gross margin estimate by 50bp to 52.0%. As has been telegraphed by management for a few consecutive quarters, gross margins are expected to decrease ~500bp-1,000bp from recent trends due to higher volume sales opportunities for ioScale (.e.g. hyrperscale customers). We are lowering our 3Q14 non-GAAP EPS estimate from $(0.07) to $(0.10).