Quantum Corp (QMCO) 2008 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the third quarter fiscal 2008 conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. If you have a question, please press the star followed by the one on your touch tone phone. If you would like to withdraw your question, please press the star followed by the two. If you are using speaker equipment, please lift the hand set before making your selection. This conference is being recorded today, Wednesday, January 23, 2008. And now, I would like to turn the conference over to Shawn Hall, General Counsel. Please go ahead.

Thanks. Good afternoon and welcome. Here with me today are Rick Belluzzo, our CEO, Jon Gacek, our CFO, and Bill Britts, our Executive Vice President for Sales, Marketing and Service. The web cast for this call are earnings release in a quantitative reconciliation of any GAAP and non-GAAP financial measures discussed today can be accessed at the investor relations section of our web site at www.quantum.com and it will be archived for one year. And the course of today's discussion, we will make forward-looking statements within the meaning of the private security litigation reform act of 1995.

Forward-looking statements include our business prospects, priorities, initiatives and opportunities, our target business model and anticipated future revenue, gross margin and operating expense. Trends in our business in the markets in which we compete and trends impacting our revenue and media royalties and the expected timing and features of new product launches. We would like to caution you that our statements are based on current expectations and involve risks and uncertainties that could cause actual results to differ materially. We refer you to the risk factors and cautionary language contained in today's press release announcing our fiscal Q 3 2008 results, as well as the reports file with the securities and exchange commission from time to time, including our most recent 10-K filed on June 13, 2007 and our most recent 10-Q filed on November 8, 2007. Such reports contain and identify important factors that could cause actual results to differ materially from those contained in our forward-looking statements. All such risk factors identified in the press release and in our filings with the SEC incorporated by reference into today's discussion. We undertake no obligation to update these forward-looking statements in the future. With that, I will turn the call over to Rick Belluzzo.

Thank you, Shawn. Good afternoon. Thank you for joining us for the Quantum Q 3 earnings call. This fiscal year, we have been focused on two critical initiatives in order to improve the strategic position of the company and drive increased value. These two efforts have included a broad range of actions and efforts across the entire company and have represented the critical next-steps following the completion of the ADIC and Quantum merger. Our first goal is to continuously improve our operating model with the goal of initially achieving an 8 to 10% non-GAAP operating income level and eventually exceeding this through a continued focus on the higher margin segments of the business. In addition to this, we wanted to turn this improved operating performance into solid cash flow allowing us to pay down debt and reduce our interest costs. The second objective has been focused on driving market momentum for Quantum branded products. The goal here is to grow our core branded business and build a significant revenue stream in the rapidly developing disk systems and software segments of the storage industry with intermediate goal of achieving $30 million in disk systems and software revenue in Q 4 of this fiscal year. The combination of these two initiatives have been intended to deliver short-term performance while providing greater revenue growth potential. We have implemented significant change over the last year or to ensure that our investments, cost structure, partnerships, and infrastructure are all optimized around the company's strategy.

Let me start with reporting our first initiative, reporting our first initiative. We are very pleased with the progress that we have made in our operating model. We delivered a non-GAAP operating margin of 9.9%, the highest in well over five years. This achievement represents the latest in a series of incremental improvements starting in Q 1 with 5.4% to Q 2 with 8% and now to the 9.9% level in Q 3. Much of this improvement has been the result of gross margin gains as we continue to focus on the higher margin segments of our business. While we recognize that this focus has cost us some revenue, we feel this position as well for the future. Our gross margin improvement along with well manage expenses is what has enabled us to achieve our operating margin gains while still making incremental investments in sales and R&D to support our growth strategy. We have also been able to imply much of our improve performance into cash generation which has in turn been applied to debt repayment. In fact, we have now been able to reduce our acquisition-related debt by $137 million or 27%. This along with our refinancing has allowed us to reduce or quarterly interest payments by more than $4 million. In short, the progress in our operating model has been significant. While we still have a number of areas to continue to address, the progress is on or even ahead of plan.

The performance on our second priority, marking momentum has not been a successful and remains our top priority. Revenue in Q 3 was $252.5 million approximately $20 million below our expectation. With most of the short fall in our branded business in north America where we experienced below plan performance in tape automation and disk systems. We believe that this short fall was primarily related to our own execution. Although like others, we are not immune from market conditions. We also underperformed in our disk systems and software business across geographies. Our DXI business showed solid growth but it was forecasted to grow faster than what we delivered and it was not enough to offset the declines in our legacy disk products. There are many actions that are underway to addresses revenue charge. I will cover these actions and provide some detail on the disk systems and software business following Jon's comments. In summary, Q 3 was a solid quarter. We have advanced software business model and continue to pay down debt. As the challenge and focus are squarely on the need to grow our revenue with the primary focus on our branded business. Let me reinforce that we clearly see this as our top priority, but we believe that we have the right products and strategy and are well positioned to demonstrate greater success. Now let me turn the call over to Jon and I will return to provide more detail on revenue initiatives. Jon?

Thanks, Rick. I am going to provide additional detail on individual income statement line items, as well as on significant balance sheet changes. But before I do, I want to emphasize several key points from the third quarter. First with regard to our debt during the quarter, we paid down 20 million of our new 400 million term loan that we secured in Q 2 leaving a balance of 360 million as of December 31st. The second point, I want to call out involves our branded revenue. At the last quarter call, we said we expected our branded business to grow. However, it actually fell slightly. As growth in Europe and Asia was offset by a sequential decline in north America. We believe that we have made progress in adding additional sales resources. But we still have not achieved the result we expected. Branded business was 62% of our total non-royalty revenue down from 63% in Q 2 and totaled 139 million versus 140 million in Q 2. Growing the branded business is key to our strategy and to further improve our profitability, we expect to continue to invest in our sales team, presales engineers, and service infrastructure to support this objective.

Third key point I want to emphasize is the growth in our DXI product line which increased 31% sequentially in Q 3. As we have discussed in prior calls, our DXI revenue is included in our overall disk systems and software product revenue that we report. This also includes, this category also includes revenue from our legacy disk products and our StorNext software sweet. In total, our disk systems and software revenue for Q 3 was 14.1 million compared to 14.8 million in Q 2. The decline was driven by a decrease in our legacy disk products of 56%. In addition to the disk systems and software product revenue of 14.1 million, we had 1.4 million of related service revenue that we include in our total service revenue compared to 1.2 million in Q 2. Because of our scale and the significant of our service revenue, SEC rules require us to break out this service separately. But to compare us to the smaller pure play companies, you need to add the 1.4 million to the 14.1 for a total revenue in the disk system and software category of 15.5. This is important growth segment of the market.

The final key point is the continued improvement in our operating model. Our non-GAAP gross margin was 37.7% and our non-GAAP operating profit was 9.9%, again on slightly up sequential revenue. Both our records for the company and continue to reflect improvements we have made in new Quantum. By improving the operating model, we have the flexibility to spend more money in areas of strategic focus which are growing the overall branded business and growing our disk systems and software business and still deliver solid operating results. Looking at the third quarter results in more detail, I will go through income statement line items describing a non-GAAP amount and highlight the related business points.

Starting with revenue, total revenue for the quarter was 252.5 million, royalty revenue reported was 26.8 million, product revenue was 185.1 million, and service revenue was 40.6 million for the quarter. Royalty revenue increased 2.2 million sequentially, DLT royalties were down slightly and LTO royalties increased as sales of LTO-4 media has began to ramp. For the December-quarter, non-royalty revenue was 225.8 of which 62% was branded 38% OEM. For the prior quarter, non-royalty revenue was 224 million of which 63% was branded and 37% was OEM. We have three product categories and groupings. Disk system and software, which we began disclosing in Q 1 as combined category to light the charter progress, tape automation systems, and devices and media. As I said, disk systems and software totaled 14.1 for the quarter compared to 14.8 in Q 2. We will expand our product family in fiscal 09 by adding our DXI 7500 enterprise product. And we also expect to secure one or more OEMs during the next 12 months. For the quarter, we deferred approximately $2.3 million of DXI 5500 and 7500 product revenue for orders we received and shipped, but could not complete the revenue recognition process. In addition, I mentioned the 1.4 million of service that we had for these products. Tape automation systems revenue was 112.8 million in Q 3 compared to 110.6 million for the prior quarter. OEM automation increased slightly, offset by small decreased in the branded revenue.

Final group is devices and media. Q 3 revenues for this group was 58.2 million compared to 59.5 million for the prior quarter, a decline of 1.3 million. Branded devices and media were down approximately 900,000, while OEM and media devices were down approximately 400,000. We expect that we will see additional decline in OEM devices revenue as current products roll off and we focus on more profitable revenue segments. As I mentioned earlier, service is a separate line item under our RPNL, it includes hardware service contracts, repair, installation and professional services. Service revenue total 40.6 million for the third quarter compared to 39 million in Q 2. Now, I will move to cost of revenue and gross margin which where the third quarter of fiscal 2008 were as follows on a GAAP basis. Cost of revenue was 165.3 million, gross margin dollars were 87.2 million and gross margin percentage was 34.5%. For Q 2, the gross margin percentages was 31.5. That is an increase of 300 basis points.

On a non-GAAP basis, third quarter cost of revenue was 157.3 million. Q 3 gross margin was $95.2 million or 37.7% compared to non-GAAP gross margin in Q 2 of 87 million or 35%. The margin increase on essentially flat revenue and similar mixed in Q 3 compared to Q 2 is the result of the increase in royalty revenue for the quarter and reductions in our manufacturing and warranty costs, as well as growth in improved margins for our DXI products. The non-GAAP [re-consigned] items are included in a detailed schedule on our web site and in the press release. They included stock camp, amortization of intangibles and a small piece of transition expenses from [data tech] the acquisition.

Moving to operating expenses, the following is comparative on a GAAP based operating expenses. R&D expenses for the third quarter were 20.1 million compared to 20.5 million in Q 2. This decline is a result of decreasing our investment and development of tape drive and restructuring our R&D and support services model partially offset by increased spending in our disk systems and software business. Sales and marketing expenses were 39.4 million compared to 34.3 million for Q 2. This increase is the result of increased labor related costs due to increasing sales head count an increase in market expenses during the quarter. General and administrative expenses for Q 3 were 18.8 million compared to 18 million for the prior quarter. This increase was the result of a one-time stock compensation, expense and increased legal expenses related to our activities to protect our intellectual property. Restructuring cost were 100,000 for Q 3 versus 200,000 in Q 2. We are almost to zero there. Total GAAP operating expenses were 78.4 million in Q 3 compared to 75 million in Q 2. Amortization of intangibles included an operating expenses total 4.7 million and 4.5 million respectively in Q 3 and Q 2. Stock base compensation including [APEX] for Q 3 and Q 2 was 3.3 million and 3.1 million respectively. So, excluding the restructuring and transition expenses related to [data tech] acquisition, amortization and stock-based comp, non-GAAP operating expenses totaled 70.2 million in Q 3 compared to 67.1 million in Q 2.

For the third quarter, we reported GAAP operating income of 8.8 million compared with 3.3 million in Q 2. Adjusting for the previously mentioned [re-consigned] items, we generated non-GAAP operating profit of 25 million or 9 .9% of revenue for Q 3. This compares to 19.9 million of operating income in Q 2 or 8% of revenue, just slightly below our 10% target. EBITDA for the quarter was 32.8 million compared to 30 million in the prior quarter.

Moving on to nonoperating items, interest income and other was 300,000 and interest expense was 11 million for a net interest and other expense of 10.6. The decrease in interest income and other was primarily related to foreign currency and cost of implementing interest hedges required by our debt agreement. Our weighted average interest rate was 7.42% for the quarter compared to 7.72% in Q 2, and 8.72% in Q 1 before we refinanced our debt. Our quarterly income tax expense was 600,000 compared to 1.1 million in Q 2. Our tax rate will continue to fluctuate quarter-over-quarter as a percentage, but expect the actual spent to be approximately 1 million per quarter. For the third quarter, we had GAAP net loss of 1-cent per share and a non-GAAP profit of 7-cents per diluted share. An 8-cents impact for the combination of intangible amortization, stock compensation, and small amount of transition expenses. This is compared to Q 2's GAAP loss of 10-cents per share and non-GAAP profit of 4-cents per share.

Now let's move to the balance sheet. At December 31st, cash and cash equivalents totaled 83.4 million, we generated 18.3 million of cash from operations during the quarter, and repaid $20 million of the acquisition debt. This compares to 3 million used to fund the operations in Q 2. Accounts receivable was 209.8 million, an increase of approximately 10.9 million for the prior quarter, DSO was for 75 days compared to 69 days in Q 2. The cash [fluctuation] cycle continues to be an area where we have a lot of room for improvement of our performance and we are working on multiple fronts to generate more velocity here. Inventory was 70.3 million representing an increase of 4.6 million from the prior quarter. This is primarily the result of missing our sales plan and increasing our inventory position to meet expected DXI 3500, 5500, and 7500 demands. Since the start of the fiscal year, raw materials and work in process are down 22.5 million and finished goods are up to 4.9 million. Fixed asset purchases amounted to 3.5 million for the quarter and depreciation expense was 5.2 million. The bulk of the additions are related to Oracle consolidation, and Oracle service project, and engineering test equipment for DXI.

Moving to liabilities, accounts payable were 98.2 million at December 31st. An increase of 13.7 million over the prior quarter. This is due to timing of payments. Totaled deferred revenue, the combination of the current and the long-term portion was 98.5 million compared to 90 million in Q 2. The increase was primarily due to the growth and service contracts associated with our growing installed base of branded automation products and deferred revenue for DXI 7500 and 5500. As a reminder, the vast majority of our deferred revenue is generated from Quantum branded products and is a result of selling an additional service contract above and beyond the product standard warranty or selling an on-going software maintenance. We expect that our deferred revenue will grow as our branded business grows.

Looking forward to Q 4, we expect increases in branded revenue and disk systems and software revenue and a decline in our OEM revenue. We expect total revenue in the range of 240 to 250 million, gross margin in the range of 36 to 38%, and non-GAAP operating expenses of approximately 70 million. Finally, with 15.5 million of total disk systems software and related service revenue in Q 3, we do not see a path to achieving our target of 30 million of revenue in this category in Q 4. While we are disappointed in that fact, we believe we have become a significant player in this new and exciting phase and will continue to grow our products, capabilities and channel partners. We expect that the DXI products will grow in Q 4 and revenue in the overall disk systems and software category will also increase. We will continue to improve DXI 3500 and 5500. We will continue to invest in our DXI, go to market capabilities. And as I said earlier, we expect to secure one or more OEM partnerships in the coming year. With that, I will turn it over to Rick.

Thanks, Jon. As we have said, we feel like we have made good progress in executing our operating model. But now, we focus on the branded revenue opportunity. Again, we see this challenge primarily as one of execution. While we remain cautious about the market, we continue to see opportunity for revenue growth. So, let me talk about what we are doing to drive this revenue growth. First over the last several months, we have taken a number of actions to address the challenges we've had in branded business. Primarily, but not exclusively, in the mid-range in enterprise phase. On the marketing side, we have recruiting a storage industry executive, [Janet] Lee, to lead our corporate and product marketing organization. [Janet] has a broad range of experience from retirement IBM, LEGATO, Avamar and Time [Spring]. We also established a field marketing function to work with our sales team and industry partners to accelerate adoption of new Quantum solutions, such as the DXI series. This team is implementing targeted programs to enhance our revenue opportunity. In addition to this, we created dedicated solution marketing team to focus on integrating our disk software and tape products within ISB applications. And then finally, we have evaluated and enhanced our pricing and channel programs to improve our competitive position.

In the sales area, we have added nearly 20 new sales people, increased sales engineers in Q 3, over half of them outside north America. And we have restructure our sales training programs to place more emphasis on solution selling. We also recently introduced disk tape solution bundles that include our DXI, appliances, scale or libraries, and storage care vision management products. We are forming a DXI specialist team in north America to support our edge to core solution sales and implementation. This will also enable us to increase our focus on DXI growth without distracting from our sales efforts around tape.

Speaking more specifically about products, we have strengthened our entry-level tape offerings with the recent launch of our full performance LTO-4 half-height drive and the continue grant of our scale of 50 library. We also have a number of OEM launches planned for our new LTO-4 half-height drive. And we have enhanced our mid-range tape automation products by offering enterprise class features such as storage networking and encryption key management at affordable prizes for mid-range customers. Most of these actions have been implemented in the last few months and we expect to see more of the results benefiting in terms of incremental branded revenue growth in Q 4 and subsequent quarters. Beyond the work we are doing to improve our overall branded performance, we also continue to focus on building our disk systems and software business. While most of this is centered around our DXI products, I want to highlight a couple of recent developments regarding our StorNext software. First as we announced last month, auto debt has become a reseller of StorNext and we expect to expand our reseller partnerships in the coming months. In addition, the latest version of the products StorNext 3.0 was just named as finalist for 2007 storage products of the year by the editors of Storage Magazine and search storage.com in the category of storage management software.

Turning now to our DXI series business, let me provide some context for where we stand and what we see going forward. As you may recall following the Quantum [ADIC] merger, we moved quickly to launch our first disk backup products with the duplication and replication. It has been almost a year since we started shipping the DXI 3500 and 5500 mid-range and remote office appliances. We have been pleased with significant customer interest we have generated from the start. But as we have ramped during the first two quarters of FY 08, we encountered some of the complexities involve in deploying the duplication technology in specific environments and applications. As a result, we initiated the series of software releases to ensure that customers could realize the full performance and capabilities of our DXI products in these situations. At the same time, we worked to build a stronger in infrastructure around this business and enhance our related expertise in sales and service. This effort continued into Q 3. And as we released the current update to our DXI software, which has been well received by our customers, however the impact of diverting engineering and sales resources to improve the overall customer experience with the DXI 3500 and 5500 was greater than we realized and affected our Q 3 results. Having said that, we still increased our DXI revenues by 31% and added about 70 new DXI 3500 and 5500 customers giving us a current installed base of approximately 200 customers. In addition, about 1/3 of DXI revenues with the quarter came from repeat purchases and about 50% of customers purchased a replication license, which reflects the growing opportunity and validation we continue to see within the marketplace. In fact, our DXI series product portfolio was just named as a finalist in the back up hardware category for Storage Magazine, searchstorage.com 2007 storage product of the year.

Let me talk about the status now of our DXI 7500 enterprise, D duplication and replication system. Up until the latter part of November, we were planning to begin shipping the DXI 7500 by the end of the quarter. However, as we got closer to the ship date, two independent developments came together and led to a decision to delay the DXI 7500 release. The first related to the complexity of some of the product's the functionality. While the overall product was solid, we are refined there which is taking us longer than expected to test certain functionality and longer than expected to close the issues that arose.

The second development involved discussions we have been having with major OEMs of the last several months in which they have been looking at utilizing our DXI software in their - to deliver their own product. As Q 3 progressed in the scope of one of the potential engagements expanded, we decided to involve more of our engineering team in determine how we could best structure our DXI development, testing and road map to enable us to continue enhancing the DXI 3500 and 5500, deliver in on our DXI 7500 solution, and also ensuring we can meet the requirements of this OEM in terms of both timing and product feature set. While we have nothing to announce at this time regarding these discussions, this process did impact our DXI 7500 schedule. We now plan to begin branded DXI 7500 shipments on a limited basis toward the end of this quarter with general availability next quarter. This is impacted our near-term revenue expectations, but we believe we made the right decision in terms of delivering a solid DXI 7500 product and not passing up a potential OEM partnership that could increase our overall market opportunity over the long run. We continue to feel for good about the DXI 7500, the benefits it will provide customers and the opportunity it represents for us. All of this has been further validated in the OEM discussions we've had and the fact that we have already received more than 200 requests for DXI 7500 quotes from customers. To say a bit more about our opportunities we look at the duplication market. We see tremendous excitement and growth potential. But then again, it is a market that is still very young. Much of this attention has been focused on start ups, who would the first to enter this market, but largely have point products that lack service and support infrastructure that will be needed to as the market expands to customers, as they pay more attention to scale ability. At the same time, the large system OEMs have not yet focused heavily on this market, part way we started since some cases have been not really viewing this as a strategic priority.

With all of this in mind, we have focused on building an integrated scalable family of disk based D duplication and replication solutions, the DXI series. For addressing customers data protection and retention needs across the distributed environment. From, excuse me, the distributed enterprise from remote sites to the primary data center. In doing so, we have leveraged our expertise in D duplication technology resulting from our pioneering patented work and our field proven high performance file system from StorNext. We have also incorporated direct tape creation in our DXI 7500 knowing that the ability to easily archive the tape continues to be a particularly important factor to enterprise customers. We believe that it is this comprehensive approach and the strong product road map underlying it that it is enable us attract interest from potential OEMs and other partners and has led to a range of customers across various industries to standardize on the DXI platform. None of this has mention suggest that we are status vary with our DXI results today. We feel good about the progress we have made, but fully recognize that we have more work to do drawing on the lessons we have learned over the past year. Enclosing now is much of the operating model actions behind this. We are very focussed on driving overall branded revenue growth and building our disk systems and software business. Thank for joining us. Now, let me turn the call back over to our operator for questions. Nicole?

Thank you. At this time, we will begin the question and answer session. As a reminder if you have a question, please press the star followed by the one on your touch tone phone. If you would like to withdraw your question, please press the star followed by the two. If you are using speaker equipment, you would need to lift the handset before making your selection. Our first question comes from the line of Brian Freed with Morgan Keegan. Please go ahead.

Hi, guys, good afternoon.

Hi, Brian.

A couple of quick questions, on your DSO and accounts receivable, this has been an on going issue. Can you talk a little more about it? I know the last two quarters, you cited issues with Oracle transition, you know, was this continuation of that? Was it back end loaded nature of the quarter?

Yes. I think there is a number of things. You got a couple - one of Q 3 tends to be more back end loaded than any other quarter. It is our own quarter-end. We also have a large branded, resale partner who has their fiscal year end. One of our largest OEMs has their fiscal year-end, so we tend to be pretty back end loaded in Q 3. The second is we actually collected, you know, $20 million more this quarter than we did last quarter. You can't see that because of the linearity. And then the third thing you mentioned was the sort of overall [turn] of putting the two companies together and the Oracle conversion. We are working through those problems, you know, we think we have made progress. We will continue to make progress and push down the receivables, that is cash we like to use to, you know, pay down debt. But there isn't really anything systemic different than that.

Okay. The second question, you mentioned you had some DXI revenue you had to defer due to revenue recognition criteria, just to give us a bit of a like for like comp as you compare to the prior quarter, was there a similar level entering the quarter?

No. This is a new -- this is new. The reason we broke it out for the quarter was really around this idea of 7500 and when we launched it. We had a handful of customers who were willing to take pretty early renditions of the product if you you will that we didn't feel we are evitable. And then one the things that is really exciting about this product is it is this hub that goes from the enterprise to the edge. And we expect in a lot of the quotes we have are in fact from multiple products. We had some 5500 business that we deferred as well because the customer wanted to utilize the product in that configuration before we felt comfortable recognizing the revenue. I know once you start one of those things, you have to kind of continue it. This was unique, we will see what happens within the next quarter. But we had none last quarter.

Okay. In turning to your branded automation business, you know, it performed a little under planned. Based on your comments, can you talk a little about the specific things you are seeing in the environment you believe it, a lesser demand from a Macro perspective for tape automation or do you believe that was more execution-related due to, perhaps, lack of sales forces.

Let me start on Bill here and let him comment. In the script, we talked about two things. One, we felt it was pretty focussed on our execution and it was pretty central to north America. We actually did quite well in Asia and Europe. Having said that, you know, we are not immune to economic and, you know, other trends that are going on. I will let Bill kind of go to the next level.

So let me give you a little background, talking specifically about the branded sales in north America. We have five customer segments that we organize our sales teams around. Large corporate accounts, general commercial, which is below the enterprise, kind of named the account segment, federal business, and then S and B entry level. We also have vertical market which is covered by our software sales specialist. Quarter on quarter growth in our general commercial segment was not enough to offset the misses in the other segments. If we kind of drill down underneath that, we do not think that it is any market opportunity issue with respect to tape automation, we think it is our own execution. We actually spent a lot of cycles working with some of our larger customers and prospects on being able to rearchitect their back up using this edged to core DXI solution. As prospects engage in that, it is a long sale cycle. It certainly takes a lot of consultative selling and support from our team. And quite frankly, some of the adjustments that we are making and going forward are reflecting the fact that we need to be able to address both the mid-range opportunity, as well as the larger corporate account opportunity. So, I would say in general, we don't see it as pressure on that segment of the tape market that is really impacting us. We see it as our own execution and we are working on things to correct that North America.

Okay. And then the last question, you mentioned that you pulled some resources, engineering resources out of the field to address the OEM opportunities for the DXI. And then you also indicate a fair deal of confidence that you will announce an OEM relationship. Are these one in the same? I guess what I am saying is, do you think it was worth it?

Well, that remains to be seen. We think we are uniquely positioned in two fronts. One, we think our edge to core strategy in the scalability of our offering our technology is unique. And we also have, you know, relationships with a number of the large players and not everybody had that. We saw a lot of OEM products today. We are trying to look at this as a long-term way we think like we have saw it in the past, partnering with the right partners to address seg ms of the market is important. And we have some very strong partnerships and we have some unique technology. So, it remains to be seen. We don't have anything done. But we felt compelled to talk about 7500 and the things we were doing and that's really why we brought it up.

I would just add. I think the last year, we have learned a lot about this market segment. First, we have learned that it is real. There's no doubt in our mind that the opportunities are there and this is profound and that the growth potential that exists more than anything we have seen it as a company and we are very excited about that. We have also just learned a lot over the last year about how to address this market, what the environment is like, what the back up applications do with data. You know, it is really quite a sophisticated complex process. And I think at the end of the day, we have stepped back and said that this unique strategy that we have, we are convinced that is a very strong strategy. We look around the market and we see nobody really doing it well. But the OEM traction is a good example of that. And we need to - I don't want to say slow down, but we need to be more measured in what we do because we really need to do it right and we have the time to do it right. And I think that we kind of reset ourselves in the last month or so, recognizing that nobody else really has the solution. If we do it right, it is a tremendous opportunity for us, let's make sure that we don't, you know, overplay our hand in the short term, and end up creating more difficulty. I think we would argue we have done some of that in the last year and we think we are a lot smarter about it now.

One way to think about this, I told some people this story, if you take, you know, the competition in space, they have been able to address this market over several years, be able to take up a few customers, you know, make it work, move to a few customers, make it work. Our strategy is not like that. We have scale. We introduce the solution and we try to implement it across hundreds, not a few. And that requires us to do things differently, to be more robust in our solution. I think the partnership thing will really help us be able to scale this business. But scale it at a time when we really feel like with we have a capability in the product and in our infrastructure to really make it successful. I don't know if all that makes sense. But to take away points are, it is an exciting market. We have a unique position and strategy. We have got to be really measured and focused on how we execute on that, and that is OEM traction that we have found does give us confidence in our strategy and it is something that we believe is worth it investing in, so that we can stay focused in segments and let our OEM pursue other segments to get the most long-term benefit out of this opportunity.

Okay. And my final question before I leave the floor, can you talk about the general Macro landscape, at least in your perspective of it, obviously you are some what of a log in the ocean.

I will make a few comments and I will let Bill who is probably closer to it than I. I think we see the opportunities to be better than what the market environment would indicate. Not to say that they're good, but they certainly, you know we haven't seen business dry up or we haven't seen deals come off the table like you are might expect. I was in New York a couple of weeks ago meeting with some financial customers. You would think they could be the most sensitive to it. There are deals out there. People haven't put the stop on spending. Now, I would also say that our historic business and backup storage is one that is a little bit like insurance. You know, people don't, don't, you know, take additional risks when business is bad. So, they still spend when business is good. They don't necessarily overspend either. We probably have less variation in the market in the segment of stories that we are in.

I just echo Rick's comments about the fact that what we really have is a market where customers have some real significant pain. They have problems in making sure that they're dealing with their operational recovery, SLAs that dealing with data retention, compliance. Tape is going to be a key part of that, especially in the core data center. That has been confirmed through our deep conversations with customers as they start to think about how they rearchitect their back ups to deal with the fast growing unstructured data growth in their environments. So, I think that while certainly there's going to be pressure on overall IT spending this year, based on just kind of looking at the Macro, there is plenty of problems that can customers can find a very, very good ROI TCO type of argument for why they should invest in these kinds of new backup and recovery solutions.

Thank you.

Thank you. Our next question comes from the line of Glenn Hanus of Needham. Please, go ahead.

Good afternoon. Jon, could you give us some update on your thinking on the operating models, financial model as we get into fiscal '09? Do you think of that gross margin sort of in the current range and where to you think that you can sort of drive the operating margin to is to?

We thought, it is a complex question in that. We are not done with our planning and we have some moving parts right now. But let me start 50,000 are kind of go from there. I mean, as you can see that, we have an ability to increase margin based upon mix and improvements in our, you know, our cost structure. That, you know, won't go on forever. But another way on flat revenue, it is hard to, you know, grow the gross margin. We are very focused on growing the branded business and it continues to be, you know, the key element of our strategy. I think you will notice this quarter, we actually had a pretty significant bump in sales and marketing expense. Here, we are investing before we have the revenue. We feel like that is warranted with our position. So, we have also talked about this goal of getting the 10% and then going further than that. I think, Glenn, you know we have a pretty good feel for our expense structure. You know, it is roughly $70 million a quarter give or take. Our gross margin right now, on this kind of mix is mid to upper 30s, you know, we are close to 38% this time around. But you can see the leverage in the model. If we added $20 million of branded business to the cost, to this model, our cost wouldn't change dramatically and our operating profit would in deed be over 10%. Really for us, it is the need to drive more profitable branded business. Having said that, we are also conscious that if we are successful in OEM software to one or more of the major players. You know, that is also pretty good margin revenue. And that will improve the model too. So, what we are going to do at this time is, we get guidance for Q 4. We are right around the 10% range. We think we have made a lot of progress. And then when we get to the Q 4 call, we will look forward to 2009 and you know, we will update our thinking about what our opportunities are and where we can get to.

Can you give us what StorNext did sort of quarter on quarter, up down, how much?

StorNext was pretty flat. It was, I think, down just a little bit, hundreds of thousands type.

Is that kind of your general outlook there, sort of flattish might slightly up?

No, I think, we think that the market has, you know, continued to evolve where StorNext type solution and software system in the storage manager behind it is more opportunity for more customers. It is still a very, very consultative sale. It is why we have, you know, a vertical sales force. But the market has moved more to the product. The product has been recently improved. I think we talked about awards we are up for. We need to turn that momentum into revenue, adding even a little bit of margin there, you know, helps the model. We think it is a place we need to keep investing. As we talked about the fact, it is core to our DXI series as well.

Is most of the non-DXI disk or legacy disk revenue now pretty much gone or?

We still have a little bit. But it is, I can safely say that the grow, I mean of the three products that are in that category, the growth opportunity is unquestionably DXI. That's where we, you know, at some point in time, it will be easier to talk about because we will be down to two things in there. But DXI is the driver. We talked about 31% growth being good sequentially, but still below we had planned on and we are driving to.

So, you think this quarter might be a little bit of slower sequential DXI growth given some of the issues that you have discussed?

No. I think we think DXI will continue to grow. And I think I tried to be specific in my comments, you know, this quarter, it grew, but the category didn't grow. I said in my comments, we expect DXI to grow and we expect the category to grow too. That was another way of saying, we are not expecting a big decline in the other areas.

Thank you.

Thanks.

Thank you. Ladies and gentlemen, if there are additional questions, please press the star followed by the one at this time. Once again, you may withdraw your question from the queue by pressing star followed by the two. If you are using speaker equipment, please lift the hand set before making your selection. Once again, ladies and gentlemen, if there are additional questions, please press the star followed by the one on your telephone key pad. To withdraw your question from the queue, please press the star followed by the two. If you are using speaker equipment, you will need to lift the handset before making your selection. (OPERATOR INSTRUCTIONS) And management, there are no further questions at this time.

Okay. Thank you. Thanks to all of you for joining us today. We look forward to talking to you next quarter.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation, and have a great day.