Quantum Corp (QMCO) 2010 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the second quarter 2010 teleconference. [Operator Instructions.] This conference is being recorded today, Tuesday, October 27, 2009.

I would now like to turn the conference over to Shawn Hall, General Counsel. Please go ahead.

Thanks, and good afternoon. Here with me today are Rick Belluzzo, our CEO, Jon Gacek, our COO and CFO, and Bill Britts, our EVP for Sales and Marketing. The webcast of this call, our earnings release, and 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 will be archived for one year.

During the course of today's discussion, we will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements include statements regarding our business strategy, opportunities and priorities, anticipated product launches and plans, future financial performance including expected revenue, gross margin, expense and income performance, and debt covenant compliance, and trends in our business and in the markets in which we compete. 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 Q2 FY 2010 results, as well as to reports filed with the Securities and Exchange Commission from time to time, including our most recent 10-Q filed on August 7, 2009. Such reports contain and identify important factors that could cause actual results to differ materially from those that are contained in our forward-looking statements. All such risk factors identified in our press release and in our filings with the SEC are incorporated by reference into today's discussion. We undertake no obligation to update these forward-looking statements in the future.

With that, I'll turn the call over to Jon Gacek.

Thanks, Shawn. Good afternoon, and thank you for joining us as we report our second quarter results. We are very pleased with our Q2 results and the continued progress we have made in our overall operating performance. On a non-GAAP basis, these results include the highest non-GAAP gross margin in 10 years, the highest operating margin in nine years, and the most profitable September quarter also in nine years. In addition, revenue increased sequentially by 9%. This is the first such increase in seven quarters, and we are quite proud of the progress that we made.

Here are a few highlights. First, disk systems and software revenue, including related software maintenance and service revenue, was 28.2 million, compared to 20.8 million a year ago. This is a year over year increase of 36%.

Second, our non-GAAP gross margin was 47%, compared to 42% for the same quarter last year. As I said, this is the highest level we have achieved in 10 years.

Third, our non-GAAP operating expenses were 54.1 million, down 15.9 million or 23% from Q2 of fiscal '09. As a reminder, Q2 of last year included $11 million of royalty revenue from the settlement with Riverbed deduplication patents and approximately 1.8 million of associated legal costs that were included in G&A.

Fourth, our non-GAAP operating profit was 16%, compared to 9% in the same quarter last year. This was the largest operating profit we've generated in nine years.

Fifth, non-GAAP net income increased 106% to 23.2 million, or $0.11 per share, compared to 11.2 million, or $0.05 per share for the second quarter last year. Again, this is the best performance in the September quarter since fiscal 2000.

Sixth, as we did last quarter, we generated a GAAP net profit of 11.4 million in Q2, compared to a net loss of 3.3 million in Q2 of last year.

And finally, we generated cash from operations of 31.4 million. We had EBITDA of 32.7 million during the quarter, paid down 20.5 million of our senior debt, and ended the quarter with a cash balance of 85 million.

I would like to refer everyone to the financial statements and the supporting schedules included in the press release. It will be helpful to refer to those documents as I make my comments. With that, I'll move to revenue.

Revenue for our second quarter ended September 30 was 174.9 million, compared to 215.4 million a year ago, and 160.3 million in the prior quarter. This is a sequential increase of 14.6 million, which is the first sequential revenue increase in seven quarters. Year over year, revenue declined 40.5 million. However, as I walk through the revenue detail, remember that our non-GAAP gross margin is up over 500 basis points from the same period a year ago.

Royalty revenue was approximately 16.8 million for Q2, compared to 30.6 million in the same quarter a year ago. The decline was primarily due to the fact that last year we recognized an $11 million royalty related to Riverbed and our deduplication patents. In addition, we had a decline in year over year LTO and DLT royalties. For the quarter, non-royalty revenue totaled 158.1 million, of which 73% was branded and 27% was OEM. That compares to non-royalty revenue of 184.8 million a year ago, of which 66% was branded and 34% was OEM.

Since the merger with ADIC in 2006, we have focused on transitioning our revenue stream to higher margin products, which has been one of the primary reasons for our year over year revenue declines. However, during this time, our non-royalty branded share has increased from 52% of product revenue to 73%, the highest percentage in the company's history and a significant contributor to the increase in non-GAAP gross margins from 31% to 47%. We strongly believe this yields a more valuable business.

Looking further at revenue classifications, devices and media totaled 27.7 million, compared to 38.8 million in Q2 a year ago. The decline is attributable to an anticipated decline in OEM devices of 5 million, branded device revenue of 2 million, and branded and OEM media revenue of 4 million. This is an example of how we've managed the business as we transform Quantum. This is a low-margin product category, and we are focused on generating gross profit dollars. As a result, we have reduced sales of the low margin products and pursued revenue growth when it's profitable.

Tape automation systems revenue was 65.5 million, compared to 85.8 million in Q2 of fiscal '09. 11 million of this decline was related to branded automation products, and the remainder was related to OEM products. The decline in branded automation was primarily related to volume declines in North America across mid-range enterprise and entry automation. However, as I previously mentioned, we had a sequential increase in automation, with both branded and OEM growing for the first time in 11 quarters.

Disk systems and software products and related service revenue was 28.2 million, up from 20.8 million a year ago. On a year over year comparison, we had a significant increase in our Quantum branded DXi revenue, a modest increase in our--in StorNext revenue, and a slight decline in license revenue from EMC.

I mentioned on last quarter's call that we expected to close several DXi deals in excess of $1 million during the quarter. It turned out that we actually closed three. We also had a number of very large follow-on orders from existing customers and saw very good demand in our larger DXi 7500 systems. Customers like the scalability of the DXi 7500, its VTL interface, and tight integration with tape. In addition, during the quarter we had a major software release that significantly increased our replication capability and overall system performance.

Finally, last week we announced our new DXi 6500 family that is focused on the mid-range NAS market. This product will begin shipping during the current quarter. We are very pleased with our progress in this category overall, particularly with our traction with our channel partners. We expect that our new DXi 6500 will contribute immediately to our disk systems and software revenue.

As for the future EMC license revenue, we expect that the amount Quantum will recognize in Q3 will be down from Q2. However, we expect the amount recognized over the next three quarters, in total, will be similar to what we recognized in the first half of this fiscal year.

Moving to service revenue, it was 39.8 million this quarter, compared to 41.6 a year ago. This decline is the result of a decline in OEM out-of-warranty repair, offset by an increase in service revenue related to contract uplifts of our branded product installed base.

Turning to gross margins, non-GAAP gross margin in Q2 was 47.1% compared to 41.9% in the prior period. This improvement was driven by an improvement in mix including an increase in disk systems and software revenue, a decline in low margin OEM automation sales, and a decline in low margin devices and media revenue. In addition, we continue to achieve cost reductions in manufacturing and lower warranty costs. The 500 basis point improvement over Q2 of last year came even as royalty revenue declined 14 million, including the 11 million last year from the Riverbed settlement. And non-royalty revenue declined 27 million.

This quarter's results show how much progress we have made improving our mix to higher margin branded products, and how much leverage we get when revenue increases. We are very pleased with the quarter's gross margin and believe it is a great indicator of the overall value of the business.

Moving to expenses, non-GAAP operating expenses totaled 54.1 million, compared to 70 million a year earlier. That is a $15.9 million reduction, or 23%. The cost decrease was primarily related to decreased costs in sales and marketing and G&A of 9 million and 5 million, respectively. The sales and marketing decline was primarily related to lower head count and better sales utilization. The decrease in G&A was primarily related to declines in legal and professional services costs.

As I previously mentioned, non-GAAP operating profit for the quarter was 28.3 million, or 16.2% of revenue, compared to 20.2 or 9.4% of revenue the same quarter a year ago. We generated improved results from both tape products and disk systems and software products.

Interest expense for the quarter was 6.9 million, compared to 7.5 million a year earlier. This includes cash interest expense of 6.5 million and amortization of debt issue costs of 400,000. The coupon interest rate for our remaining senior debt of 187 million at September 30 will be approximately 3.8% for the quarter ending December 31, and our average coupon rate for our total debt will be 7.8% for that same quarter ending. We expect interest expense will be approximately 7 million per quarter for the remainder of fiscal 2010.

For the second quarter, we recognized a net tax benefit of $500,000, primarily related to foreign taxes. We still believe it's reasonable to model 1 million per quarter in tax expense.

So summing up for Q2, we had non-GAAP net income of 23.2 million, with non-GAAP EPS of $0.11, compared to a non-GAAP net income of 11 million and $0.05 in the same quarter last year.

Focusing on cash flow for the quarter and the balance sheet at September 30, I would like to highlight several key points. Cash flow from operations for the quarter were 31.4 million, 12.4 million resulting from the net EMC pre-paid license fee. We paid down 20.5 million of our senior debt in Q2, and at quarter end, the composition of our debt was 187 million of senior debt, 122 million outstanding with EMC, and 22 million of convertible debt. We ended the quarter with cash of 85 million.

Non-GAAP EBITDA for the quarter was 32.7 million. We continue to be in compliance with all debt covenants at September 30, and we expect to be in compliance with our debt covenants during the next 12 months. For purposes of calculating our debt covenants, our EBITDA for the last 12 months was 111.6 million.

Sequentially, manufacturing inventory decreased 4.7 million, and accounts receivable increased 17.5 million. We had an accelerated payment of 11.7 million from one customer. CapEx was 1.2 million. Purchases of service parts inventories were approximately 1.5 million, and depreciation, amortization, and service parts lower of cost or market expense totaled 14 million for the quarter.

Looking forward to Q3, we are forecasting revenue of 175 to 185 million, a slightly lower gross margin percentage due to mix changes, and slightly higher non-GAAP operating expenses, and as a result, we expect non-GAAP operating income to be essentially flat or similar to what we just did in Q2.

Now let me turn the call over to Rick.

Well, thank you, Jon. Today I would like to discuss two topics. First, I would like to talk about how our Q2 performance aligns with the work that we've been doing to transform the company, and then I would like to make some comments on our go-forward plan.

Q2 was a very critical quarter for Quantum, given the ongoing impact of the economic downturn and changes in the deduplication landscape. Despite these factors, we were able to capitalize on a number of the initiatives that we have been implementing over the last year, which allowed us to deliver very strong results. In addition, during the quarter we also made an aggressive shift in our go to market focus as the EMC relationship went through a dramatic change. All of this demonstrated that we remain very clear about what we have to do to complete the transformation of Quantum into a higher value storage systems company.

As we have discussed in the previous earning calls, we've been driving this transformation for the last few years, as illustrated by our focus on two primary objectives. First, improving our operating model, and then secondly, growing our disk systems and software revenue. First, with regard to our operating model. We have been focused on improving both our gross margin and operating margin. Our goal has been to deliver a non-GAAP gross margin in the mid-40% range and non-GAAP operating margins in excess of 10%. To achieve this we have worked to shift our revenue stream to higher margin, higher value segments, while allowing lower gross margin businesses to decline.

Furthermore, we have aggressively managed our cost structure to ensure that our investments were focused on our strategic priorities. Our Q2 results were very much in line with this focus on gross margin and operating margin improvement. As Jon said, our non-GAAP gross margin of 47% was the best in 10 years and our non-GAAP operating margin of 16% was the best in nine years. Many of the initiatives that we have implemented over the last couple of years have taken hold and resulted in significant enhancements to our fundamental business model. And it is important to note that while our overall revenue performance in Q2 improved from recent levels, these gross margin and operating margin results were mostly driven by a combination of shift in our revenue priority and aggressive cost management.

Our second main objective has been to build a growth platform in disk systems and software. We have endeavored to position the company in two growth segments of the storage industry. First, disk systems backup with a focus on deduplication, and second, high performance file sharing with integrated archiving. These two segments have ample opportunity for growth and today more than 60% of our R&D investment is focused here. Last quarter, we said that our goal for Q2 was to begin sequential revenue growth in disk systems and software and we increased revenue by nearly 50% over Q1. We did this even in the face of the EMC-Data Domain transaction, aggressively adapting our go to market priorities and delivering very solid results. Our focus here is very clear and we will strive for continued sequential growth.

In short, we know that becoming a more valuable storage systems company ultimately requires the establishment of both a solidly improving operating model and a vibrant growth platform. In Q2, we were very successful in delivering on both of these goals.

Now, let me provide some additional background on our Q2 results. There was a measurable improvement in the storage purchasing environment during the quarter, which is--was a significant recovery in EMEA. In recent quarters it has been difficult to get deals through the approval process, resulting in widespread delays. This quarter there continued to be deals that pushed out, but clearly not as many. It also appeared that channel inventories started to improve in order to replenish unsustainable levels. The enterprise segment of the market demonstrated the greatest improvement while the mid-range continues to suffer from a constrained economic environment. In short, the IT purchasing environment demonstrated clear recovery, which was a factor in our improved performance.

Our revenue growth was most notable in higher margin segments. Non-royalty branded revenue was up 13% sequentially, while OEM sales were up only slightly. Additionally, our strongest sequential growth was in disk systems and software, followed by tape automation and service revenue. This was the biggest contributor to our gross margin improvement and reflects our established revenue priorities. The growth in disk systems and software was most significant, growing from 19 million in Q1 to 28 million in Q2, with related software maintenance and service revenue included. The growth was most notable in our branded DXi sales and driven by enterprise wins, including several million-dollar-plus deals. Our goal in the enterprise market is to focus our sales effort on customer environments where we have proven success.

One thing is clear - the market for deduplication replication is very strong. Our sales funnels are growing and it is important for shareholders to understand that we've been primarily operating in a relatively narrow segment of the disk backup and deduplication market, that is, VTL enterprise systems, and we have been very closely tied to EMC. In other words, we've really--we haven't really begun to capitalize on the opportunity outside of the enterprise and [as] we now have the opportunity to do so with our new DXi 6500 family, which I will discuss shortly.

Looking more specifically at our branded DXi results for Q2, I just wanted to mention some of the highlights. Revenue grew significantly with the DXi 7500 revenue at a record level. We also set new records for the number of repeat DXi 7500 customers and the number of replication licenses sold. Our million-dollar-plus deals included new DXi customer wins with one of the top utility companies in the world and another national utility provider in Europe. Other notable wins included a large deal with one of the biggest U.S. insurance companies, a new DXi customer, and repeat business with the U.S. Federal Reserve Bank, and one of the largest wireless providers in America and the Paris Airport System. While the EMC portion of our disk revenue was slightly down, EMC continued to sell EMC disk libraries with Quantum deduplication technology throughout the quarter.

Our software revenue, predominantly StorNext, was up in Q2 with modest growth both year over year and sequentially. In addition to a strong contribution from federal government sales, we closed several major StorNext deals, including a new win with one of the leading U.S. cable TV networks and repeat purchases by a large multimedia retailer and one of the largest system integrators in China.

In summary, we are very pleased with our Q2 performance as we responded to the recent market events and executed solid revenue results in the areas that provided the best margins. And we did this while continuing to manage our expense structure carefully. In Q2, we were able to demonstrate the value of our strategy. Now, of course, our priority will be to continue the momentum we established into Q2--into Q3 and beyond.

Before I address this topic, let me say a few words about the impact of the EMC-Data Domain transaction. Previous to this event, we had built our deduplication go to market focus and R&D investments around optimizing with EMC. EMC's acquisition of Data Domain required us to reevaluate our program and make aggressive moves. On a positive note, it clearly demonstrates the importance of deduplication, which has resulted in more customer visibility and a higher sense of urgency for storage companies to define their plans.

As one of the few leaders in this breakthrough technology, we believe that there are many opportunities to capitalize on this increased attention. As for EMC, they remain an important partner overall. We will continue to deliver on our commitment to meeting their requirements for our deduplication software and will also continue to partner with them closely as their exclusive tape automation provider. Of course, we know that EMC sales incorporating our deduplication software will diminish even though it declined only slightly in Q2. As a result, we are pursuing a new agenda based on the reality of the changed dynamics with EMC and the expectation that there will be minimal ongoing opportunity with them related to deduplication in fiscal 2011.

So now, let me say a few things about our priorities for the coming quarters. Well, let me start with tape. We continue to execute our tape business in the way--in a way that recognizes the mature nature of the technology. We have a very clear roadmap that will deliver several incremental opportunities in the near term. Those will include the introduction of a new entry level library which will ship in the current quarter and the release of LTO-5 early next year. The entry level library will greatly improve our competitiveness in this segment. We also must remember that while the tape market is mature it was still a $3.6 billion market in 2008 and is forecast to remain around $3 billion in 2012. And as the worldwide leader in open systems tape automation, we see opportunities to take share from weaker suppliers.

In summary, we have a very focused strategy and a new product plan that will allow us to continue to contribute to this market and make it a very attractive business. Additionally, we will have some near term opportunity with products like our new entry level library as well as solutions like our recently introduced tape encryption product.

Turning to disk, the VTL NAS disk based backup market is expected to double from 2008 to 2012. Within this category, the deduplication segment has even greater growth opportunity. Our plans in this area include the following. First, today, nearly all of our disk systems revenue in the VTL--is in the VTL enterprise segment of the market and the DXi 7500 is well positioned in the segment. The combination of Quantum and EMC have enabled us to establish a leadership position with over 800 pedibytes of data protected using our deduplication technology. In the near term we will focus our enterprise sales efforts to gain accounts and revenue with the Quantum brand, recognizing that EMC will likely try to shift its customers to Data Domain technology.

We will also focus our sales resources where we have the best opportunities to win and we will continue to enhance our product offering as we did with the recent 1.2 software release, which greatly improved performance in a number of key areas. We will use an aggressive account focus, our VTL position, and our integration with tape to deliver greater revenue momentum. We started to establish this with our Q2 results and expect that we will be able to continue to deliver strong momentum going forward.

Second, last week we introduced a new platform focused on the mid-range NAS segment of the disk backup market. The DXi 6500 family consists of five pre-configured appliance models for protecting environments from three to 30 terabytes of primary data. Market research shows that 75 to 80% of mid-range customers have not yet adopted deduplication in large part because of the concern over complexity and cost. Therefore, the DXi 6500 family was designed to provide an unparalleled combination of simplicity and value while delivering all the benefits of advanced deduplication technology. We have bundled all licensed software features in the price of the appliances and made them easy to order, deploy, operate, and manage. All of this makes the DXi 6500 family an ideal offering for the independent channel.

We also see this as an incremental opportunity in the segment of the market where Data Domain has been strongest and where the timing is quite good, as EMC--the EMC-Data Domain transaction has created a lot of disruption in the channel and with ISVs. We intend to capitalize on this and build a revenue stream to complement the traction that we have obtained in the enterprise VTL segment of the market.

A third focus area will be partnerships that range from alliances with ISVs, such as Symantec, to new OEM customer development opportunities. We have already had several announcements regarding tight integration between our DXi product and Symantec OST, including being the first and still only deduplication provider whose products are certified for direct tape creation through NetBackup OST. Additionally, we are in the process of working through various OEM opportunities. The EMC-Data Domain combination has raised the status of deduplication and it has become a strategic issue for a number of large storage companies. We expect to play a role in providing solutions to some of these companies, but it is too early to provide any indication of timing.

In short, these three initiatives - extending our enterprise VTL leadership, establishing a strong position in the mid-range NAS market, and developing new OEM and/or alliance partnerships - will allow us to continue to build momentum and a broader revenue base in the very fast growing disk backup and deduplication market.

Now, let me turn to the other component of our disk systems and software focus, StorNext. StorNext is a well established, high performance cluster file system that also offers policy based tier storage in archiving as well as deduplication. This gives us a powerful asset we can leverage in a market with significant opportunity. In the media and entertainment space, where we have established a leadership position, the continuing growth of high definition content and more recently the move to 3D is creating tremendous demand for storage. At the same time, we are seeing new opportunities in areas such as healthcare, life sciences, and energy, where the need to share, manage, and protect hundreds of terabytes and even pedibytes of data is critical. And finally, the high performance scalability and resiliency of StorNext provides new opportunities in developing segments, like cloud computing.

In summary, the traction and growth prospects we are seeing with DXi and StorNext, along with the opportunities for new partnerships should enable us to continue building quarterly momentum with our disk systems and software products, providing an increasingly significant revenue stream and a profit contribution.

Let me close by saying we are very excited about our Q2 results and the momentum that we established. While the market is still very competitive and still marked by uncertainty, we intend to extend this momentum into Q3 and beyond. We are in the midst of a broad based new product introduction cycle and we have a leadership position in exciting growth segments.

With that, I will turn it back--turn the call back over to the operator for questions. Operator?

Thank you, sir. (Operator Instructions.) And our first question is from the line of Brian Freed with Morgan Keegan. Please go ahead.

Hey, guys. Great quarter. So my first question, on your new product, can you talk a little bit about how it differentiates from both your prior products as well as the competing Data Domain products, and specifically how you make use of SSD in those products?

Well, I'll start and I'll have my partners here jump in as necessary. So when we--we had a mid-range product offering - that was our first launch with the original DXi - we learned an awful lot in that process. And when we reentered the market with the 6500 line, we were really focused on this notion of simplicity. And we wanted to take our latest software and we wanted to take a new hardware family, we wanted to put those together, we wanted to package them in a way that makes--that allows people to implement these solutions to sell, support, et cetera, very easily, and really work to align all the software/hardware features to make that happen.

Additionally, we recognized that this is a new platform, so we made a number of decisions around hardware that make this platform very extensible over time. Those include the latest Intel processors and SSDs, which frankly, as we advance our software will give us more performance capability over time. So we've really focused on the immediate opportunity in the mid-range with the NAS segment of the market and we also introduced a product that over time our software will further take advantage of some of the advanced hardware features to be able to make--be able to tell customers that not only are you buying a simplified, good value solution, but there's also a growth path that as software improves you'll be able to have this be an enduring platform in terms of performance.

Thanks. And secondly, as you look at--I know you mentioned that you expected immediate contribution. As you kind of look at product cycles in terms of the evaluation and adoption, specifically the enterprise where you have--the bulk of your traction seems to be fairly long product eval cycles, what are you seeing in terms of the new 6500? Do you think it will have a little bit shorter go to market cycle than say the historic DSi 7500 products?

So--Brian, this is Bill. The whole kind of process of how we sell it and really focusing on the channel and being able to bring some of these characteristics that we--as we've kind of looked at the product portfolio are really important in the mid-range - ease of use, simple to deploy, easy for the channel to be able to quote, to be able to have the user install these systems. We think there should be shorter sales cycles. We think that demonstrating the value of the product is going to be more straightforward because it's really optimized around these different use cases and the models kind of are tailored in specific use cases. As far as what we've seen so far, we just announced the product last week, which is [slated] to be shipping in November. So we'll have just a month and a half of actual shipments in the quarter. But we do anticipate this will be a much more easily quoted and deployed product than the 7500 VTL, which typically required proof of concepts, larger--bigger evaluation cycles, and leads to a longer sales cycle.

Okay. And one last thing, a technology question, then I want to jump to the operating models. But if you look at your bundle, one of the products you deliver on is the (inaudible) Express. Can you talk a little bit about the adoption you're seeing there? It looks like it gives customers kind of an end to end opportunity for back up and maybe eliminates the need for a third party provider of those backups of the virtual machines. Can you talk a little bit about it and what--how many customers you have and if you're getting good traction with it?

So you're mentioning a few things together. The mid-range product that we currently have is the DXi 7500 Express, which is kind of--it will be the VTL product that continues on in that kind of space for customers that need 10, 20, 30 terabytes of data to protect. We also bundle in a software module called ES Express, which is just a tool for being able to do better data protection, easier data protection, with deduplication (inaudible) backup appliance like 7500, for VMware or virtualization types of environments. So in terms of the update of that, it's still early. We've had that product in market a couple quarters. I would say that it's a better fit overall with the 6500 in terms of kind of ease of use, ease to deploy, the ability to quickly integrate into a customer's environment. And so, I would anticipate that the focus on the mid-range, the simplicity of the new product, will all help the uptake of ES Express [in that case].

Okay, great. I meant to say ES Express. But anyway--and then, turning to the operating model. And Jon, you've done a phenomenal job on the margins, so congrats there. As you look forward, particularly as you try and pursue more branded opportunities in light of EMC's moves, do you feel like there is--you're going to be able to move operating margins further upward or do you think they will trend flat to down going forward as you invest in your channels?

Man, you are greedy. That was [16%]. I think the main message here is we think we've done a good job on the cost model. We have definitely improved our mix. We tried to give all the shareholders a view of how much that's moved. This quarter really demonstrated something that we haven't been able to see in a couple of years, which is how much leverage we get when revenue increases. And that's really the next step in our model is that as we grow revenue here, especially branded, we get a lot of leverage. And we get it at the gross margin line and we get it at the operating model line. So I don't want to--I didn't--we didn't guide to higher operating margin or higher gross margin. We actually guided slightly down on the gross margin and flat on operating.

But it does show as the business grows how much leverage we get and how much flows to the bottom line. So as revenue grows over time in the branded business, I think we'll see an expansion. But in the short term, we're forecasting this is a really good spot we got to. Now, we have to replicate it a few quarters.

Okay. I'm not trying to be greedy, Jon.

I know you aren't.

You do need to invest going forward. I just wanted to make sure this wasn't a one time anomaly and it's something we could see again in the future.

Yes. So I think on the investment side--we get this question from time to time. I think we feel like for the next two quarters in the sales and marketing side we'll do a few things. But we have capacity to sell more. And on the R&D side, we've got a lot of great opportunities ahead of us. We'll spend a little bit more money in both those areas, but it's--I will emphasize sort of a little bit of money. We're not going to spend a lot more.

Okay. I'll cede the floor for now. And congrats, again.

Thank you.

Thank you. (Operator Instructions.) Our next question is from the line of [Jeff Crown] with GoldenTree. Please go ahead.

Hey. Just a quick question on the capital structure. You mentioned that you had about--the 187 term loan, about 122 of the EMC loan and 22 million of the converts.

Yes.

The EMC loan - how does that break down again? I think there's like 75 that's due on September '14, and then there's a 25 and another 25. What's the breakdown of that again?

It's 100 that's due in September of 2014 and 22 that's due in December of 2011.

And when does the--and the term loan matures in July of '14, correct?

That's correct.

And are the--is this EMC loan subordinated to the term loan or [prior] to the term loan?

It's subordinated.

Subordinated to the term loan. And both of the coupons are like 12%, correct?

Correct.

Okay. Thanks a lot. That was it. Thanks, guys.

Yes.

Thank you. (Operator Instructions.) Our next question is from the line of Joe Feshbach with JFP. Please go ahead.

My, what a great quarter. Congratulations.

Thank you.

And great long term progress. A couple of things. Can you just provide maybe a little bit more color on the price performance advantages of the 6500 versus obviously the key competitor, Data Domain, just sort of box-to-box, to the extent that you can?

I would simplify it by just saying that what we've done is bundled all of these kind of key features that are important to this particular disk space backup product - bundling in the deduplication license, the OST license, replication, all of that. And then, it's focused on data to protect. So what we're trying to do is simplify the whole process of this is what a customer environment looks like, this is how much data that they want to protect with this particular model, and then be very aggressive in being able to bring all of that together with a very simple to present solution with these different models. And they line up against those particular customer data to protect and use cases. So when you look at the value that we're providing in having all of this bundled together, it's really--it's kind of a different approach than what other people are taking into the space.

Got it. And then, Jon, do you just happen to have a copy in your head of the service gross margin?

Yes, I can get that in--.

--Or I can--I mean , I can get it

It will take--I'll answer it. Go on to the next question. It will take a second to calculate.

No problem. And then, in terms of tape, did you see the--I assume that the quarter got stronger not only because it's a bit back end loaded because the economy got a bit better. Have you seen--assuming my first statement is correct, have you seen momentum continuing into the December quarter in terms of customers loosening up? Do you see some budget flush possibilities?

I'll start, and then I'll let Bill answer. I think it's--we do a lot of business at the end of the branded, but there's a lot in the third month--and a lot at the end of the year. Having said that, our funnels are really full. I'm--Bill's agreeing with that. And people are spending money. We--it comes down as it does always. We have to go close the business and get the order and ship the product. So I think we feel good about kind of the environment overall on tape and on disk both. I think our funnels are really strong on both of those. And then, those are going to get augmented by what we would think about as two fairly incremental products, both the DXi 6500, but we're quite excited about the new low end library, too. We think it's going to be disruptive. We will be the only ones selling it. In other words, we won't have any OEMs for it. It's just a branded product. And we'll be competing with a product that, while it's a very good product, has been around for quite a while. And we think we're going to grab some share there, too. So we're feeling good about kind of where we sit today, but we've got a lot of work to do to close the quarter.

Sure.

The only thing I would add is that we were really pleased to see Europe come back--the EMEA business in Q2 was quite strong relative to Q1, and it does look like the environment there has firmed up.

Got it. And then, it wasn't a huge number, but still service--you had originally indicated that service revenues would probably be down sequentially and it looked to me like what they were--they were either up or flat to up versus Q1. And I'm just curious whether demand for service is starting to reemerge as well.

In my prepared comments I talked a little bit about the fact that actually our branded installed base service contract was actually up. We also have a repair component from our OEM business, which has been trending down as our business has gotten smaller there. So we actually have seen an increase in our branded side offset by a decline similar to our product situation--lower margin, less profitable OEM repair business.

Got it. Okay.

The margin was 36% on services.

Wow. Is that 1,000 basis points better than it was a year ago or am I--is my memory failing me?

It's about--it's quite a bit better. On 2 million less revenue, it was 5 million more in margin. But as Jon said, the service mix is a little bit like the product side. We had a higher content of OEM like repair, device, repair oriented, which is very price sensitive, very competitive, coupled with contracts where you have an opportunity to differentiate with better service and the like. So it's the same kind of--that's why we're so--we've been so insistent over the last few years as we get beat up on revenue declines, we are so insistent about the point that we are building a higher value business. And we will find some revenue base level that makes sense given all the changes we're making, and we will grow from there. But what we will end up with is a business that is higher gross margin, higher operating margin, more sustainable over time than the big, lump lower margin OEM oriented kind of low end part of the business, which really dominated the Quantum model several years ago.

Well, I'll vote for that. That sounds great. Okay. I think that covers my questions. Were you going to say something more? I'm sorry.

No, thanks. We appreciate the support.

Okay.

Thank you. (Operator Instructions.) And I show that there are no further questions. Please continue.

Okay. Well, thank you for joining us. Of course, you can sense our excitement. But I'll also be really clear that we know we have a lot of work still to do. One quarter doesn't make a successful company. We believe it's--are pleased to see the progress that we've made in a lot of our initiatives, but we have a lot of work still to do and we're not losing sight of that at all. We're very focused on product execution and market success and managing our costs, all the things that have brought us to this point. And so, we look forward to reporting on that during our next call. Thank you for joining us.

Ladies and gentlemen, this concludes our conference for today. If you'd like to listen to a replay of today's conference, please dial 1-800-406-7325 or 303-590-3030, followed by the access code of 4169130 and the # sign. Thank you for your participation. You may now disconnect.