Quantum Corp (QMCO) 2010 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Quantum Corporation third quarter 2010 conference call. During today's presentation all participants will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator Instructions). This conference is being recorded today, Thursday, January 28th of 2010. I would now like to turn the conference over to Shawn Hall, General Counsel. Please go ahead.

Thank you, good afternoon and welcome. 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 in the Investors section of our website 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 and expense 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 Q3 2010 results, as well as to our reports filed with the Securities and Exchange Commission from time to time, including our most recent 10-Q filed on November 6, 2009. 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 our press release and in our filings with the SEC, are incorporated by reference in 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 Jon Gacek.

Thanks Shawn. Good afternoon, and thank your for joining us as we report our third quarter results. We are very pleased with our Q3 results and the continued progress that we have made in our overall operating model, closing on our third sequential quarter of delivering GAAP net income. We are reporting our second consecutive quarter with increased total revenue and branded revenue. In the December quarter, we continued our trend of transitioning our business to higher margin branded business. Our gross margins continued to be some of the highest we have recorded in ten years. Operating expenses were managed tightly and we reported non-GAAP operating profit of $22.7 million, or 12% of revenue.

Additionally, this quarter's results include minimal OEM DXi software revenue, compared to a year ago and to last quarter, and as you can see from the results, we have been able to transition away from OEM DXi software revenue to branded DXi growth, and still deliver solid double-digit operating profit.

Here are a few additional highlights. First, disk systems and software revenue, including related software maintenance and service revenue, was $24.8 million, compared to $31.3 million a year ago. The amount we recognized this quarter was 95% branded, and excluded the impact of OEM DXi software revenues in this category. Both this period and last, our disk systems and software revenue grew 29% over the same quarter a year ago. So our branded DXi grew 29% year-over-year.

Second, our non-GAAP gross margin was 44% compared to 45% for the same quarter last year. We continued our trend of moving to more branded business, reporting 76% of branded non-royalty revenue for this quarter, compared to 65% in the same quarter of last fiscal year. In absolute dollars, branded revenue increased both sequentially and over the same period in the last fiscal year.

Branded sales typically have higher margins, however, this quarter the improved mix was impacted by other things, including a sharp reduction of OEM DXi software revenue, an increase in lower cost for market charges associated with writedowns of service and manufacturing inventory related to end of service life dates on certain product families and planned product road map transitions overall, and a reduction in benefit from lower warranty obligations.

Third, our non-GAAP operating expenses were $57.9 million, down $2.2 million, or 4% from Q3 of fiscal 2009. We remain focused on managing our cost structure, but we will invest in additional R&D and sales & marketing resources, as we see profitable growth opportunities.

Fourth, our non-GAAP operating profit was 12%, compared to 15% in the same quarter last year. We have achieved non-GAAP operating profit in excess of 10% for two consecutive quarters. The last time we reported similar results was nine years ago.

Fifth, net income was $16 million, or $0.07 per share, compared to $25.6 million, or $0.12 per share in the third quarter of last year. Those were both non-GAAP numbers.

Sixth, we have for all three quarters in fiscal 2010 generated a GAAP net profit of $4.6 million in Q3, compared to a net loss of $328.8 million in Q3 of last year. A goodwill impairment charge of $339 million was included in third quarter fiscal 2009.

It has been nine years since we have reported GAAP net income in each of the first three fiscal quarters of the fiscal year. And finally we generated cash from operations of $17.1 million. We had EBITDA of $29.1 million during the quarter, paid down $500,000 of our senior debt, and ended the quarter with a cash balance of over $100 million.

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

Revenue for our third quarter ended December 31 was $181.7 million, compared to $203.7 million a year ago, and $174.9 million in the prior quarter, a sequential increase of $6.8 million. This is the first time in two years that we have had sequential revenue increases in back-to-back quarters. Year-over-year, revenue declined $22 million as a result of significantly lower OEM DXi software revenue, and slightly lower OEM tape and OEM devices and media revenues. However, as I walk through the revenue detail, remember that our non-GAAP gross margin is only slightly down from the same period a year ago.

Royalty revenue was $18.1 million for Q3, compared to $19 million in the same quarter a year ago. This was primarily driven by an expected year-over-year decline in our DLT royalty.

For the quarter, non-royalty revenue totaled $163.6 million, of which 76% was branded and 24% was OEM. That compares to non-royalty revenue of $184.6 million a year ago, of which 65% was branded and 35% was OEM. In Q3, our branded business revenue increased both sequentially and year-over-year from the same quarter in fiscal 2009.

Since the merger with ADIC in 2006, we have been focused on transitioning our revenue stream to higher margin products, which has been one of the primarily reasons for the year-over-year revenue declines. However, during this time, our non-royalty branded share has increased from 52% to 76%, the highest in the Company's history, and a significant contributor to our increase in non-GAAP gross margins, from 31% to 44% over the same period. We strongly believe this transition yields a more valuable business.

Looking further at various revenue classifications, devices and media totaled $27.3 million, compared to $29.7 million in Q3 a year ago. The decline is attributable to anticipated declines in OEM devices and media of $5.5 million, offset by increases in our branded revenue of $3.1 million. This is an example of how we have 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 pursued revenue growth when it is profitable.

Tape automation systems revenue was $75.5 million, compared to $85 million in Q3 of fiscal '09. Approximately $5 million of the decline was related to OEM automation products, and the remainder was related to branded products. The decline in OEM automation was primarily related to volume declines in our mid-range product offering. However, we again had a sequential increase in automation, with both branded and OEM revenue growing for the past two quarters, after reporting a lack of growth in this category for three years. Disk systems and software product and related service revenue was $24.8 million, down from $31.3 million a year ago.

On a year-over-year comparison, we had significant increases in our Quantum branded DXi revenue, moderate increases in StorNext revenue, and a severe decline in license revenue from our existing OEM agreement. During the quarter, we closed two deals in excess of $1 million, and we had a number of very large follow-on orders from existing DXi7500 customers. We continue to see very good demand for our DXi7500, as customers like its scalability, its VTL interface, and its tight integration with tape. All are important factors for enterprise customers.

During the past quarter, we launched the first two products of our mid-range DXi6500 NAS product line. We have received very positive feedback from end users and channel partners. During the fourth quarter we plan to launch three more DXi6500 models, the 6530, 6540 and 6550, all of which add more capacity and features, while maintaining the ease of use and overall value concepts introduced in the 6510 and 6520.

As for future OEM DXi software revenue, we expect that Quantum will recognize in Q4 an amount that will be consistent with Q3, and that is a very insignificant amount, and in Q1 of fiscal 2011, the amount of OEM DXi software revenue that we will recognize will be similar to what we recognized in all of fiscal 2010. In other words, substantially all of the remaining expected OEM DXi software revenue will be recognized in Q1 of 2011. This is to comply with contractual requirements and Generally Accepted Accounting Principles.

Service revenue was $39 million, compared to $40.8 million a year ago. The $1.8 million decline is primarily the result of a reduction in OEM out of warranty repair. Branded service revenue was comparable to that in Q3 of fiscal 2009.

Turning to gross margins. Non-GAAP gross margin in Q3 was 44.4%, compared to 44.9% in the prior year period. Our branded sales mix trended well this quarter, strengthening our overall gross margin position, along with our continued improvement in managing our manufacturing and service costs, but we had offsets such as a decline in OEM software revenue, a lower of cost or market adjustments related to both manufacturing and service inventories, driven by planned product transitions and near term end of service lives, and a reduction of benefit associated with lower warranty obligations.

We have continued to see progress in reductions in both manufacturing and service costs overall. This quarter's results continue to show how much progress we have made improving our mix to higher margin branded products, and how much leverage we gain when we have revenue increases. We are very pleased with this quarter's gross margin, and we believe it is a great indicator in the value of the overall business.

Moving to expenses. Non-GAAP operating expense totaled $57.9 million, compared to $60.2 million a year ago. That is a $2.2 million reduction, or 4%. The largest driver of this decline in operating expenses was the reduction in sales and marketing spend of $4.1 million. The sales and marketing decline was primarily related to lower head count and associated costs.

Non-GAAP operating profit for the quarter was $22.7 million or 12% of revenue, compared to $31.3 million, or 15% of revenue for the same quarter a year ago.

Interest expense for the quarter was $6.8 million, compared to $7.3 million a year earlier. This included cash interest of $6.4 million, and amortization of debt issue costs of $400,000. The coupon interest rate for our remaining senior debt, $187 million at December 31st, will be approximately 4.2% for the quarter ended March 31, and our average coupon rate for our total debt will be 7.2% for the quarter ended March 31. We expect interest expense will be approximately $7 million in the fourth quarter.

For the third quarter, we recognized a net tax expense of $300,000, primarily related to foreign and state taxes. We still believe it is reasonable to model tax expense of $1 million per quarter.

Summing it up for Q3, we had non-GAAP net income of $16 million, with non-GAAP EPS on a fully diluted basis of $0.07, compared to non-GAAP net income of $25.6 million and $0.12 in the same quarter last year.

Focusing on cash flow for the quarter and the balance sheet at December 31, I would like to highlight several key points. Cash flow from operations for the quarter were $17.1 million. We paid down $500,000 of our senior debt in Q3, 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 over $100 million in cash. Non-GAAP EBITDA for the quarter was $29.1 million. We are in compliance with all debt covenants at December 31st, 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 $100.1 million. Sequentially, manufacturing inventory decreased 1.2 million to the lowest level in over five years. Accounts Receivable increased $10.5 million. We had an accelerated payment of $9.7 million from one customer. CapEx was $2.6 million, purchases of service part inventories were approximately $600,000. And depreciation, amortization and service parts lower cost or market expense totaled $16 million for the quarter.

Looking forward at Q4, which is typically a seasonally weak quarter, we are forecasting revenue of $165 million to $175 million, gross margins similar to that in Q3, and higher operating expenses in engineering and sales and marketing, for an estimate or forecast of total non-GAAP operating expense of $58 million to $60 million. Interest and taxes should be similar to Q3.

Now let me turn the call over to Rick.

Well, thank you, Jon. And thank you for joining us for our Q3 earnings call. Over the last year we have worked our way through a series of significant changes, including the challenging economic environment, an altered EMC relationship, the pressures of a constrained debt environment, and of course, the normal market transitions.

In the midst of these changes we have continued to focus on executing on strategy, leading to a significantly improved business model, and an exciting growth opportunity. As a result we have now seen two consecutive quarters of revenue growth, and three consecutive quarters of GAAP profitability, solid cash generation, and most importantly, solid operating income performance.

As demonstrated in the last two quarters we can and should be able to deliver operating income margins solidly in double digits. Whether it is with a meaningful contribution from OEM DXi software revenue as we saw last quarter, or with almost no contribution as we experienced this quarter. In addition, we remain confident that we have a foundation to expand our opportunity and overall performance as we continue to launch critical new products, and work to translate these products into market success.

Let me now take a few minutes to summarize our current position and opportunity by our main product lines. First, over the last several quarters we have positioned our tape business into a very healthy place. The margins for these products have continued to improve, and we have maintained our position as the leading automation provider in the open systems tape market. The last few years have been difficult as the industry has struggled to deal with a declining market. Some players have disappeared, while others have barely hung on, and the market has reached a level now, where there are a few strong surviving companies, that have scaled their business model to meet the current $3 billion to $3.5 billion market size.

We have developed a very focused and leveraged model while continuing to deliver innovative products, such as the recently-introduced Scalar i40/80 tape library, an encryption solution, and soon, LT05. In addition, next quarter we will release a new enterprise library that is an extension of our current Scalar i2000, and expands our market opportunity into larger enterprise segments. As a result of this, we expect to continue to perform well, and will focus on several incremental opportunities, not only with the new Scalar libraries and LT05, but also with the SDK installed base and improved integration with our DXi de-duplication/replication systems.

In addition, we have recently expanded our tape automation reseller relationship with Fujitsu beyond western Europe, so that we are now their preferred partner everywhere outside of Japan. To summarize, while de-duplicated disk is rapidly becoming the standard for backup and fast recovery of active data, automated tape continues to hold a strong role in the data preservation hierarchy, particularly in long-term data retention, and active archive of large files, such as the growing inventory of digital media. Over the last few years we have improved our position, we have built a business model now that allows us to continue to innovate, as evidenced by our product launches and near term road maps. We believe that this will provide us incremental opportunity.

Turning now to disk systems and software. Over the last couple of years we have been heavily focused on this component of our revenue stream, which is currently operating at around a $100 million run rate. It is here that we must deliver increased growth. This starts with the DXi product line which is well positioned in the very high growth disk space backup market, where de-duplication is increasingly a required feature. The de-duplication segment of this market is growing at well over 50% a year.

Currently our DXi results are dominated by the DXi7500 product, and the VTL implementation. This has become a more enterprise focused business, and we will continue to pursue this market in a very targeted manner. We see continued opportunity here, and we will work to expand and further improve our product line, to deliver what we will refer to -- what we have referred to as Edge to Core solutions, which tend to be the focus of larger opportunities. Over the last two quarters over half of our DXi revenue stream is made up of deals over $200,000. These opportunities will continue, and we will remain focused on those that provide the best fit to our competitive advantages.

At the same time, we see an incremental opportunity for our new DXi6500 NAS based mid-range family. We began shipping two of the five models in Q3, and the focus here will be increasingly on building the VAR channel and serving midrange and small enterprise customers. We developed the product for the segment, and while it is very early in the process, the Q3 results were very consistent with this opportunity. That is a larger customer base, a different competitive environment, and more leverage with the channel. In Q3, we saw an improved win-loss experience with the 6500, as compared to the 7500, and more channel engagement.

Our priority in Q4 will be to begin shipping the remaining models and drive success with our channel partners. This will require a somewhat different sales and marketing focus than the DXi7500, which we began implementing in this last quarter.

The EMC data domain acquisition has greatly changed the competitive dynamics of this market, leading to an increased attention by all storage providers to focus their deduplication -- or to define, I should say, their deduplication offerings. As I said in our last call, we expect to turn this event into new OEM and partner opportunity. What I can say today is that we are in the final stages of completing the details of our first OEM agreement. This relationship will expand our channel and technology reach.

In short, the DXi growth opportunity will come from continuing to drive our core VTL business in a very focused manner, growing the midrange with a Channel-based opportunity and NAS opportunity, and then finally adding a strategic OEM. The combination of these three elements will result in DXi becoming a much more significant portion of our revenue stream. Behind all of this, of course, is a very aggressive product and technology road map, which we will continue to expand.

Finally, our StorNext business represents another growth opportunity. In Q3, we experienced very solid results. The vertical market focus for the StorNext business continues to show further potential, as more industries face the challenge of dealing with massive amounts of data that need to be continually processed, stored and accessed, leading companies to invest in improving the management of these larger data repositories.

Last week we announced our latest release, StorNext 4.0, which incorporates integrated file system deduplication for nearline data and multisite environments, a flexible replication engine, and distributed data tiering, as well as an expanded file management and archiving capability. It has also become clear that this technology has the potential to become significant in the developing market for cloud like deployments, which rely on some of the critical elements that have made StorNext a success, scalability, high performance, support for heterogeneous environments, and more. For example during this third quarter we are announcing today we won a large deal for over $1 million, in which StorNext will play a central role in a multisite private cloud implementation for a Fortune Global 10 company.

In summary, we feel very good about the results and the position of Quantum. We have managed the tape business into one that meets the current market realities, and provides incremental opportunities. We have near term potential to grow our disk systems and software business with DXi and StorNext. We see even greater longer term potential as we apply our de-duplication and StorNext IP to expanded storage opportunities.

Finally, we have transitioned our business model to allow us to continue to leverage solid operating margins while we pursue growth. We feel that our base level of spending and investments allow us to execute on our strategy, and that growth will largely come as we increase our gross margin dollars. Of course, we recognize that we have a lot of work ahead of us in terms of delivering new products, establishing leadership positions with our recently released product releases, and building greater sales and marketing success.

Let me close by saying now a few things about the market environment. We definitely saw an improving storage purchasing environment in Q3. IT budgets were more available. Channel inventories began to replenish, and as a result, the industry did see modest growth. However, there are still noticeable levels of deal slippage, as the market has not fully returned to pre-recession levels. In our view, Europe was much healthier than North America.

As we look to the future we believe that the underlying IT and storage environments are better than what we saw last year, yet it is still prudent to recognize some caution as we enter the new calendar year and new budget cycle. The coming quarter is seasonably weak and there remains an incremental level of caution, given the current economic realities. In spite of this caution, I will reinforce that we believe Quantum is well positioned, and we must execute our product and market programs to capitalize on this opportunity.

Operator, I would like the turn the call back over to you for questions.

Thank you sir. We will now begin the question and answer session. (Operator Instructions). Our first question is from the line of Brian Freed with Morgan Keegan. Please go ahead.

Good afternoon. A couple of quick questions. I guess, first of all, on the royalty front. Jon, just want to confirm did you say that your branded disk and tape grew by 25% year-over-year?

No, what I said was our branded DXi grew 29% year-over-year. And that branded made up 95% of that segment this quarter.

Okay. So as I back into the OEM number, I can perhaps work at that, and it would suggest something like $12 million in OEM revenue in the year-ago quarter?

You know, you will have to do the math.

Okay. The second question in terms of the timing of the guaranteed minimum payments, that looked to be pushed to Q1 of fiscal '11, was that a change based on your expectations going in, where it gets back end loaded? Did you think it would be evenly distributed across the three forward quarters?

Our plan was to take it over the three. And when we got into this quarter, we concluded with our auditors that we should push it to the back. So that is what we did.

Okay. Okay. And lastly, as you look at the product roll outs in the quarter, I mean you had the 6500, you had the next generation StorNext, the i40, i80. Can you talk a little bit about revenue recognition for products shipped in the quarter?

Did you see any issues where you shipped products, and they remained an evaluation unit. And also on that line of questioning, I know your sales guys are selling some of your automation with a promise for a future upgrade to LTO-5. Can you talk about the revenue recognition for those as well?

Sure. Most of that is just about timing. When we launch products generally we will ship a lot of products that don't turn into revenue, because they are going to partners, or VARS or ISVs, and in some that are customers for eval. So certainly in the first couple of quarters we will ship a lot of product, more than normal, and then we don't recognize revenue. That would be typical in the hardware products you mentioned.

StorNext came in after the quarter, 4.0 so that is going to be a Q4 product. And then on LTO-5, basically what we do is give the end user an opportunity to upgrade, or a known trade-in price on the drive if they choose to do so in the future. So generally they have a need for new technology now, they want it now, but they want to be able to upgrade if and when they want to on LTO-5, so we just give them a price for that.

Okay. Great.

We think that will happen in, you know, over the next couple of quarters, that you will see LTO-5 in automation products -- actually next quarter.

Okay. And lastly, another quarter of sequential growth in tape automation. As you look at the tape automation market after a long period of declines for you guys, you see some relative stability and/or growth. What does the tape market feel like to you guys in terms of longer term growth rates, say over the next 12 to 18 months?

Bill is going to take that.

So the way that we are viewing the tape market, especially when you look at midrange and enterprise automation, is, we know that that is not going be a growth market but there is a significant opportunity when you look at next generation backup using de-duplication disk appliances and tapes changing role, to be able to basically provide a more cost-effective solution for backup and recovery.

We also see tape playing a very important role in these larger archive, longer data retention types of use cases, where we see that tape will continue to play a critical role there. So we kind of look at our Q3 results in terms of we took share, especially when you look at kind of what is happening in the Sun StorageTek space, as well as the fact that the market had stabilized.

I would also add that for us too, the market -- I referred to it in my comments -- that it really has been a struggling number of years, as there was fairly, a pretty good decline in the market and there were too many players, and everything was being adjusted, and companies went away and it was this entire process.

I think we are feeling that we are at a point of equilibrium today, where the market is still a declining market, in single digits probably over the next three years, if you go by analyst estimates. There are fewer players. Business models that make more sense. For us, we hadn't introduced new automation products for a very long time. We had the i40 and i80, which is an area of weakness that we had, and then I referred to in my comments are our new focus in the enterprise space and the new enterprise library.

I think that this business will be better for us going forward, both because of the dynamics of the industry improving, the economy improving, and our product line improving, all covered though, by the fact that it is, over time, a declining market.

Great. Great. And then lastly, can you guys give any qualitative metrics or commentary around the response for the 6500, the number of customers who got it, or anything like that?

I would say just to reiterate the prepared remarks is the feedback from the VAR channel, the independent storage channel, has been overwhelmingly positive. We basically have a product that is much better suited for the channel in that medium enterprise. We have introduced just the first two in the last quarter, the first two products in the 6500 family, so we expand that in this quarter.

Feedback really is around ease of use, the fact that we have packaged all of the options that are critical to being able to implement a next generation backup solution. We packaged that very cost-effectively, and this is really part of the changing dynamics in the independent storage channel, where with EMC's acquisition of Data Domain, basically there are opportunities for people that have an alternative to what Data Domain was selling to those customers in that medium enterprise midrange space.

All of that kind of lines up to where we have seen VARS take a lot of interest in the entire portfolio, including the 6500 VTL. We think that that creates also opportunity for additional tape. I would say early indications based on last quarter were very positive, and heading into this quarter with the additional products in the family we are very optimistic.

I mean it would be fair to say that VARS really want the rest of the products too.

That's right.

That it really rounds out the product line to be applicable to more customers and broader solution sets, so we are really focused on getting that done.

So the 6530, 40 and 50, you have additional capacity, you have higher performance, we scale up to 2 terabytes an hour of NAS performance, it includes 10 gig E. It basically -- and it includes a direct to tape option with Net Backup and Backup Exec 2010, so it is really the rest of the family that is important in terms of this midrange opportunity.

Great, thanks.

Thank you. Our next question is from the line of Joe Feshbach with Joe Feshbach Partners. Please go ahead.

Hi guys. Really good on the execution, particularly in the margin and the branded business. I have several questions. First, Jon, just a housekeeping question. What was the service gross margin for the quarter?

We will calculate. I don't have it off the top of my head.

All right. Well, maybe we can --

It is thirty-something, I remember. 37. 37.

So it's up a little bit again. So if I were to -- as I look at disk and software, it seems to me that the difference between growth and sequential growth in that category is really principally tied into the difference in the way you are accounting for the EMC royalty, or at least for it to have been flat to slightly up. Am I thinking about that correctly and (multiple speakers)?

We tried to be very specific about the DXi OEM revenue piece, which is it down sharply from last quarter. We have pushed it all to the Q1, and it really is the difference between being over and above all of the targets we gave, to where we ended up. If you look at business as a whole, we outperformed where we thought we would be, even though we had a few what I would call difficulties during the quarter. Just expense things. We had our first bad debt expense we've had in like three years as an example.

The big change from what we thought we were going to do was we pushed all the OEM revenue to the back end, and that was a decision we made during the quarter after the call. I would have probably guided differently had I known that. But again, we have been talking about it being a little bit nebulous.

No question we are pleased with the branded execution on DXi, branded execution on tape, the things that we control we did a really good job of.

In some ways it does make everything clearer, because we all know that EMC is not going to put a lot of sales effort into that product, and that we are not going see real revenue opportunity there. So now you see what that looks like. That is what a quarter looks like without that.

And so now it is really about looking forward to ramping the 6500 product line, continuing to focus the 7500 where we can win, and eventually you will see the revenue from OEM that will provide further opportunities. It does present a very clear picture of the reality of where we are, and when you do all of that, if there was any confusion about how important EMC was to our profitability, you can see, we are still in double digit operating income with that all gone, in addition to some of the problems Jon referred to.

That is why we feel good. That is why we feel the foundation of the business is solid, and now it is growing the disk and software business, which I think we got a good look at what that base looks like this quarter.

Excellent. I see that completely. And it makes total sense. As far as a new OEM relationship, you said you were close to documenting it, and I am sure you are not going to let on us to with whom. A, what are the differences in terms of opportunity, obligations that you all have? Is it something -- how should we think about this new partnership going forward, versus the EMC relationship?

Why don't I start and Rick can comment. We said, EMC is a hard -- we are not going to replace EMC. From a scale opportunity magnitude, that is not possible. The type of agreement that Rick is alluding to is a software agreement where a partner is using our software on their own hardware. It will be similar to EMC where it is the same software, the hardware is just different. And we look at those things, we have talked about it where we are trying to get incremental channel. I think Rick had that in his remarks.

As well as reach of our technology, because remember this is about deduplication as well as replication. The fact that our technology gets further into the market we think is a really good thing. And we also like partners and people who understand the whole value proposition, including the path to take feature of our technology, and the way that we have it positioned.

Got it. And that said, could you add a little -- I am just trying to keep all these relationships straight in my tiny little head. What was your commentary on Fujitsu?

We have a tape resell arrangement where it was principally inside of central Europe or Europe, which is now worldwide other than in Japan. So they are a much tighter link. They have traditionally sold one of our competitor's products too. I think they will do some of that, but our relationship with them on tape is substantially broader than it used to be.

Got it. And then do you have any -- you have given guidance obviously on the upcoming quarter, and I just have one follow-up question after this. I am just curious, how the quarter -- how January has gotten started relative to last year. And what kind of visibility you see in your order book, compared to the visibility you had been seeing for calendar '09?

I mean our process isn't any different. I mean so we have -- we talked about this. We have our OEM business that has a forecast, and we plan our build off of that. And then we use sales force to manage all of our branded funnels. We have lots of opportunities. That has been the case for the last few quarters, and you can see our results have improved.

Generally, January is slower because of the big push at the end of December than, say an October would be in the prior quarter. We are giving the guidance based upon what we see today. I think Rick commented appropriately, that it is still a cautious spending environment. There still are a lot of signatures that are required. We have had deals slip that were down to the last signature, and it is just part of, I think, the economic environment we are in. We are super-optimistic about our position and our market opportunity, we are cautious about the environment and the spending, and we are just going to keep trying to execute on what we can.

And I think we would say this, that this January feels like there is less headwind than there was last year in January, Point Number. one. Point Number two is we see opportunities that exist in funnels and everything, don't feel like they are alarming.

At the same time, it is always a slow start in the new year because budgets are still floating around, and it tends to move really not -- January tends not be a good representative start of the quarter. So that is probably the best characterization of Q4.

Got it. And then just really quickly, you went through a bunch of one-time items on the expense side, Jon.

Yes.

Can you give us, I know they are not part of your non-GAAP results, but I would like to sort of have a better understanding of what the real impact was in terms of normalizing, so I can normalize the margins. Because I was honestly very impressed with how high the gross margin was without any EMC. That is like incredible.

Thanks. I mean we have made tons of progress. I will think there are a couple of things. Some of them are just the costs of operating the business, and some of them are identified to some other decisions that we have made.

On the service amortization as we changed to the new model that we agreed to with the SEC, it tends to be a little bit lumpier, and it is driven around product transitions and end of service life. So in this particular quarter and maybe next as well, the expense is a little bit higher than run rate, because we have some older products where the service life is ending, and so we take more charge than we would have on a rateable basis. That was one.

We had one item of -- I don't know -- it was about $1.5 million related to a specific obsolete product that we took in the quarter that we hadn't planned on. And then we didn't have it in the prepared remarks, but we also had our first -- we actually had two, but I can remember one larger one -- bad debt expense during the quarter. Those are the primary things. But I don't want to focus too much on those because we are running a business, and we are going to have those things, and we have to manage better on those.

For sure, the biggest impact was the change in the DXi OEM revenue without a doubt. The other things were there, and it just shows how much progress we have made, and how powerful our model is as we grow the branded business. We get scale, we get leverage, and it just -- we create a lot of profit.

Excellent. And last but not least, just for Rick -- or Bill. How do you guys see LTO 5 affecting tape? Should we think about this as a new product cycle? Should it improve the royalty rate, and add some support to royalty revenues over the next few quarters, since it is at a higher rate, et cetera?

Do you want me to start? So let me do that one first. The good news about it is that LTO 5 royalty on the media is higher than LTO 4, when it comes out. The bad news is generally the other ones drop down, and so you see this kind of one replaces the other.

Generally over time you get a little bit of a bump, but in the case of LTO 4 there wasn't as much of a bump, so we don't really know where that is. On the product side -- I will start and Bill can go -- is that we generally have seen improved automation, a bump in automation. Again, it is hard to predict under each cycle.

Yes, each introduction of a new generation of tape, generally the penetration starts at the high end so in the enterprise space, that is where they can get more of the benefit, and the economics are easier to justify. So that will be one kind of important indicator that we will be looking at.

I think that as you kind of look at what tape has to do in terms of maintaining its cost advantage, I mean LTO 5 is just an important part of being able to show that road map for tape being able to provide, not only -- and primarily because of the changing role of tape, the economics have to be there, but also the fact it is removable, that it is an important part of a DR strategy in addition to a next generation backup with de-duplication, and this archive component. Those are important drivers that you have to be able to continue to show the economic advantage of the road map.

And this has probably been the longest time between LTO cycles, the longest cycle between versions. So hopefully that does result in a bigger take-up of the new technology which will stimulate the business.

Right. Okay. Thanks. I dominated the call, I apologize.

Okay, thanks.

Thank you. (Operator Instructions). We do have a question from the line of Brian Alger with Strata Capital Management. Please go ahead.

Good afternoon, guys. Just looking for a little clarification on -- I hate to call them one-time items, because as you point out they are kind of cost of doing business -- but the end of life lower cost of market charges you mentioned were higher this quarter, and might be higher next quarter. Should we think of those as coming down after this adjustment period, as those older products kind of work their way out of the system?

It is little bit lumpy. I would say last quarter I think the number was $1.2 million. This quarter it was like $3.3 million or something. It was a couple million higher. I don't think it will be quite that high next quarter, but it is just going to be a little bit lumpier.

One of the things that we identified, which is the thing you are bringing up, is we are going to have to budget and think about those things a year in advance or more. Right now we tend to think about the end of life really around customer and service contracts, and not how it kind of rolls back through the rest of the P&L.

So I think it will be a little bit less than last quarter. I don't know what the right run rate is. Maybe $2 million, low $2 millions. If I just think about ongoing, but it is going to be a little bit lumpier for sure. And so we have to do a better job of identifying it early, and then building it into our guidance.

All right. So as we are kind of looking forward at kind of that COGS line, or at the gross margin capabilities, maybe adding back 100 bps for a normalized level, assuming that there is going to be some variance in there might make sense?

That might be a little bit high. Maybe half.

Okay.

To three quarters. Because I think in any one quarter, I am not exactly sure how it will be. If you said it is going to be $8 million a year, and try to do it that way, you would be close. If you wanted to be conservative you could put, you know, $2.5 million a quarter, or $10 million a year, but it is not going to be at the run rate that we just demonstrated in the last quarter. It won't continue because you can see we just don't have that much --.

Right. And the bad debt expense, I guess that showed up in the G&A line. That is why that popped up?

Yes. That was one of the reasons, yes.

So as we are modeling to your guidance, we should expect that G&A line to come back down?

Yes. I would say G&A will be down. I tried to give a little bit of guidance where we are going to spend more money on sales and marketing and R&D. The G&A side again, I don't like making excuses on that. I wasn't going to bring it up, it [was] in the prepared remarks, but Mr. Feshbach in his due diligence asked some good questions.

It just is what it is. Appreciate it, guys, thank you.

Thanks.

Our next question is from the line of Paul Sonz with Sonz Partners. Please go ahead.

Hi Jon. Two questions. One, the amount that was deferred on EMC revenue for this quarter was $5 million, is that correct?

We haven't given an amount, Paul, we gave percentages.

Okay.

Trying to not be coy but also honor what the agreement says.

No problem. I understand. The second question was did I catch it right, I may have missed this, that there was some revenues that there were shipments of the 6500 that the revenue was not booked last quarter, but would be booked this quarter?

No, what I think I was asked -- Brian was asking the question earlier about -- there is a lot, we put a lot of product out and I think some of it will be revenue and some of it will be customers using it for demo, VAR partners, ISVs. Brian was really asking a timing question, around how much revenue in the quarter do we get on these new products, and what I was trying to answer was we will get a lot more in future quarters.

Okay.

Just because of the timing of when they were announced, and then the behavior of when you announce a new product, you do put a lot of it out there that doesn't make it to the top line, if you will.

Okay. All right. Thank you.

Yes.

Thank you. Our next question is a follow-up from the line of Joe Feshbach with Joe Feshbach Partners.

I can't remember my name, I think it is Fleshbach or something. Jon, can you talk a little bit about the balance sheet. Obviously you are comfortable, you have got $100 million in cash, but you have also got some high cost debt with EMC. Are you -- and the liquidity environment at least looks a lot better. Any thoughts on a global refi at some point?

Yes, I mean it is one of the things that -- it is not the most important thing like it was last year.

Sure.

We have a bunch of other things going on. But I do think that balance sheet, our strength of generating cash -- our net debt now is 188ish kind of number, less than $200 million. It certainly does provide us opportunities. And it will be not a short-term but a mid-term project, to try to figure out what's the best capital structure going forward. And take advantage of the market, interest rates, what we think is going to happen. Our senior debt actually is a pretty good piece of paper. No LIBOR floor, and LIBOR plus 3.5, so if we could refinance the higher cost debt that would be a great start.

Perfect. Do you see working capital in the coming couple of quarters contributing to cash flow, or being a user?

I think we are -- I mean I don't want to take the pressure off the inventory team, because they continue to exceed expectations, but I think eventually we are going to run out of room in inventory.

And then on receivables, it is a little bit the good news/bad news, when we have growing revenue we tend to be branded back end loaded, our receivables goes up. That team still does a fantastic job of collections. So I think we'll try and always work receivables down, but we don't have a lot more room to squeeze the balance sheet. I think those groups have done just a fantastic job getting us here.

So net/net, you think it is neutral pretty much?

Probably. Remember, too, I didn't put this in the script, but EMC has prepaid us so this is also a cash flow without an OEM as well.

Sure. Thanks for all those answers.

No problem.

Thank you. (Operator Instructions). Management, I am showing no further questions at this time. Please continue.

Well, thank you and I would like to thank all of you for joining us for the call. I just want to summarize again that we feel this was a very good quarter and a good year for Quantum, as we've transitioned through a lot of challenges, and what you see in this quarter's result is kind of a base level foundation of the kind of business that we are. That we have been striving for, with operating income in double digits, and starting to see some elements of growth. And as we look forward, given the product cycle we are on, and the way the revenue has transitioned to this point, as we look at the next year we are very, very focused on building on that, and we see that even in the tape market which has been tough, that we have some unique opportunity because of the strength of our product line, the new products we have announced recently, and the ones that will follow, as well as some of the dynamics of the StorageTek Oracle change.

All these things we think provide us opportunity to strengthen that business. And then additionally, of course, our DXi product line, our OEM agreements with our DXi software, and what we can do with StorNext short and long-term, we think also provide us opportunity to start to transition the Company, to think of ourselves more as a growth story than what we have been the last couple of years, which is about improving our profitability and then leveraging that into our capital structure.

We think this is an important transition time, and we really felt that this quarter reflected a lot of those attributes. With that, we would just say thanks for joining us again, and we look forward to talking to you during our next call. Thank you.

Thank you sir. Ladies and gentlemen, if you would like to listen to a replay of today's conference, please dial 1-800-406-7325, or 303-590-3030, using the access code of 4201068 followed by the pound sign.

That does conclude the Quantum Corporation third quarter 2010 conference call. Thank you very much for your participation and for using ACT Conferencing. You may now disconnect.