Quantum Corp (QMCO) 2013 Q1 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Quantum Corporation's first quarter 2013 conference call. (Operator Instructions) This conference is being recorded today, Tuesday, July 31, 2012. I would now like to turn the conference over to Shawn Hall, General Counsel. Please go head.

Thank you and good afternoon and welcome. Here with me today are Jon Gacek, our CEO, and Linda Breard, our CFO. 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 website at www.Quantum.com, and will archived for 1 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, and future financial performance.

We'd 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, as well as to our reports filed at the Securities and Exchange Commission from time to time, including our most recent Form 10-K filed on June 14, 2012. These risk factors are incorporated by reference in today's discussion and we may undertake no obligation to update them in the future. With that, I will turn the call over to Jon Gacek.

Thanks, Jon. Welcome to our fiscal 2013 Q1 earnings call. Today we reported revenue of $140.9 million and non-GAAP loss per share of $0.04. These amounts are consistent with the announcement of our preliminary results on July 9. Clearly, this is a very disappointing result on both fronts, although the revenue shortfall was the primary cause of the $0.04 loss. Today I'm going to address the major factors contributing to our Q1 results and then Linda will provide additional details. I will come back to address our plans for Q2 and the rest of fiscal '13.

Our revenue shortfall was primarily caused by four things. First, $6 million, or nearly half of the shortfall, was due to lower than expected results in Europe across all product lines. Second, we didn't close forecasted big deals with the non-European portion accounting for another $4 million of the shortfall again across all product lines. Third, entry level OEM revenue was $2 million lower than expected, due to a decision by one OEM customer to reduce inventory. And four, we had a one-time change in the basis on which tape royalties are reported and paid by one of the tape media manufacturers which had a $1 million impact on the quarter.

Now let me say a bit more about each of these four factors. In Europe, the $6-million shortfall was due to difficulty closing deals the last 2 weeks of the quarter. This was across all segments and all products. We believe this is a combination of the economic environment, budget uncertainty, and our go-to-market model, which relies on help from channel partners to close deals with end users. We fully recognize that Europe is a difficult market right now and we are increasing our inspection of European deals and driving for more senior end-user contact especially in larger deals.

Not closing forecasted big deals was part of the issue in Europe, but was also a challenge in other regions, most notably North America. We saw it across all product lines, but it was particularly the case with Enterprise DXi. Basically I'd say that in this economic climate, the bigger the deal, the higher the risk of a purchase not getting funded and PO not being issued, regardless of the size of the entity or geography, and we certainly saw this in Q1. Also, the bigger the deal, the greater the need to be close to the end user which, as I mentioned earlier, is harder with a channel centric model such as ours. In short, this reinforces both the need to be working more deals, so if a deal falls out, we have others to work on closing, and the need to get deals closed as soon as possible during the quarter. As I said earlier, not counting Europe, our inability to close big deals impacted our Q1 revenue by approximately $4 million.

The shortfall in OEM revenue was a unique situation with one of our OEM partners who lowered their forecast and revenue by $2 million during the quarter. This involved a low end, low margin product but impacted us at the revenue line. We believe this is a reflection of the economic climate and we have now taken necessary steps to validate our OEM partner's plans early in the quarter. Finally, our tape royalty was approximately $1 million lower than expected, due to a change in the basis in which royalties are reported and paid by one of the tape media manufacturers. This happened during the quarter. This was a one-time event that affected the timing of royalties, but not the ultimate amount we will receive. So although it impacted Q1, we believe that we will be back on track for approximately $13 million of taped royalty this quarter.

Having addressed four main contributors of the shortfall, I also wanted to provide a high-level reconciliation of the difference between our actual results of $141 million and the $155 million that we expected on a product and royalty basis. So first, the tape royalty was $1 million less for the reason I explained above. OEM tape revenue was $2 million less for the reason I explained above. Branded tape was off $3 million, mostly due to the European climate and fewer big enterprise deals being closed. And fourth, DXi was off $8 million, primarily due to weakness in Europe and big deals.

Now before I turn the call over to Linda, I do want to hit couple of positives from the quarter. First, disk and software, including related maintenance totaled $30.7 million and up 11% year-over-year despite all of the issues I described above. This was driven primarily by StorNext software and appliances. We feel very good about our market opportunity in big data with our technology and, while the DXi results were below our expectations, we still added over 100 new customers and continue to have very strong win rates. Second, tape is far from dead. We were over planned in branded mid-range in entry tape automation and the OEMs other than the issue I described above had a very solid tape quarter. In summary, we are not pleased with this quarter's overall results. However, we believe we have identified the issues that we can control and we will improve our performance moving forward. We were focused on driving growth, earnings and share holder value. Now I'm going to turn the call over to Linda to provide more detail and color on the results and then I will come back to address our plans and guidance.

Thanks, Jon. Before I walk through our results, I would like to refer everyone to the financial statements and supporting schedules included in the press release and on our website. It will be helpful reference those documents as I comment. Revenue for our first quarter ended June 30 was $140.9 million, compared to $153.5 million a year ago. As Jon said, we had geographical weakness in Europe and also in closing big deals, typically defined as deals in excess of $200,000. The primary driver of the year-over-year decline in product revenue was in our enterprise business. Both Enterprise Tape Automation and Enterprise Disk Space Products were down year-over-year. For branded entry and mid-range tape automation and disk products, revenues were relatively flat to slightly up year-over-year.

In addition, royalty revenue is down $3.6 million from the same period in the prior year. Partially offsetting the declines big data revenue, which includes StorNext software and related appliances revenue, was up nearly 50% year-over-year. Royalty revenue was $11 million for Q1, compared to $14.6 million in the same quarter a year ago. The largest contributor to the decline was LTO royalties, of which half was expected and half was due to the change in the basis on which royalties were reported and paid by one of the media manufacturers that Jon described. Expected declines in the DLT royalties contributed to approximately one-third of the year-over-year decline. For the quarter, non-royalty revenue total $129.9 million, of which 82% was branded, and 18% was OEM. That compares to non-royalty revenue of $139 million a year ago, of which 80% was branded and 20% was OEM.

Looking further at various revenue classification, devices in media totaled $18.7 million, compared to $21.1 million in Q1 of the prior year. The primary driver of the expected decline was branded media revenue, which was down $2.4 million year-over-year. In Q1 of fiscal 2012, we experienced higher than usual purchases in media due to the tsunami and related issues in Japan. Tape automation systems revenue was $50.5 million, compared to $57.7 million in Q1 of fiscal '12. OEM and branded automation contributed equally to the decline. In our branded business, the largest decline was in our Enterprise Tape Automation platform, where we saw weakness in Europe and North America with fewer territories selling Enterprise Automation. The opportunities are there, they just did not close in the quarter. We experienced moderate year-over-year revenue growth in our branded mid-range platform, while branded entry level revenue was relatively flat compared to the prior year.

We acquired approximately 120 new mid-range and enterprise tape customers in Q1, which we believe is an indicator of our continued market share gain in this category. In our OEM automation business, enterprise is relatively flat, while entry and mid-range business were down approximately equal amounts in absolute dollars in year-over-year. Disk system software and related maintenance revenue, which includes our DXi, vmPRO appliance, and vmPRO data protection offerings, as well as our StorNext software and appliances for big data management and archive, was $30.7 million in Q1, up 11% from $27.6 million in the prior year. Fiscal '12 was a year filled with new product releases, many of which were in the disk systems and software category. Revenue from these new products was the primary driver of nearly $11.5 million in total new product revenue we generated in Q1.

Looking more specifically at disk systems revenue, we were down approximately $1 million year-over-year. The primary driver of the decline was Enterprise Disk, which was partially offset by growth in mid range and entry disk systems revenue on a year-over-year basis. We added approximately 100 new disk customers during the quarter and our overall DXi win rate was 50%. As we have mentioned in the past, big deals coming in and out of a quarter can make for wide revenue swings given the size of our disk systems business. The primary cause of the disk revenue decline was a reduction in the number of big deal in our enterprise business, which were down approximately 60% year-over-year and sequentially. Our enterprise DXi win rate for Q1 was again higher than our overall DXi win rate of 50%. In addition, it was higher than our Enterprise DXi quarterly win rates in fiscal '12, with the exception of Q4, when we had an all-time high.

Mid-range disk revenue was up 10% year-over-year. The year-over-year increase is due to the continued competitive strength of our DXi6701 and DXi6702 product offering driving a significant increase in new customer purchasing these appliances. Entry level disk revenue increased modestly over Q1 of last year. The DXi4601, the industry's first capacity on demand reduplication appliance, along with our entry level virtual data protection appliance, the vmPRO4000, contributed to the year-over-year growth as they continue to ramp. Over the past several years, we have been very focused on delivering a world-class disk-based data protection portfolio. In Q1, the strength of our offerings was again reinforced as the Quantum DXi6000 family won its third product of the year award. Our DXi6700 series of disk back up reduplication and replication appliances was named Disk Product of the Year in the Enterprise category at the 2012 storage awards in London.

Turning to StorNext software and appliances, revenue up nearly 50% year-over-year. We continued to exhibit strength in our appliances driven by our enterprise and mid-range archive-enabled libraries, which we have found makes StorNext much more competitive in places where we had not been successful in the past. Our StorNext M330 and new M660 meta data controller appliances, along with our Q series disk, also contributed to the strong results. During Q1, we added approximately 65 new StorNext customers. The recent announcement of StorNext 4.3 software, which brings new intelligence features, greater performance, and increased scale to managing big data, further strengthens our offerings. Incorporating a new database in supporting up to 1 billion files and dozens of petabytes of tiered storage, StorNext 4.3 pushes the boundaries for file system and archiving performance.

Moving to service revenue, it was $36.1 million in Q1, down slightly from $36.7 million in the same quarter of the prior year. OEM out of warranty repair was the primary contributor to the year-over-year decline. And this decline is related to both timing of repair questions and business we exited in the prior year. Turning to gross margins. Non-GAAP gross margin in Q1 was 41%, compared to 43% in the prior-year period. On a year-over-year basis, the decrease in non-GAAP gross margin was primarily due to the decline in royalty revenue which contributes 100% gross margin. Looking at expenses, non-GAAP operating expense totaled $63.6 million in Q1, compared to $59 million in the prior year. Year-over-year, we increased our investment in sales and marketing by $4.5 million. The primary driver of the increase in sales and marketing relates to incremental salaries and benefits from additional investments we have made in the team in the past year.

In addition, we have increased our marketing programs. Marketing programs spent to drive greater awareness and demand. Non-GAAP operating loss for the quarter was $5.9 million, compared to operating profit of $7 million in the same quarter a year earlier. The largest contributors to the decline in operating profit on a quarterly basis were the overall revenue decrease including lower royalty revenues and incremental sales and marketing spend. Interest expense for the quarter was $1.8 million, compared to $2.8 million a year earlier. This included cash interest expense of $1.5 million and amortization of debt issue cost of $300,000. The current coupon interest rate for our revolving line of credit, $49.5 million at June 30, is 2.46%, and the average interest rate for our total debt will be approximately 3.29% for the quarter ending September 30.

For the first quarter, we had other expenses $300,000 due to net foreign currency losses, and we recognized tax expense of $500,000 primarily related to foreign and state taxes. Summing it up for Q1, we had a non-GAAP net loss of $8.6 million, which is a non-GAAP loss per share of $0.04. This is compared to non-GAAP net income of $3.5 million and $0.01 in the same quarter a year earlier. Focusing on cash flow for the quarter and balance sheet at June 30, I would like to highlight several key points. Cash flows used in operations for the quarter were $1.1 million. At quarter end, the composition of our debt was $49.5 million of revolver, and $135 million of convertible debt. We ended the quarter with $50.2 million in cash.

We are in compliance with all debt covenants at June 30 and expect to be in compliance with our debt covenants during the next 12 months. EBITDA for the last 12 months was $51.6 million and on a sequential basis, manufacturing inventory increased $2.5 million, accounts receivable decreased $24 million, and we had an accelerated payment of $7.1 million from one customer. CapEx was $4 million. While we fell short of our first-quarter plan, the team is very focused on growing revenue in fiscal '13. As Jon would say, we are reviewing the game film, paying close attention to those areas in which we did not achieve our goals, and working to improve performance in the remaining quarters. Now let me turn the call back over to Jon.

Thanks, Linda. Clearly, our overall results in Q1 were not what we expected nor are they acceptable. Moving forward, there are several positive trends which we will continue to build on, and there are areas where we need to adjust and drive for a different result. As we analyze last quarter's results and look at the rest of the year, we are proceeding on the basis of three key principles. First, we are in the right markets and have a strong product portfolio. Data protection in both traditional and virtual environments is a market that's growing and is at the top of the list of problems our end users are trying to solve. The combination of our scaler tape, DXi appliances, and vmPRO solutions is unique in terms of breadth, depth and flexibility that we can offer customers.

The big data management and archive market is also growing, and our strategy of leveraging the industry leading characteristics of StorNext in a family of appliances is also unique. With the addition of next generation object storage or wide area storage technology to our portfolio, we believe we will be able to offer customers new unparalleled solutions with incredible value. Second key principal is that the uncertain global economic conditions are impacting customer buying decisions. I spent time on this earlier in the call, but to reiterate, there are a lot of deals, but the hurdle to close them goes up the bigger the deal. Our go-to-market is through the channel, and we have to make sure we really understand the buying decision process in this economic environment.

Finally, given our attention to grow the Company, we need to be in more deals, have more channels to market, and have more end-user and channel awareness. This is not a new principle for us and it's something we've been working on, but it's clear we must do more. So, with these three key principles in mind, we are going to do the following as we move forward. First, we are going to continue to drive hard on our unique value proposition with end users and channel partners. Specifically, enabling customers to maximize the value of their data by protecting and preserving it over its entire lifecycle in any environment and at any scale. This includes offering performance, ease of use and tight integration of quan solutions at a price point that provides more value than the competition. Second, we're going to be more aggressive in building our pipeline and do so earlier. This will be through a combination of targeted marketing and broader awareness activities directed at both install base customers and new prospects, as well as the channel.

Our win rates are very high, and when we are in deals, we do very well, but we need to be in more deals. Third, we were going to continue to broaden our routes to market, including aligning more deeply with our partners, adding additional partners, and pursuing additional strategic or OEM partners for our tape, disk and software products. As an example, building on our partnership with Xerox, we will be launching our Quantum-based cloud data protection offerings later this quarter, leveraging Xerox's cloud services infrastructure. In addition, we have signed an agreement for a large integration -- integrator solution provider to standardize on our tape libraries as part of their offering. We expect to announce more details about this arrangement later this quarter.

Fourth, we are going to take additional steps to inspect big deals more closely and work to get them closed earlier in the quarter. Fifth, we're going to monitor the economic climate and the uncertainty and adjust our investments and focus accordingly. And finally, we're going to spend wisely. We are still focused on building a growth business and creating long-term share holder value, but we need to be balanced in our decisions around spending for growth and the need to make money. Our intention is to do both. So now let me turn to guidance. For Q2, we expect revenue of $150 to $155. Non-GAAP gross margin of 42%. Non-GAAP operating expenses of $64 million to $66 million. Interest expense of $2 million and income tax expense of $1 million. Thanks for joining us on the call. We expect better results in Q2 and we will look forward to taking your questions. Operator?

Yes, thank you. (Operator Instructions) Our first question is from the line of Alex Kurtz from Sterne, Agee, please go ahead.

Thank you for taking the questions, guys. Just two for me. Jon, when you think about these enterprise deals getting pushed, I look back at Data Domain, who is very much a direct driven organization, and CommVault, which is obviously direct driven outside of Dell, do you think this segment of the market that you are going after can actually be managed through the channel, especially as these environments get more complex and these deals get bigger? Is this something that can actually work for you guys, or do you have to reassess what you are going after?

Yes. I think, though, there's a couple of elements to that question. I don't know about how Data Domain and CommVault -- I thought Data Domain was channel company, but let's set that aside. What we're finding is, we are very much involved in the technical part of the sale at the end user with our channel partners. And I believe that's important and going to continue. But what we are finding is that those individuals are not as clear or as close to what the financial situation is of that end user. And oftentimes they are surprised that POs aren't approved. I don't think it's really about, do we have the right solution, or are the channel partners there? I think it's -- the scale of our deals are getting bigger, so you are starting -- it gets escalated farther.

This economic environment means more things are getting escalated. We just are not getting enough signals around what the economic buyers are doing in these end users. We are going to try to address that. I have been spending time with customers; I'm going to spend a lot more. So is Ted. So are our two GMs. We're just going to get out in front of some of these deals early and make sure we are clear that we fit for them and that there is going to be money because -- especially in the big deals. But I'm not concerned about the product set or the go-to-market piece of it. It's really about information flow.

Okay. I appreciate that, Jon. Linda, can you revisit us on the operating margin assumptions between tape and disk and how we should be thinking about that as on a run rate basis, what are the different margin profiles for both segments?

Alex, we typically don't break out by segment the product, the gross margin on products. I would say --

I meant operating.

On operating profit. That either. So obviously from a tape perspective, that's a very profitable business for us. And the disk business is also very profitable business for us. I think overall if you were to think about adding $20 million of revenue to the top line, you would -- gross margin would have been up at 42% this quarter and the $10 million would have flown down to the operating profit line.

Alex, I think what Linda is addressing there is the lack of revenue is the challenge, because the margin and branded tape is good and the margin in disk and software is good, and so when you don't have that -- and obviously margin on the royalty is very good, right, 100%. It's kind of a math problem if you compare this quarter to last quarter, just at a high level, it's just volume. And our fixed cost structure or our cost structure is fairly fixed, except for variable comp. So, that's the bad news. The good news is that, as revenue grows, we get scale really quick the other way, too. So, when you look at some of our more profitable quarters, you can see, as Linda points out, you add $10 million of $20 million of revenue, a lot of that flows through at a really high percentage, so it's why the growth thing is so important.

Now in fairness, you know, it's exacerbated when you're investing more on the OpEx side and revenue goes down. And we think that is really about timing around the investments. I think our early returns around our new territories and some of our new models, people are pleased with. And I'm sure this is going to come up later, so I will just address it now. We feel good about our overall game plan because we've got a number of our people and a lot of them who had very strong quarters. It's just that our standard deviation between those that are doing great and those that aren't is too big. I think revenue growth is the best thing here. But I tried to moderate that and if things get tougher here, we will adjust accordingly. We will get more profitable as we grow for sure.

Thank you.

The next question is from the line of Ryan Bergan with Craig-Hallum. Please go ahead.

Thanks. I was just wondering if you could give some perspective on the back half of the year, if you expect normal seasonality to be sequentially through the back half of the year?

Yes. So historically, for sure Q3, or the December quarters are our biggest quarter, and that is over the last six years. This quarter that we're in is generally our second biggest quarter, and that's often been driven by the fed year-end and then product cycles as well. Then Q4 is historically our second worst or third best, depending how you want to count it. And there -- at a high level, we don't see differences in that right now. I would say our guidance around that $150 million to $155 million doesn't -- I think is less than last year. I know it is. We are driving internally for more than that, but I don't feel the need to change anything around guidance until we start proving that we can do better. We expect the seasonal pattern that looks historically the same and we are driving to move the revenue number up in all those periods.

All right. Then could you talk about what you are expecting from the US Federal -- if you expect a normal seasonal budget flush from them or do you see any weakness there and are you more oriented towards larger enterprise deals with US Federal?

Yes. The answer to that is yes, we are. And we tend to be more program driven and most of that business works its way through in September, the month of September. Having said that, I was just in Washington, DC with Janay, who runs the big data group and there are a lot of opportunities right now. And we were in some very good programs Our belief is that we are going to be successful, but, like everything else -- and it's even maybe a little worse than the Federal Government. The deals come out, they go through the procurement cycle and they pop out, so it's a little bit more tense than commercial space. It's an important space for us and on the big data piece, in particular, there is a lot of upside. And actually on DXi as well. I was in Washington, D.C. -- some of our big data customers have also moved to our data protection products as well, so we will see. We're pensive about all it because it is an important quarter, but there is good opportunity there for us.

Alright. And then you're operating expense guidance for the quarter, I guess was a little higher than I was expecting, but I'm wondering, do you feel like that's kind of the new run rate here? Or that's a run rate you can go with going forward where you might see the sequential step up in Q3 and another sequential step up in Q4 like you have in prior years based off this new operating expense guidance you have given us?

Yes, that's a good question. What we try to do this year if you recall, you know, was to front load the expense to increase the opportunity for growth. That was the goal, so I would say, from the a sales and marketing side, at a sort of fixed level, the expense run rate is what you described it. We can manage it over the next three quarters. If it goes up, it's going to be because we sold more, which everybody will be happy about. But it will be in manageable numbers. I think 64 to 66, I'm looking at Linda is probably a good range to think about and, to be candid, I'd like to pay more than that, because we blew it out in a quarter. I think from a fixed perspective, though, we are fine. And then if things got really bad or worse, we'd have to spend less on fixed basis. That's not what we are planning on right now at all.

At what point do you decide things have gotten that worse or you need to scale back that sales and marketing spend?

Yes, well, we're monitoring it closely, as I said. You know, we think we are in the right market markets, you know data protections and big data and those are growing. But let's use Europe. If Europe gets a lot worse and we can't execute there because of what's going on around us, we'll know we will need to be smart about where we are spending money. We actually expanded into some other geographic areas this Q1 and we did very well. So, we are going to be pretty active about where we are spending and trying to get the most growth for the cost. I'm not going to just spend money to be spending money. It's not our DNA. It's not how we've run the Company and we are going to be smart about that.

Thank you.

The next question is from the line of Cindy Shaw with DISCERN Group. Please go ahead.

Yes, thank you. Couple questions. You just said that you are not really planning on spending more on sales and marketing unless there is a lot more revenue, which would make sense. Earlier in the call, you also talked about, if I understand, doing more with less in terms of stepping up awareness efforts in advertising and things like that. So, can you explain how you are going to basically do more without increasing spending?

So, what I was trying to say, Cindy, thanks for helping clarify. It's built in to the guidance that Linda gave.

And --

Which was the prior question. So, our intention of that range that we gave will cover what we are talking about doing.

And how do you increase awareness without stepping up the expenses?

So think of it as focusing on the places where we get the most return, where we are getting the most end user contact. If there is a pot of money, we are really going to really focus it on driving that specific attribute, as compared to say general corporate awareness, or some other marking campaign. It's really about driving a specific result around end users.

Is there going to be a lot more focus in terms of managing the sales funnel and those types of more sales productivity type of issues?

Ted and his team have been particularly focused on that. I think we were all surprised at the result, and I say that in the most transparent and kindest way, even with the week to-go. So there is definitely room for improvement. What I try to address on the call was, after sitting down with the sales team, and going through, you know, why did we think we would be here and end up here? We did it deal by deal. And in doing so, those trends that I talked about were the things that came out. And so we are going to take the steps that I mentioned earlier and we are going to get more executive involvement in the bigger deals earlier. We are going to drive for a better result.

And how long do you think it's going to take to really sort of make that shift in terms of how the Company operates? Is that something that is a one-month or three-month or a few-quarter type thing? And at what point will that start to really get the Company better visibility, do you think?

Well, a couple of things. I think we are trying to adjust to two things. One, our business and the types of deals that we are in is changing. I will use the big data example. We are in much bigger more strategic accounts. That's good.

Understanding the buying decisions around those we need to improve on, so I use that as an example. The Macro-economic environment is dynamic and we are just taking the position that it's tough. And it's not going to be easy and so we've got to have more information sooner. So I would talk about the things that we are doing as adjustments to what we see and why we didn't get to where we were going to get. Because, again, this is not where we thought we would be, and I think Linda used a sports analogy, which normally is me. We watch the game film, we went through the deals and we are going to do what I said on the call. We are going to take those steps.

And again, predicting the results is harder. I can tell you that there is a lot of deals. We like the markets, we like the products, we're getting super good feedback around the strategy, around big data. DXi continues to win awards. Channel partners continue to contact us. We just added another big tape partner. We are launching our Xerox -- our Quantum-branded cloud powered by Xerox. We have a bunch of things that are really positive, so we are not going to hang our heads around where we are, but we're not going to be pollyannaish around the things we have to do better.

Okay. And can you remind us what sort of a typical linearity for the Company would be during the quarter and how that shifted lately?

Yes. So in total it's like 20-30-50. I'm looking at Linda.

Overall business.

Overall business hasn't changed much. But the devil is in the details around that because in that 20-30-50, we've got royalty and OEM, which is pretty linear and we have service, which is linear. The branded business tends to be really back-end loaded; it always has been. So again when you think about the risk profile for us, starting the quarter strong is great, but it really matters how you finish. You know, I think if Ted were here, he is out with customers in Asia I think this week, he would say, you know, we've got to do better in getting the deals that we've got on our sites closed. And if we are not going to get them closed, we have to have more deals to go close. It's really -- the more we can upload early in the quarter and the better visibility so we can make decisions about what we do, we just have to do that.

Okay. Thank you very much.

You bet.

Operator. Thank you. The next question is from the line of Brian Freed with Wunderlich Securities. Please go ahead.

Hello, Jon. I have about three questions here, so I'll kind of fire away here. You know, first, hearing a little bit of commentary out there about EMC, a little more focused on tape with their Spectra Logic reseller relationship. Wondered if you are seeing them at all and if the deal slippage in the quarter is at all attributable to that?

On a deal slippage basis, no. What our relationship with EMC on tape has always been funny because they would sell it as a last resort. And it's -- but we have been selling with them for a long time, so what's really happened is we're still selling tape through EMC. It's not very material, and it tends to be into their installed base. So that's where we are selling. And those are all Quantum-branded systems so they have our name on them; we carry the service paper and we know where they all are. I think the opportunity to sell in the install bases still exists.

We do see them taking Spectra into accounts from time to time and competing with us. Spectra is a privately held company. They have some interesting products, but we have no trouble competing with them, given the opportunity we have been for a long time. I don't know how big they any more; they're private, but it's a different scale. And I just don't think the EMC Spectra Quantum tape thing is really the issue.

Okay. My second question relates to the patent litigation out there. And really two things. There has been a fair bit of new update with the -- saying they don't really infringe except in limited configuration. Going through the complaint, you guys apparently, according to Overland storage patent to license their 766 back in 2010. Can you talk -- what can you say about that dispute and your rational for wanting to license that?

(laughter) Well, that's a new one for me. I don't know. Let me -- I have a -- Brian, I had a canned answer to this but, since you asked me that I will have to go off script. They have filed a lawsuit on two patents relating to tape. I can tell you that we are very well-positioned around what the facts are around those patents and our products. We have never asked them for a license. I'm looking at Shawn. That's right. We've never talked to them about a license. And so that's never happened. We have a -- we actually have the largest and the biggest tape automation patent portfolio in the world and we have a lot of experience with dealing with these things. I would just say, I think the BDT Overland press release conference call thing is sort of funny.

There just seems to be a disagreement about what the facts are, which I'm going to let Shawn address here in a second. And at the end, and I think the most important thing for us is, we are confident in our position and we're confident that our customers aren't going to be impacted and we are going to stand behind our products and our position, as we feel we are fine. I don't know exactly how to talk about the BDT Overland. I guess there was a press release today and a conference call. I am not qualified to read what the ITC -- I could read it, but I'm not qualified to talk about it. So I've asked Shawn actually to give you a quick summary if somebody asks this around our read of what's happened. Shawn, you want to jump in and save me?

Sure, I'd just say a couple things. First to your comment about the complaint. I would just note there -- I know what you are referring to. There is a section in the complaint that suggests that we kind of affirmatively sought a license, and that is just not the case. And that will get resolved as litigation proceeds. As far as the ITC action, there is a lot of confusion about that. I think each side trying to characterize it in the -- you know, going to take the highlights that favor them.

I would just note, we're not a party to the ITC action, and so, the results there aren't binding on us at all. I mean, the patents at issue in ITC are the same as the patents that are at issue in our suit, and so there are aspects of it that are perhaps informative, but it's not binding; we're not a party to it. Specific to the infringement, I would just note that the ITC found that BDT did not infringe either of the patents. I think that's pretty clear and factual. The ITC found that IBM and Dell infringe in kind of limited circumstances, but Dell and IBM have both settled. That's not, as far as we can tell, very relevant to the current case against BDT was found explicitly not to infringe.

Okay. I appreciate that -- that color. So, jumping to my next question, Jon. Can you give us any color on quarter-to-date trends? I imagine you acted fairly quickly to try and regroup after last quarter. What are quarter-to-date trends looking like? Do you feel like you are getting off to a good start at least?

Yes. What is horrible about the result in Q1, is Q2 is like the toughest quarter to feel good regardless of what we just did and that's because it's the fed year end. The stuff pops up out in September. You have the European vacation in August. And can't believe the whole world is somewhat on vacation.

I would say we are doing a couple things. We are really focused on getting these deals that we thought we were going to close, closed. And to the extent that they are not ready to close, we're working very hard to get them closed. And I would just put that under -- we need to do more selling. I think, if I compare it to last quarter or a year ago, I think we are in the parts that we are focused on, I think we are about the same in total for the branded business. On the parts that we don't control, the royalty is going to be down some and the OEM business would be down, based upon the change in the products. But we've included -- we've taken that into account as we look at guidance.

I'm not -- I mean, there is no way I'm going to feel good at the end of July, regardless of what the number is, so I'll just put it that way based upon the way this quarter works. I like the way Ted and his sales team are responding. I like the steps that we are putting in. I like the way we've proactively addressed territories that aren't performing at the level that we need to, and that's around coaching and help. So I think if Ted were here, he would say his team gets it. We see the deals. I know I'm going to look around the room and Bill is here, funnels are bigger. Opportunities are bigger. So that's all good. Now we have to get deals closed.

Okay. Then my final question, when we are out earlier in the last quarter, you talked a bit about your wide area storage solution. And you kind of look at the new products coming out of the gate. That, along with your hosted products and cooperation with Xerox. I guess what elements of your portfolio are you most bullish about and what elements are you most cautious about based on early customer interest?

I think -- it's a little like talking about your kids, I'm going to talk about them all in some way, just so you know. On StorNext, I think our strategy around the appliances are right. We see the traction there; we're getting a better customer result, and we're getting into more deals. I think the wide area storage addition of the technology is super important. We are driving like heck to be able to launch a product, and we're going to probably launch a series of them, is what we decided on here. And we had very modest expectations about the number of deals that we would try and do work right out of the gate because we don't have a product yet. And I would say we are five or six times higher than that, what our plans were. So, we've got a lot of things that we are chasing, and the engineering team is feeling the pressure of getting the product integrated with StorNext and tested so that we get a good result for customers. We absolutely think we have something unique with StorNext and wide area storage, and, based upon the earlier discussions -- and I have been in a bunch of them, I think that is going to be super important.

On DXi, I think our product portfolio is good. The thing that makes me nervous about it is we are small compared to the referenced competitor. We do not mind competing with them at all. And when I see them talking to customers about our financial results and our size of our Company, it just reaffirms the fact that I think we've got them when it comes to product solutions and the value for the customer. But they're a big formidable competitor and we just have to be on our game; we've got to get deals closed quickly and we can't be afraid to compete.

Then on tape, the thing that makes me the most nervous on tape is that, we are the share leader. We have the best products. And that's business that we should get all the time. We are adding a lot of focus around the new businesses. I just want to make sure we're picking up all of the tape deals that we should get, whether it's in our inner installed base. Whether it's taking them from a competitor. The tape business is -- that market is not going away. We have the best products. We have the best data protection solution. Our sales team and our channel partners need to make sure we get those deals, and so we're doing a lot around an emphasis around that.

So, I put it in order I'd say, the tape stuff concerns me the most because it's the biggest piece. And I just think we have to get it all. And I'm most excited about StorNext and the appliances. And then DXi is a solid product. There is no reason why we shouldn't sell more than our fair share of that. We just need to be in more deals and Ted and Bill and the team are driving to get us more leads and more at bats, because when we get a chance, we are tough to beat.

And then we still have things that haven't occurred yet. The branded cloud offering just comes out. We are pursuing other channel partners. I loosely announced this new tape thing. We will have a press release out; more specifics around that here during the quarter. There is good stuff going on; in all parts of the business, we just had a crappy quarter. And you know we have to do better.

Okay. Thanks so much.

The next question is from the line of Glen Hanus from Needham & Company. Please go ahead.

Just a quick follow-up. On StorNext, that seems to be going well; up 50% year-on-year. Was that up quarter-on-quarter, and do you think you can be growing that a little more predictably quarter-on-quarter as you go through the year?

Let's check in on your first question. The thing about StorNext and the growth is that, by doing the appliance-ization, Glenn, even those deals are getting bigger, too. Because, remember, for every $1 of software, there is probably $5 to $7 of hardware when we sell an appliance. Yet, I think there is a stat in there, we added 60 some new customers.

65, yes.

So I think there is a couple of things happening. One the breadth of the types of people we can sell to is growing, the use cases are growing, and the overall deal size is also growing. And all of the appliances are fairly new. So, I think with the -- based upon what I see, when we add the wide area storage to the portfolio, because that just makes the deal that much bigger, our ability to sell one, two, three, four, five petabyte-sized deals just exponentially changes. So I think you will see it grow these next two quarters. I think that's the case.

We have a lot of installations of StorNext in the Federal space, so this is an important quarter for them. And then our wide area storage products, they start rolling out here starting this quarter and into next. I feel good about StorNext and where we are headed. I like -- and I have been in a lot of the customer meetings with Janay, and we used to call net out boxes islands of storage, and you had to link a bunch of them together, and what's happening now, is with this product, we can call [isolan] boxes islands of storage. The islands are a little bit bigger, but we get really big. And we are going to be -- as that product comes out, we are going to have unique offer. There is nobody who can -- the combination of StorNext speed and performance and the scalability of wide area storage and the resiliency and the cost is going to be really disruptive.

Thanks, Jon.

Thank you. (Operator Instructions) The next question is a follow-up from the line of Alex Kurtz with Sterne, Agee. Please go ahead.

Thanks. Just want to do a couple quick follow-ups here. Linda, could you give us a broad reminder of directionally the gross margin between the products. I know you are not going to give the exact numbers, but can you just sort of give a hierarchy of how the products play out as far as gross margin?

You know, we haven't given that publicly, Alex, so I would look at and say, well StorNext software is 100% margin royalties, 100% margin, branded tape, disc and soft-- branded tape and disk are high margins and then you have the OEM business and median devices they are the lowest.

For sure the royalty's the biggest thing. So, when you look at these results, compared to a year ago, you know, the margin is really a loss of $3.6 million in royalties. Losing that is big. Disc and software, what we've said is it's like the reference competitor, so that's going to be -- when you put the two together, and you take that category, that's going to be next. Then branded tape, it would be the next highest and then you get down into OEM and the devices and it's below the corporate margin.

Okay. And Jon, is your assumptions around the branded versus OEM tape really change as far as how we should be modeling that over the next couple years as far as branding grown grade of the market and then OEM at some single-digit decline? Is that still accurate or should we be more aggressive on those declines?

I think -- I think tape is going to continue to be under pressure at the low end and in backup and it's going to grow in the mid-range in enterprise, and in archive. So I think the guidance we've given was trying to reflect that -- be reflective of that. The reason we do it that way, Alex, is that, on the OEM side, we don't control the go-to-market and how they position it. So it's hard to say anything but market, which I believe is small declines. Driven on the branded side, you know, we feel like our ability to sell a DXi, a tape library, all managed by vision is a unique offering that you know Storage Tech can't do, or I guess it's Oracle now. IBM can't do that. HP can't do it. They are probably the closest. Spectra can't do it, a name that was dropped earlier. We like our competitive position on the branded side and that's why we think we're going to grow better than the market. I'm looking at Brad -- we have any new data on market? No, so it's what we've said in the past.

And just a clarification on the OpEx question from earlier, Jon. Should we just be used to OpEx in the 60s now going forward, or is there going to be a reset at some point, how should we think about that?

Well, I think the answer to the question is, if we are not going to grow or we, as our market position changes, we are not going to spend this much money. But that's not what we see right now. We see more around macro things that we have to be wiser about and investments that we've made that haven't yielded results yet, and new things that are coming. For instance, we are doing a lot around StorNext marketing. I am not going to pull back on that because it just grew 50% and when we add this wide-area storage technology, which we think we are super disruptive in, you know, the percentages are going to look different.

DXi, same thing. That market is going to double, according to how you see. We want our fair share of that and we are spending accordingly. Now if, for whatever reason, the world changes, we will adjust. But, right now, we are being smart. What I mean by smart is, we are spending where we need to, but I'm not telling the team to go find ex-amount of OpEx to take out because I don't think the market or our product position dictates that.

Okay. And last question I guess is back to Linda. You talked about mid-40% gross margin as sort of the target, historically. I think you may have talked about that back in May. Obviously, that changes with the how the product mix looks from quarter to quarter, but is mid-40% gross margin still a good go-forward target as we model out the years?

I would say it's really scale is what drives that. I think I said earlier for every $20 million of additional revenue you are going to add a point to a quarter. Assuming growth from where we were last year and increased scale, and that being more in disk and software and branded business, we move towards the mid-40s, so that's how we model that out.

And did you guys talk about why the margin was so high in the quarter? I think it was in the 40s but maybe we had that calculation right.

Yes, I know we have been down and I think that's reasonable. We have been down over prior quarters just related to some cost associated with service inventories and so forth. And that kind of returned to normal levels this quarter.

So you think 40s on the service margin, low 40s is a reasonable place, or you think high 30s going forward is how we should be modeling it?

Yes. We typically -- we've had more quarters in the high 30s than in the low 40s. So that's probably more reasonable.

Okay. Thank you.

Thanks.

Thank you. (Operator Instructions) There are no further questions at this time. I will turn it back over to Management for any closing remarks.

Well, I want to thank everybody for joining the call. We ran over an hour. We felt like we needed to be reflective of the -- what we saw occur in the quarter. I can assure you, on behalf of the team, that we spent a lot of time digesting the data and what's going on and we are going to adjust some things to reflect what we've talked about. And our overall goal here is for this to be a growth Company. We think we are in the right markets. We think we have a good product position and we believe we've got more good things coming to take to our customers as the course of the year plays out. We will talk to you in October. And you can be assured we are driving for a better result. Thanks very much.

Ladies and gentlemen, this does conclude the conference call. If you'd like to listen to a replay of today's conference, please dial 1-800-406-7325, or 303-590-3030, and enter and access code of 4546490. Thank you for your participation. You may now disconnect.