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Quantum (NYSE:QTM)

Q3 2013 Earnings Call

January 30, 2013 5:00 pm ET

Executives

Shawn D. Hall - Senior Vice President, General Counsel and Secretary

Jonathan W. Gacek - Chief Executive Officer, President and Director

Linda M. Breard - Chief Financial Officer, Chief Accounting Officer and Senior Vice President of Finance, IT & Facilities

Analysts

Cindy Shaw - DISCERN Investment Analytics, Inc

Jack McCarthy

Brian S. Freed - Wunderlich Securities Inc., Research Division

Glenn Hanus - Needham & Company, LLC, Research Division

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Quantum Corporation Third Quarter 2013 Conference Call. [Operator Instructions] This conference is being recorded today, Wednesday, January 30, 2013. I would now like to turn the conference over to Mr. Shawn Hall, General Counsel. Please go ahead, sir.

Shawn D. Hall

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 be 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, opportunity 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 with the Securities and Exchange Commission from time to time, including our most recent 10-K filed on June 14, 2012, and 10-Q filed on November 9, 2012. These risk factors are incorporated by reference into today's discussion and we undertake no obligation to update them in the future.

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

Jonathan W. Gacek

Thanks, Shawn. Welcome to our fiscal 2013 Q3 earnings call. Today, we reported revenue of $159.4 million, non-GAAP gross margin of 43.6% and non-GAAP earnings per share of $0.02. In addition, we generated $6 million in cash from operations and ended the quarter with a cash balance of $55 million. Our disk and software revenue totaled $41 million, driven by another record quarter of DXi revenue, and our tape automation revenue rebounded strongly from Q2.

I'm going to address the key elements of this quarter's results. Linda will give more detail on the results, and I will come back to address Q4 and our fiscal 2014 plans.

The clear highlight in Q3 was our overall financial performance, including sequential revenue growth and the resulting profitability and cash flow. This reflected a series of actions we took in October to adjust our financial model to the current economic environment with a balanced approach to both drive for revenue growth and generate income and positive cash flow.

First, we reemphasized our growth objectives with the sales team and we reiterated the importance of not getting overly focused on a single product line at the risk of missing opportunities across the entire portfolio. This was particularly true in the case of tape automation, where we stressed the need to ensure we are taking full advantage of the market opportunities.

The tape automation market has been difficult this year, with the overall market down approximately 20%. However, we have the best tape product portfolio and market position and we should gain share even in a tough market. This year, we've added a lot of excellent salespeople with a wide range of backgrounds, but most have a historical experience was in selling disk and software products. We have taken steps to make sure we are getting the tape opportunities, train our new sales team members to be successful and making sure we have adequate support to close tape deals.

The second action we took in October, following the reduction in our Q1 and Q2 tape revenue, was to adjust our spending levels accordingly, with a focus on generating cash and income while still driving growth in this system's software and Big Data products. We implemented a plan that reduced headcount by roughly 10%, with basically all of the actions completed by December 31. Changes were implemented in all functions and in all geographies. We focused on performance, productivity, opportunity and strategic importance as we made these changes. The impact was approximately $1 million of benefit from those reductions in Q3 and we expect to recognize $6 million per quarter of benefit beginning this quarter.

The third action we took was to improve our overall balance sheet by refinancing our senior debt with a convertible security. The refinancing will allow us to accumulate cash and gives us more flexibility to run the business. Linda will provide details on the EPS and interest impact of the new debt later in the call.

The results of these actions was that we grew revenue by 8% over Q2; reported non-GAAP operating income of $7.5 million, which was a sequential improvement of $10 million; and generated cash from operations of $6.4 million, a $20 million swing from the $13.4 million of cash used in operations for Q2. As this demonstrates, our financial model is very leveraged, and as we add revenue, we generate incremental operating profit very quickly. In addition, when increased revenues coupled with full savings from the cost reductions we've made, the result will be even better operating results and cash flow generation.

Beyond our improved financial results, we also continued to -- our aggressive approach to product launches in Q3. We announced version 3.0 of our vmPRO virtual machine backup software and a new microsite at quantum.com where you can get a full-featured, free download of vmPRO and our DXi V1000 virtual deduplication appliance. These can then be upgraded as your data storage mans grow.

We also introduced the first products in our new family of Lattus, wide-area storage solutions for Big Data environments. This product incorporates next-generation object storage technology and it overcomes the limits of RAID-based architectures. Lattus provides global distributed disk-based archives that are extremely scalable and cost effective and allows storage of data on disk forever without interruption or migration.

We had our first deal for this technology in Q2. We didn't have any sales in Q3. These are large deals and start at 500 terabytes. We expect the next-generation object storage technology to be disruptive in the coming year, and we believe we have a unique solution when it's fully integrated with our StorNext technology in our second Lattus offering expected to be generally available in the first half of this calendar year.

In addition to launching vmPRO 3.0 and Lattus, we also did a soft launch of our new DXi6800-series deduplication appliance for midrange and enterprise customers and sold it to several customers under NDA. Officially announced today, DXi6800 is 4x faster and 3x more scalable than EMC's nearest competitive product and sells for the same price. It has also 50% smaller footprint and has Pay-as-You-Grow extensibility.

By continuing to build in our virtualization, data protection and deduplication portfolios, we are positioning Quantum to take greater advantage of the significant growth opportunities in these market segments. However, we are also capitalizing our tape leadership and continued innovation. In Q3, we began shipping LTO-6 tape drives in our midrange and enterprise scaler libraries, as well as our tape autoloaders, drives and media, and the technology will be important to improving the tape revenue moving forward.

And finally, today, we also announced our new Scalar i6k HD enterprise library, which includes the industry's highest slot density, twice that which is offered the other competitors, providing nearly 5 petabytes of storage in a single rack and scaling to more than 75 petabytes of capacity.

With that, let me turn the call over to Linda to provide more detail and color on our results, and then I will come back to address our plans and guidance.

Linda M. Breard

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 to reference those documents as I comment.

Revenue for our third quarter ended December 31 was $159.4 million compared to $173.5 million a year ago. We grew total disk and software revenue, including related maintenance, by $4.6 million, a 13% year-over-year increase. Contributing to this increase was record quarterly disk revenue, driven by record midrange disk revenue and a 60% increase in enterprise disk sales from a year ago.

Offsetting our growth in business, we had a revenue decline of $9.5 million in branded and OEM tape automation, devices in media revenue also declined $4.1 million, and as expected, royalties declined $2.5 million over the same quarter in the prior year. I would also note that we added a record number of new customers in Q3. We have said that increasing end user and channel awareness is key to driving our business, and we believe this new customer acquisition is a testament to the marketing focus and awareness campaign that we have invested in over the past year.

Royalty revenue was $11.5 million for Q3 compared to $14 million in the same quarter a year ago. Expected reductions in both LTO and DLT royalties contributed to the decline. For the quarter, non-royalty revenue totaled $147.9 million, of which 83% was branded and 17% was OEM. That compares to non-royalty revenue of $159.4 million a year ago, of which 81% was branded and 19% was OEM.

Looking further at various revenue classifications, devices and media totaled $17.8 million compared to $21.9 million in Q3 of the prior year. The majority of the year-over-year decline was in media, which was expected due to the events of the prior year which caused higher than usual purchases at media. Tape automation system revenue was $61 million compared to $70.5 million in Q3 of fiscal '12. Our branded business performed better than our OEM business, declining approximately 10% year-over-year compared to our OEM business which was down nearly 20%.

On a sequential basis, we grew tape automation by 25% driven by the introduction of LTO-6 technology, year end IT budget spending and our increased focus on making sure we fully capitalized on tape opportunities, including training and regularly communicating the importance of selling tapes throughout our sales organization. We shipped our enterprise and midrange products with LTO-6 drive technology in the last month of the quarter. Once we have a few quarters of shipping LTO-6 in our full portfolio of products, we will have better visibility into the market and its outlook. LTO-6 tape drives nearly double capacity and increased transfer rates over 40% more than in LTO-5 technology.

What we have said in the past remains true today. We are focused on running this business to generate profits and cash flow while maintaining our market leadership. Sales of branded enterprise tape automation units increased on a year-over-year basis, while overall revenue from these systems declined approximately 10%. This decline related to lower upgrade revenue in Q3 compared to the same quarter in the prior year.

Branded midrange tape revenue was relatively flat year-over-year, while entry-level automation declined approximately 20% over the same quarter a year ago. In our OEM tape automation business, enterprise revenue is relatively flat year-over-year and we saw the largest dollar decline in midrange followed by decreased entry-level sales.

Overall, our tape business has been outperforming the market. We acquired approximately 175 new midrange and enterprise tape customers in Q3, the highest new customer count in tape we have posted in 3 years. Finally, as Jon mentioned, today, we announced our new Scalar i6k HD enterprise tape library, which will be available in March. We believe this is an important addition to our offerings in this segment and reflects our continued leadership and innovation in tape as its role evolves.

Disk systems, software and related maintenance revenue, which includes our DXi, vmPRO appliance and vmPRO software data-protection offerings, as well as wide-area storage solutions and our StorNext software and appliances for Big Data management and archive was $40.9 million in Q3. This was up 13% from $36.3 million in the prior year. This is the second quarter in a row that we surpassed $40 million in revenue in this category.

Looking more specifically at disk systems revenue, it was up 19% year-over-year to a new record. In addition, we added approximately 175 new disk customers during the quarter, and our overall DXi win rate was 57%. The primary driver of our overall disk systems revenue growth was our enterprise business, which was up 60% over the prior year. Big deals, which we define as deals over $200,000, drove the year-over-year growth enterprise growth.

The September quarter addition of 3-terabyte drives in our DXi8500 Enterprise has been embraced by our partners and our customers. We were the first in the market to incorporate 3-terabyte drives, and this enabled us to provide the industry's highest storage density and power efficiency for enterprise disk backup and deduplication. Q3 midrange disk revenue was up 10%, up over 10% year-over-year to record revenue levels for this category due to both increased big deals and overall unit volume increases

At the end of October, we had shipped more than 1,000 DXi6701/6702 units in just over a year since their introduction in the market and the momentum continues. In addition, as Jon said, today we announced a new DXi appliance, the DXi6800, that is far superior to any of the competitive offerings. DXi6800 was available on a limited basis in Q3 and contributed to our record DXi revenue. We are very excited about its prospects moving forward.

Entry-level disk revenue declined over Q3 of fiscal '12. The number of large edge-to-core deals, an important driver of entry-level sales, was down from the prior year. Further, reinforcing the strength of our DXi portfolio. We've continued to garner industry honors. In November, our DXi V1000 virtual deduplication appliance was named Virtualization Product of the Year at the 2012 Storage, Virtualization and Cloud Computing Awards. And a couple of weeks ago, the DXi V1000 was selected as a finalist for Storage Magazine's SearchStorage.com's 2012 Product of the Year Award. In addition, our DXi6701/02 appliance is a finalist in the Network Competing 2013 Product of the Year Awards. Winners with both of these awards will be announced in the coming months.

Turning to StorNext software and appliances, revenue was relatively flat year-over-year. While we grew appliances and Q3's disk revenue over the same period last year, standalone StorNext software sales declined over Q3 of last year, fully offsetting the growth in appliances. The year-over-year decline in StorNext software reflected lower-than-expected federal revenues, resulting from the uncertainty around the U.S. fiscal cliff. We added approximately 75 new StorNext customers in Q3.

In addition, as Jon said earlier, we formally announced our new family of Lattus wide-area storage solutions. Lattus-X, the first product in this family, became generally available in December, and we plan on introducing 2 other Lattus solutions in 2013.

Moving to service revenue, it was $35.3 million in Q3, unchanged from the same quarter of the prior year. Branded service revenue increased but was offset by a decline in OEM out of warranty repair compared to Q3 in fiscal '12. Turning to gross margins, non-GAAP gross margin in Q3 was 43.6%, the same as in the prior year period. Although we had a decline in overall revenue, including royalty revenue, which places downward pressure on margins, we maintained a gross margin rate due in part to reduce costs associated with lower excess and obsolete provisions for service parts and manufacturing inventories.

Looking at expenses, non-GAAP operating expense totaled $62.1 million in Q3 compared to $60.6 million in the prior year. Year-over-year, we increased our investment in sales and marketing by $1.5 million. The primary driver of the increase relates to incremental salaries and benefits from additional investments we made in the sales team throughout the past year. Research and development spend increased approximately $900,000 over the same quarter last year due to increased compensation and benefits associated with our StorNext Big Data investment related to next-generation LTO development.

General and administrative cost declined $800,000 due to reductions in compensation and benefits from decreased staffing and cost-reduction measures that resulted in decreased spending. Non-GAAP operating profit for the quarter was $7.5 million compared to operating profit of $15.1 million in the same quarter a year earlier. The largest contributor to the decline in operating profit on a quarterly basis was the overall revenue decrease, including lower royalty revenues.

Interest expense for the quarter was $2.2 million compared to $2.5 million a year earlier. This included cash interest expense of $1.9 million and amortization of debt issue cost of $300,000. The average interest rate for our $205 million of convertible debt will be approximately 3.84% for the quarter ending March 31. On a go-forward basis, assuming no amounts are drawn on the revolver, our total interest expense will approximate $2.5 million per quarter.

For the third quarter, we had other income of $100,000. We recognized tax expense of $300,000, primarily related to foreign and state taxes. Summing it up for Q3, we had non-GAAP net income of $4.9 million, which is a non-GAAP earnings per share of $0.02 compared to non-GAAP net income of $12.1 million and $0.05 in the same quarter a year earlier.

Let me also take a minute here to provide additional guidance around computing non-GAAP EPS with both our converts in place. For the $70 million convert just completed, if non-GAAP net income per quarter is in excess of $4.5 million, you would add approximately 43 million shares to the denominator and add back the related convertible interest expense of $800,000 to the numerator. The $135 million November 2010 convert enters into the computation when non-GAAP net income for a quarter exceeds approximately $10 million. At that point, you would add approximately 31 million more shares to the denominator and add back the related interest expense of $1.2 million to the numerator. Both are accounted for using the if-converted method, but below certain non-GAAP net income levels, they are anti-dilutive and therefore, the shares are excluded from EPS.

Focusing on cash flow for the quarter and the balance sheet at December 31, I would like to highlight several key points. Cash flows provided by operations for the quarter were $6.4 million. We paid off the $49.5 million revolver balance during the quarter. At December 31, our debt consisted of $205 million of convertible debt which has no covenants and we ended the quarter with $54.9 million in cash.

As I just noted, we had no amounts drawn on our revolver at quarter end. We were in compliance with all debt covenants at December 31 related to this revolver, and we expect to be in compliance with our debt covenants during the next 12 months. With the convertible debt offering complete, we are reviewing the potential opportunity to restructure the revolver to better align with our needs and operating model.

EBITDA for the last 12 months was $24.1 million. On a sequential basis, manufacturing inventory decreased $900,000, accounts receivable increased $16.4 million and we had an accelerated payment of $5.8 million from one customer. CapEx was $2.7 million.

On our last earnings call, we described our plan to implement cost-reduction actions that would reduce overall spend by $1 million in Q3 and $6 million in Q4 of fiscal '13. In November, we filed a Form 8-K further describing the actions taken, which were consistent with those described in our October earnings call, and we achieved the expected $1 million savings in Q3.

In terms of Q4, Jon will provide our guidance shortly, but I wanted to note that we still expect to achieve our $6 million in cost reduction. If you look at sequential OpEx, these cost reductions are somewhat offset by expected increases in commissions as certain commission team members are in accelerators and across-the-board payroll tax resets for the new calendar year.

Finally, in last quarter's call, we stated that we would be opportunistic in improving our capital structure. We did this by completing the $70 million private placement convertible debt offering I mentioned earlier and utilizing the net proceeds to repay the entire amount outstanding under our senior secured credit agreement with Wells Fargo, with the remaining proceeds for general corporate purposes. As a result of the cost reductions and refinancing actions, we provided cash from operations in Q3 and strengthened the balance sheet. We also expect to continue generating cash from operations.

Now, let me turn the call back over to Jon.

Jonathan W. Gacek

Thanks, Linda. We started fiscal 2013 with objectives to grow overall revenue and to generate operating profit and cash flow. The plan was based on an expectation that we'd have a fairly flat tape market and growth in the StorNext and Big Data appliances and in DXi and vmPRO. However, in Q1 and Q2, there was a significant decline in the tape market overall and a 17% decline in our own tape automation revenue, which significantly impacted not only our total revenue, but also our profitability. In addition, our Q1 disk systems and software revenue was affected by the economic situation in Europe and our own difficulty in closing large deals due to customer caution in the face of economic uncertainty.

In Q2, we succeeded in gaining our disk systems and software revenue back on track, achieving record revenue. Even with this shortfall in Q1, our revenue in this area is up 14% year-over-year through the first 3 quarters of this fiscal year. This reflects the strong market opportunity for DXi and StorNext, our strong product portfolio which is built around continued innovation in both product lines and finally, better channel traction and improved sales productivity.

Given the tape revenue declines that we saw in the first half of the fiscal year and the, particularly, the impact on profitability, we recognized the need to reduce spending and took that action in Q3. As a result, our overall financial performance for the quarter was much better with dramatically improved profitability in cash flow. And this was without the full savings, we will realize from the cost reductions we have implemented.

In short, as we look back at Q3, we see improvements on both the revenue and profit side upon which we plan to build in the coming year. We had a record DXi quarter and a strong tape rebound in tape automation and we continue to invest in new products and technology that will enable us to drive increased growth and profit. Our recent vmPRO 3.0, Lattus, DXi6800 and Scalar i6k HD launches are just the most recent examples of our industry position and strength in helping customers meet their evolving data protection and data management needs. Finally, Q3 reflects the leverage in our business model as the benefits of the revenue growth get magnified as it flows through to the bottom line.

So now let me turn to guidance. Taking into account typical seasonality and some of the macro uncertainty, we expect total revenue for fiscal Q4 of approximately $145 million to $150 million, with sequential growth in disk systems and software. We also expect non-GAAP gross margin of 42%, non-GAAP operating expenses of $61 million to $63 million, interest expense of $2.5 million and income tax expense of $500,000.

As we look forward to fiscal 2014 which begins in April, we believe we're in the right markets to drive growth. Our product portfolio and installed base of tape, DXi and StorNext customers continue to be real strengths and we will continue to be aggressive about utilizing our technology assets to create products and solutions that are clearly differentiated, and create superior value for our customers.

We also will continue to drive greater end-user awareness and demand. We think that has been key this year and continues to add to our net new customers that we report each quarter. In addition, we are still very focused on adding new channel partners and new routes to market, either in branded or OEM.

And finally and most importantly, we recognize the need to make money and generate cash. In fiscal '14, therefore, it will be a balance of driving for growth and making money and we expect to both grow and be profitable. At our next call, we'll spend more time on our fiscal '14 detailed plans. Thanks for joining today.

Now I'll turn the call over to the operator for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from the line of Cindy Shaw with DISCERN Group.

Cindy Shaw - DISCERN Investment Analytics, Inc

Couple of questions for you. On the tape automation, I know that the LTO-6 started shipping very late in the quarter. But it sounds as if from the guidance, like you're not necessarily expecting that to pick up in the March quarter. And I'm wondering, can you just give us a general sense for that tape automation outlook over the coming quarter or 2 and how you think that might play out? And then I have some more questions.

Jonathan W. Gacek

Let me try to address the overall guidance, and then I'll be specific about tape and disk. So we were -- in this quarter, we basically came in where we thought we were. We got here in a slightly different way and we were very teed up to have, what I would call, more of a breakout quarter. And really, the fiscal cliff and economic uncertainty, I think, hurt us on some of our bigger deals. And so it's hard for us to really be precise about which products, which geos and which routes to market. So we have a very strong growing funnel in the growth business of DXi and StorNext, and we feel good that we'll be up next quarter on that or the quarter we're in. Tape, we talked in the last call, Cindy. We thought the tape business would bounce back. It's just not easy to predict. And so the guidance that we gave would show a decline in tape from this particular quarter. Having said that, we think LTO-6 is important. We think our new library is important. No question that the declining market this year of 20%, it's been a surprise for everybody. IDC's numbers were -- it was going to be flat at the start of the year. So I think we're all adjusting to that. We're being cautious and we're really emphasizing the fact that tape is an important part of what we're doing. But ultimately, we've got to grow the growth business too. So long-winded answer to say, we're being fairly cautious on tape. Linda had in her script, as we get a couple of quarters under our belt, we'll have a better sense of how LTO-6 has impacted and what the tape market looks like going forward.

Cindy Shaw - DISCERN Investment Analytics, Inc

Okay. And then it sounds like there's still some training with the sales folks. Can you talk about -- do you feel like the training's behind you? And what's the sort of sales cycle at which point you can say, okay, now, they're trained on tape. Here's when it should really start hitting -- POs should start coming there. And is that why the couple of quarters to really get a handle on it?

Jonathan W. Gacek

I think there's a couple of things in there. One is, we've added a lot of salespeople this year. And I feel like we've added some great people, high quality from disk and software companies that everybody talks about, and their experience with tape is limited. And we recognized right away that we had a gap there, and we've put some processes in place to help support people. But that doesn't really scale. So we've done what you described. We've done lots of training. We put technical resources behind the sales folks to help them when they run into a difficult tape situation. I would say the team that we have now is up to speed and understands the products. And they also know where to go to get help if they are in a big competitive deal. Ted and his team are doing a lot of inspection in those deals, so we identify the need for help early. So all those things, I think, are goodness and will help stabilize, if not improve, the tape results. The thing I'm reticent to do though is just to predict a big tape rebound that's off where we are today. I really want to see what happens with the market and how the execution improves.

Cindy Shaw - DISCERN Investment Analytics, Inc

That makes sense. Do you feel there's any disruption with the restructuring and in the sales force that would hit any of your product lines?

Jonathan W. Gacek

Yes, I'm sure there are some, to be honest. We went about this. I mentioned in my part of the script how we went about this. I think the team did a great job of identifying the areas where we needed to change our spending, and we did it in a cross functional, sort of rifle shot way as compared to, Jon said, 10% has to come out of very function. That's not what we did. And we really focused around opportunity, productivity, strategic importance and across all geos, which we really hadn't done for a while. And sometimes, doing that is more expensive. And we just felt that was the best thing to do. I think we did a good job implementing it. We got it done quickly. It's never any fun. I hope not to have to do it again. But I think it was a good healthy move, and I'm not worried about disruption as much as I am about just taking advantage of the opportunities that are in front of us. We should have enough resources to do that.

Operator

Our next question is from the line of Jack McCarthy with Craig-Hallum Capital Group.

Jack McCarthy

What actions are you taking to broaden out distribution, so you can get into more deals, particularly with DXi, whether it's from adding more channel partners or adding larger OEM partners?

Jonathan W. Gacek

Yes, so on just generally on DXi, we've had a sort of a two-pronged focus. We have a set of what we call platinum partners, who we spend a lot of time -- they're our biggest bar partners, and they tend to sell the upper parts of the DXi product line. And with the new products, both vmPRO, DXi V6700, even to some extent 6800, we feel like there's more opportunity in our gold and silver partners. So we spent a lot of time getting depth in the last couple of years, technological and buy-in depth. I would say now we're still driving our team towards the platinum partners, but what we've added to that is breadth in the silver partners. So you can procure our products easier. There's online training. The vmPRO microsite is an example. You can go online and actually download the software and then buy it over the web for free. So a lot of it is product position and some of it is focus. I would say our silver partner focus has proven the benefit these last couple of quarters, and we'll continue to build on that next year. As far as OEMs go, we haven't announced any new OEMs. We've announced some strategic partners in Quest, which was acquired by Dell. This isn't DXi, but it's tape with Teradata. We continue to believe there are a number of opportunities where primary storage vendors have a hole in their portfolio around disk-based backup products. And we continue to believe our portfolio has gone to a spot where we're are in the industry best and we're pursuing where we can. But ultimately, people have to have a need and want to do something with us. So I'm not adverse to having more channel or more OEMs, but it has to work for us and the partners as well.

Jack McCarthy

Last quarter, you talked about there being a shot that you could exceed $50 million in DSS revenue in Q3. It fell a little short. How much conviction do you have that you could reach that figure in Q4?

Jonathan W. Gacek

Yes, I think it'll be hard in Q4. The reason I said that in Q3 is we had a very, very strong funnel and line of sight on some deals that I thought would close in the quarter. I think the combination of the economic environment, particularly here in the U.S. around fiscal cliff, our own availability of Wide Area storage. And then we did a limited release on 6800. We didn't take it out broadly, and we've tried not to disrupt sales because we've had that happen in the past. I think we did a good job with that, but I think there's probably some impact there. There's no question in my mind we'll get over $50 million. I really thought we had a shot at it this quarter. It didn't turn out that way. And in fact, if we've done that, you can see we would have had quite a positive financial quarter both in terms of revenue and operating profit. So I feel good about where we got. We're sort of on the cusp of really breaking out. I like the products, I like the portfolio, I like the market, I like the discipline that Ted has with the sales team. I think we'll get there. I think this will be a hard quarter to do it in because of the seasonality, but I can guarantee you we're driving to get as much revenue as possible each quarter.

Jack McCarthy

And last one here. You talked about a strong growth funnel for StorNext. Is your appliance strategy with StorNext still in the same upward trajectory it's been on in recent quarter? What would be the biggest risks to slower adoption of StorNext at this point?

Jonathan W. Gacek

Well, we've got really 2 types of solutions. We sell a software-only solution, which is -- really allows the end-user customer to create their own hardware bundle. And that has been predominantly all of our revenue up until last year when we started selling appliances. And then we have an appliance strategy were we've integrated software and hardware to make a solution, to make it easier. What tends to happen is the software-only deals are bigger deals with big customers, and so they can be lumpy. And the appliances are fairly new, and people getting used to both selling them and, including the channel, and customers adopting them. So I think the risks are different. I mean, one's on the software side of lumpy deal on this on the appliance side, it's just getting traction and gaining the growth that we believe is there. We made an announcement, I think a week or so ago, we've added a gentleman, who came from Apple and did the stop -- Active Storage along the way. His name is Alex, and he -- we brought him onboard because we see a real opportunity with the StorNext appliances in the former Xsan market, which was supported by an Apple set of products. Apple's discontinued those products. Our StorNext appliances fit very well in that space. Alex has unique industry knowledge and customer knowledge because he drove that business for Apple. We think that is an incremental market for us as far as both products but also people. And so we're very focused on, as an example, a higher volume solution-type sale into that particular market. So we're going to continue to drive on StorNext. We think we have something unique both in performance and value and then just overall solution. And the last commercial I'll give on this is the Wide Area Storage product that we've announced is very disruptive. We've got one of our largest government customers using it with raving results. And we think the government will be a place where we can sell a lot of that. I think the fiscal cliff issue definitely hurt us this quarter on that product.

Operator

Our next question is from the line the Brian Freed with Wunderlich Securities.

Brian S. Freed - Wunderlich Securities Inc., Research Division

A couple of quick questions. StorNext, you mentioned that you saw some federal delays there. Some of the other folks I have talked to with big Federal exposure said that after they got past the third, they saw some of those deals close. Did you see any of those delays on the StorNext side close quarter today?

Jonathan W. Gacek

No, actually, I don't know. I don't know the answers to that. I know that -- one deal that I am aware of that was quite large has not closed yet, the one I'm aware of. But for sure, the uncertainty around the fiscal cliff hurt us in the federal space. I'm not aware of any real large deals that have closed since, but that doesn't mean there hasn't been some. But the one I know about has not.

Brian S. Freed - Wunderlich Securities Inc., Research Division

Okay. And then secondly, as we look to next quarter, you talked about disk and software likely growing. On the tape side of the business, are you seeing any signs of a real, what I would call, persistent stabilization with the introduction of LTO-6? Or is it more a function of this continuing to gain share, particularly with the new products?

Jonathan W. Gacek

If I had a complaint about tape from this last quarter, it was we didn't have as much upgrade business as I think we could have or maybe will. I mean we had a record -- I think it was Linda had in her script. We added 175 new customers. It's the highest rate of new customers that we've had in 3 years. And 2 of those years, we were growing branded revenue every quarter in tape. So the OEMs were down again. We mentioned that. We did much, much better than the OEM. So I feel like it's going be share grab for sure. That's going to be a part of that, Brian. I still think there's room for us to do better, always to do better. But to do better with our installed base on upgrades, I think that's something that we'll continue to focus on. I don't want the whole thesis to be that we have to grow tape to be profitable because I think that's going to be a short-term strategy. But I do think we have to perform well in tape because I think we have the best products, and we're the best-positioned, and we're the share leader. So there's no question that we're super focused on it. I'm just reticent to say it's all going to bounce back. And I think Linda put in her script, we'll give thoughts about it as we see more traction. But we didn't see a 20% industry decline this year, and neither did the industry analysts. So I'm just being cautious about how I talk about it, but certainly not cautious about how we're driving it internally.

Brian S. Freed - Wunderlich Securities Inc., Research Division

Got you. And then the other question I had is on your expense reductions, I think if I recall correctly, you guided $61million to $63 million in OpEx for the quarter? The March quarter?

Jonathan W. Gacek

Yes.

Brian S. Freed - Wunderlich Securities Inc., Research Division

When I'm finished marking where we get the $6 million in cost savings, was that relative to an original internal plan? Or is there room for that to be in the sub-$60 million when fully realized of OpEx setting?

Jonathan W. Gacek

I think the one thing that's been confusing for people, I think Linda tried to address it a little bit, and I'm going to let her go here, but of that $6 million, as you -- because it's going to be a bigger number obviously than the one, there's a high percentage of it that comes out of COGS. So you don’t just see it in OpEx. And so what you're seeing in OpEx is some amount of reduction. And then I think Linda commented on a couple of potential increase area, payroll, taxes and commissions. But let her expand on that.

Linda M. Breard

Yes. So, Brian, as you kind of talked about last quarter around this is a number of the reductions are up in the service manufacturing area, too, which you'll see in better gross margin contribution, and with part of them down in OpEx. And my commentary around the OpEx portion and around the gross margin portion is that we will have some offsets in Q4 in the March quarter as payroll tax resets for the year. As our team is in accelerated commission position in the quarter, that's somewhat offset. But to your original question, the $6 million savings was off what we had forecasted before we did the cost reductions for our March quarter expenses.

Jonathan W. Gacek

Across the P&L.

Linda M. Breard

Across the P&L.

Brian S. Freed - Wunderlich Securities Inc., Research Division

Okay, great. Now that actually helps. The blend between COGS and OpEx explains a lot to me. And then my final question, I think this is probably more for you, Jon. You've talked a lot about opportunities for OEMs in the past, but it is something I would say you've been more in the view of we don't need -- we don't have to have OEMs to succeed. As you look at your strategy going forward, particularly into 2014, do you see a reason or would it be part of your business plan to more aggressively pursue OEM opportunities, or is your current kind of trajectory of continuing to execute and being somewhat selective more your plan?

Jonathan W. Gacek

Well, the first thing is the part that we control is the branded business that we have today and the OEM relationship we have with Fujitsu. So job one is to make those as successful as possible and be balanced between growth and profitability. So that's point one. Point two is I have continued to evolve my thinking as the products have improved. I mean I really feel like the 6800 is just a classic example. We have a product now that is head and shoulders above the referenced competitors in the same space. I mean, there isn't any comparison in -- I'm happy to test it any time against any and any deal. I mean it just is so much better. And the reason I bring that up is I feel like we're going do what we can on the branded side, and best product doesn't always win. We recognize that. And the market really hasn't changed. There's a number of big providers of primary storage and software that just don't have competitive solutions here. And EMC has a very unnatural market share in this particular segment. And so to the extent that it makes sense for a partner and us to do a deal, we would certainly look at that. And I think we're in a much better position technologically than we've ever been. But as I've said before in these questions, it takes 2 parties to make that kind of deal. And we're going to look at it from our own perspective and -- but we believe that there's opportunities there. Having said that, I don't control it. So I'm certainly going to talk to people if they interest, and we'll be -- we'll pursue with vigor. But from a day-to-day basis, we've got to run the business wisely, and that's what we intend to do around our current OEM and our branded focus.

Operator

[Operator Instructions] Our next question is from the line of Glenn Hanus from Needham & Company.

Glenn Hanus - Needham & Company, LLC, Research Division

Jon, could you spend a minute talking about -- on the Lattus, the competitive -- as you look at your initial funnel, the competitive kind of landscape there? And I think EMC has talked about more announcements through the year in that object space. And kind of how do you expect that to evolve for you competitively through the year?

Jonathan W. Gacek

Yes. So -- I don't know about -- I know about EMC product to date, but I don't know about their announcements. We -- today, as you know, Glenn. . .

Glenn Hanus - Needham & Company, LLC, Research Division

All they said was they were going to have some announcements.

Jonathan W. Gacek

Okay. So we compete in the big data archive space in primarily in an archive element that's focused on some attributes of heterogeneity, high performance, really big files. And then because we have this unique software in StorNext, we tier the storage out, so that you could have different types of storage under one file system, so it looks like one big storage repository. And that allows you to mix and match performance and costs. What Lattus provides us in our implementation is a disk tier that is very disruptive cost-wise and has good performance. And it's disruptive cost-wise because it doesn't use raid, [ph] and it doesn't use replication, and it uses very low-power servers to reduce the OpEx as well. So these repositories are infinitely scalable. Linda and I joke, we don't know where it stops, but she's not going to let us test it because it'd be too expensive to buy a 20 or 30 or 40 or 50-petabyte system. We just don’t know. We'll virtually test them for sure, so customers have a good experience, but I'm not going to own that much hardware. What that does for us is it allows us to compete in a way that really competes against today multiple Isilon boxes, NAS boxes that have replication that have costly overhead profile systems and multiple servers. It allows us to have a very green, big repository that's not tape-based either because there's some verticals, where the access to data is so important that even the cost of tape doesn't work. So it opens up a lot of market. And we don't really see anything that competes at the solution level when you combine StorNext with Wide Area storage. We have the fastest file system. We have the -- for big files. We're the standard in rich media. So when you couple that together, we think we have something pretty unique. I think the natural places we'll bounce up would be against Isilon boxes, against large NAS implementations and then big file system implementations like GPFS from IBM. But none of those companies have the same sort of combination at the solution level. We feel good about our installed base of StorNext. We're going to sell into that for sure. Our particular version of this is optimized -- going to be optimized around StorNext. That's the product that Linda talked about releasing in the coming year. Right now, it's based on StorNext, but it doesn't get all the benefits of this file system. So we are very excited about the first deal that we had and the feedback we've been getting. We knew that was a beta deal when we did it. These are 500 terabyte and above types of solutions, so they're going to be lumpy. And we have a lot of excitement for the product in our traditional StorNext environments and then broadening out into other archive use cases.

Glenn Hanus - Needham & Company, LLC, Research Division

And then shifting to gross margins. Can you comment a little on -- you have a downtick in the gross margin there in the fourth quarter and then with some of the cost reductions. How should we think about margins for fiscal '14?

Jonathan W. Gacek

So the big change in margin in the sequential is just the volume. I mean we're so volume-sensitive right where we are right here that adding the extra revenue over our fixed cost makes a big difference. So that's point one...

Linda M. Breard

And reset the payroll taxes a little bit.

Jonathan W. Gacek

Yes. So some of these other sort of timing expense things will be in there, too. It doesn't sound like it should be that high, but for us to move our sides, it makes a difference. I still think we're a mid-40 type target. And as revenue grows, it'll get better. There's -- just we get leverage very quickly.

And we haven't spent a lot of time talking about '14, and we will on the next call. But we're going to try and provide more color across some of these product families and business units, so you guys can understand them better. We're going through a project on that right now so we can talk a little bit more definitively about the various margin portfolio -- profiles and the costs associated with data protection versus big data. I think for '14, it's 43%, 44%, 45% gross margin from what I can tell you today. And we expect to have better revenue, too. So we still have work to do on the '14 plan, but we'll spend more time when we talk in May. I want to remind people, too, on that it's our fiscal year end, so our call will be in the first or second week of May, typically as compared to the third or fourth week of the succeeding month.

Glenn Hanus - Needham & Company, LLC, Research Division

And then as we adjust our models for the new -- can you give us sort of a baseline OpEx run rate as we enter fiscal '14, and how you're thinking about growing or not growing OpEx as we go sequentially through fiscal '14?

Jonathan W. Gacek

I mean, I think if you use just kind of the range of OpEx that we have right now, I think it will be around $60 million average per quarter, so $60 million to $62 million, probably average. And you know it's higher and typically higher in the higher revenue quarters. We're not done with our plan yet. I will tell you that we're -- I'm serious and I think we should all be more serious about this need to balance between revenue growth and profitability. So we're going to make sure we're making money and generating cash. For sure, disk and software will grow, and I think our profitability will really be driven by how much tape hangs in there.

Operator

Our next question is a follow-up question from the line of Cindy Shaw.

Cindy Shaw - DISCERN Investment Analytics, Inc

I wanted to follow-up on some of the trough as soon as you talked about it on the call last quarter. Two of them -- a lot more attention from very senior executives of the company to better qualify sales deals, make sure the sales funnel is being kept for all and getting engaged with the clients. And related to that, the converts that came out in November related to the strengthening of the balance sheet and removing one of the weapons from EMC's competitive arsenal in terms of selling against you with the balance sheet strength. Just looking for an update on how that's going. Do you feel like it's where you want it to be? And if not, the progress you're seeing.

Jonathan W. Gacek

I think the convert definitely took off the plate our violation of that covenant, and the company is going to fail, and they're going to be bankrupt and all of the things that were said. So I think that's been gone. I think we further put pressure on our competitors to try to compete with us on products. I just -- I'm happy to do a POC anytime anybody wants to do one. We don't think we -- the product is not an issue for us. And so they tend to pick on other things. Now it's more about our size and our scale, which we're never going to grow to their size anytime soon. So we'll just have to fight our way through that. We think, Cindy, the balance sheet risk sounds terminal to people. And taking that off, I think, is going to -- has and will continue to help. And then I think we're going to generate cash. We'll generate cash next year. We'll generate cash next quarter. I'm looking at Linda to make sure I'm right on that. And we don't have any debt to pay down now. So we'll accumulate cash and further strengthen the balance sheet going forward.

Cindy Shaw - DISCERN Investment Analytics, Inc

And on the sales efforts to better qualify the deals to get more engaged?

Jonathan W. Gacek

Yes, yes, that's for sure. That's paid off. I mean whether it's myself or Ted or other executives, we are in front of customers at high rate. And I think it has paid off. It doesn't always -- it's not foolproof, for sure, but it gives us better visibility. And I can -- the reason I can talk about one StorNext deal is I know, I'm very close to that deal and I'm in constant contact with the principal, and that was true. The fact that funding didn't come through though, that couldn't be changed.

So absolutely, we think that's key. I think it's more important that these deals get bigger around Wide Area storage to be close to customers. And that's just something we're going to -- will be part of our playbook forever, and we're just going to continue that. It's worked well, and it's good for the customer, and it's good for us.

Operator

[Operator Instructions] I'm showing no further questions at this time. I'd know like to turn the call back over to management for closing remarks.

Jonathan W. Gacek

Thank you. Well, thanks for joining today. We are pleased with the result from Q3. We're happy with the quickness and speed that we -- the changes that we made were embraced across the company and the result. And as I said, think we're in the right markets. We're going to drive growth and profitability, and we look forward to reporting in Q4. And as a reminder, it'll be a little bit later than in prior quarters. So thank you very much, and we'll talk to you soon.

Operator

Ladies and gentlemen, this concludes the Quantum Corporation's third quarter 2013 conference call. If you'd like to listen to a replay of today's conference, please dial 1-800-406-7325 or 3035903030 with the access code of 459-1376. ACT would like to thank you for your participation. You may now disconnect.

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