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Quantum Corp. (NYSE:QTM)

F4Q10 Earnings Call

May 13, 2010 5:00 pm ET

Executives

Rick Belluzzo - Chief Executive Officer

Jon Gacek - Chief Operating Officer & Chief Financial Officer

Bill Britts - Executive Vice President of Sales and Marketing

Shawn Hall - Senior Vice President, General Counsel

Analysts

Brian Freed - Morgan Keegan

Glenn Hanus - Needham & Company

Joe Feshbach - JFP

Newhall Chuckie - Technology Insight Research

Operator

Good afternoon ladies and gentleman. Thank you for standing by. Welcome to the Quantum Corporation, fourth quarter 2010 teleconference. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions)

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

Shawn Hall

Thanks, and good afternoon and welcome. With me today are Rick Belluzzo, our CEO; Jon Gacek, our COO and CFO; and Bill Britts, our EVP for Sales and Marketing.

The webcast of this call, our earnings release, and a quantitative reconciliation of any GAAP and non-GAAP financial measures discussed today can be accessed at the Investor Relations section of our website at www.quantum.com and will be archived for one year.

During the course of today’s discussion, we will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements regarding our business strategy, opportunities and priorities, anticipated product launches and plans, future financial performance, including expected revenue, gross margin and expense performance, and debt covenant compliance, and trends in our business and in the markets in which we compete.

We’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 announcing our fiscal Q4 2010 results, as well as to our reports filed with the Securities and Exchange Commission from time to time, including our most recent 10-Q filed on February 5, 2010.

Such reports contain and identify important factors that could cause actual results to differ materially from those contained in our forward-looking statements. All such risk factors are identified in our press release and in our filings with the SEC who are incorporated by reference into today’s discussion. We undertake no obligation to update these forward-looking statements in the future.

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

Jon Gacek

Thanks Shawn. Good afternoon and thank you for joining us, as we report our fiscal 2010 and fourth quarter results. I’m going to walk through our results for the year and quarterly period ended March 31, 2010, and comment on a few areas where we’ve made significant progress towards Quantum becoming a more profitable growing storage systems company.

As we end fiscal 2010 and begin fiscal 2011, it is clear that Quantum is well positioned, having greatly expanded our portfolio of tape, disk and software products during the year and shifted our go-to-market focus to capitalize on change in the competitive landscape and is growing market opportunity.

In just the last five months of fiscal 2010, we introduced a new DXi family of mid-range, disk phase, eduplication and replication appliances, a new version of our StorNext software, a new entry level Scalar type automation platform, and take drive library and media, incorporating the newest generation of LTO technology.

Most of these products began shipping during the March quarter, during which we also prepared for last month launch of the new Scalar enterprise library, and this week’s announcement of the new DXi plans that design for SMB and remote office customers. Our financial model, product introduction, and fiscal 2010 results, provide a strong foundation for growth in 2011.

Now I move to the results. Revenue for fiscal 2010 and the fourth quarter were $681.4 million and $164.5 million respectively. Non-GAAP EPS for the year was $0.26 and for the fourth quarter was $0.04, compared to $0.18 in fiscal 2009 and $0.01 in the year ago quarter.

When we evaluate our performance, there are several measures that are important to both our fiscal 2010 results, and our mid to long-term business strategy. These include the branded versus OEM revenue mix, non-GAAP gross margin, disk systems and software revenue growth, non-GAAP operating profit, and finally cash generation and EBITDA. Let me comment on each of these.

For the fourth quarter, our branded business represented 78% of our non-wealthy revenue, compared to 70% in the same period the year ago. On a year-over-year basis, our fourth quarter branded revenue grew 8%. As we look to fiscal 2011, we expect our branded business to continue to grow for tape, disk systems and software products.

Non-GAAP gross margin for fiscal 2010 was 44.5%, up from 40.8% in fiscal 200, and is our best result in ten years. For Q4, non-GAAP gross margin was 44.4%, compared to 39.6% for the same quarter last year. This is a 480 basis point improvement, and reflects the increase in $6.4 million in gross profit dollars on slightly lower revenue.

Disk systems and software revenue was $95 million for fiscal 2010, and $22.8 for the fourth quarter. Branded disk and software revenue in Q4 was up 29% year-over-year and comprised 96% of the total, compared to 70% of the total a year ago. As we look forward to fiscal 2011 we expect this product category to be a significant driver of growth. The end user market is large, we have excellent products, and the independent channel partners want an alternative set of solutions to sell to their customers.

Non-GAAP operating income for the year was 11.7%, up from 8.2% in fiscal 2009 and our best performance in nine years. On a year-over-year basis, Q4 operating profit almost doubled to $14.6 million or 8.9% of revenue; and finally, we generated cash from operations for the year of $100 million, and had EBITDA of $103. For the fourth quarter cash from operation was $18.6 million, and EBITDA was $20 million for the quarter. We pay down 500,000 of our senior debt and ended the quarter with cash of $117.

During the year we have increased our cash balance by nearly $30 million while repaying a net $64 million in debt. All this demonstrates how much we’ve accomplished over the past year, and why you feel good about the opportunity ahead. It also provides context for much of the way we view Q4, namingly the final step in positioning Quantum for growth in fiscal 2011.

With that, I’ll walk you through this quarter’s financial results. I would like to refer everyone to the financial statement and the supporting schedules included in the press release, it will be helpful to both read those, but also refer to them as I make my comment.

Starting with revenue; revenue for the fourth quarter ended March 31 was $164.5 million, compared to $168.1 million a year ago. Year-over-year revenue declined by $3.6 million, as a result of significantly lower OEM, DXi software revenue, and OEM page device revenue. The $164.4 was at the low end of the range of our guidance, but we are pleased given that we were later than planed, releasing the DXi 65, 30, 40 and 50 series, and the fact that LTO-5 drives were released late in the quarter or in the last month of the quarter.

Royalty revenue was $17.7 million for Q4, compared to $16.2 million in the same quarter a year ago. This was primarily driven by increases in our LTO royalties, while VLT royalties remained relatively flat year-over-year. For the quarter, non-royalty revenue totaled $146.8 million, of which 78% was branded and 22% was OEM. That compares to $151.9 million a year ago, of which 70% was branded, and 30% was OEM.

The decline is primarily related to again, the reduction in the OEM DXi software revenue and OEM devices, offset by growth in our branded products. As I mentioned, our branded revenue increased 8% year-over-year in the same quarter in fiscal 2009.

Since the merger with ADIC in 2006, we have been focused on transitioning our revenue stream to higher margin products, which has been one of the primary reasons for the year-over-year revenue declines. However, during this time, our non-branded share has increased from 52% to 78% in this quarter, the highest percentage in the company’s history, and this mix shift is a significant contributor to the increase in non-GAAP gross margins from 31% to 44% over that same period of time.

Looking further at various revenue classifications, devices and the media totaled $26.4 million compared to $28.8 million in Q4 a year ago. The decline is primarily attributable to anticipated declines in OEM devices and media of $4.8 million, offset by increases in our branded devices revenue of $2.1 million. The more significant year-over-year increases were in sales of our branded LTO devices.

Tape automation system revenue was $61.9 million, compared to $61.3 million in Q4 of fiscal ’09. Branded automation showed a slight increase, while OEM automation remained relatively flat. Disk systems and software products and related service revenue was $22.8 million, down from $24.2 million a year ago. However, on a year-over-year comparison, we had a significant increase of 66% in our Quantum branded DXi revenue.

StorNext revenue was relatively flat year-over-year, and revenue from our existing OEM agreement declined significantly. We continued to see very good demand for our DXi7500, as customers like its scalability, VTL interface, and tight integration with tape, all of which are important features in enterprise environments.

The strength of DXi75 offering combined with the later launch timing of the DXi6530, 40 and 50, means that larger deals continue to be a significant part of our DXi revenue mix. In fact, nine deals, over $200,000 made of newly half of our overall disk revenue, including one deal in excess of $1 million.

However, despite the product launch timing during the quarter, sales of our midrange DXi6500 mass line, more than doubled from the previous quarter and with all five of our DXi6500 models now shopping, we expect to significantly increase the revenue contribution from higher velocity deals moving forward.

We have received very positive feedbacks from end users and channel partners on the DXi6500, and our confident we now have a disk product that fits our branded go-to-market model in the midrange, including being well aligned with our midrange tape system products.

Service revenue was $38.8 million compared to $40.1 million a year ago. The $1.3 million decline is primarily the result of a reduction in OEM out of warranty repair, and branded product service revenue increase slightly this quarter from Q4 of fiscal 2009.

Turning to gross margin, non-GAAP gross margin in Q4 was 44.4% compared to 39.6% in the prior period. This is the result of higher branded sales mix, and our continued improvement in managing our manufacturing and service costs.

On a year-over-year basis non-GAAP gross margin was negatively impacted by the decline in OEM DXi software revenue. However, we are very pleased with this quarter’s gross margin and believe is a great indicator of the overall value of the business.

Moving to expenses, non-GAAP operating expense totaled $58.4 million compared to $59.1 million a year ago. The largest driver of the decline in operating expenses was a reduction in G&A spend of $2.3 million, partially offset by a $1.5 million increase in R&D spending on new product launches. The G&A decline was primarily related to lower headcount and associated costs, and the recovering question of previously written off accounts receivable.

Non-GAAP operating profit for the quarter was $14.6 million or 9% of revenue, compared to $7.6 million or 5% of revenue in the same quarter a year ago. This has nearly doubled from the prior year, driven by our increased branded mix, and sales of its higher margin products, along with ongoing management of our operational costs.

Interest expense for the quarter was $6.1 million compared to $5.7 million a year earlier. This included interest expense of $5.7 million, and amortization of debt issue cost of $400,000.

The current coupon interest rate for our remaining senior debt of which was $186 million at March 31 will be 3.8% for the quarter ended June 30, and the average coupon rate for our total debt will be approximately 7% for the quarter ended June 30. We expect interest expense will be approximately $6.2 million for the first quarter of fiscal 2011.

For the fourth quarter we had other expense of $500,000, due to foreign currency losses and we recognized a net tax expense of $600,000, primarily related to foreign and state taxes. We still believe it’s reasonable to model of $1 million per quarter for tax expense.

So summing it up for the quarter, we had non-GAAP net income of $7.3 million, and non-GAAP EPS of $0.04, compared to non-GAAP income of $2 million and EPS of $0.01 in the same quarter last year.

Focusing on cash flow for the quarter and the balance sheet at March 31, I would like to highlight several key points. Cash flow from operations for the quarter were $18.6 million. We paid down $500,000 of our senior debt in Q4. At quarter end the composition of our debt was $186 million of senior debt, $122 million outstanding with EMC, and $22 million of convertible debt. We ended the quarter with $117 million in cash.

Non-GAAP EBITDA for the quarter was $20.4 million. We are in compliance with all debt covenants at March 31, and we expect to be in compliance with our debt covenants during the next 12 months. For purposes of calculating our debt covenants, EBITDA for the last 12 months was $102.9 million.

On a sequential basis, manufacturing inventory increased $4.3 million. Accounts receivable decreased $13.2 million and we received an accelerated payment of $11.7 million from one customer. CapEx was $2.9 million and purchases of service part inventories were approximately $1.3 million. Depreciation, amortization and service parts lower cost to market expense totaled $15.8 million for the quarter.

As we close on fiscal 2010 and reflect on our performance, we see it as a very good year, which ended with an improved balance sheet and a strong financial model. A mature but enhanced state portfolio that is very profitable, and a large growth opportunity with our disk system and software products. We believe we are now well positioned to grow and we expect to do so in fiscal 2011.

For those who have models, here is our guidance for fiscal 2011. Revenue of $700 million to $750 million; we expect growth in disk systems, software and tape products. Non-GAAP gross margin of 45% to 47%, the improvement over fiscal 2000 is primarily related to product mix.

Non-GAAP or operating expenses of $240 million to $250 million, the increase primarily reflect investment in sales and marketing aligned with our growth plan, including sales commission and demand generation, and it also includes an expectation to accrue incentive compensation across the company…

Interest expense of $24 million and $4 million in taxes; you can assume weighted average shares outstanding of $220 million. We will payoff the remaining $22 million of our convertible debt with cash and we will comply with the terms and covenants of our senior debt agreement.

For Q1 which is typically a seasonally week quarter, we are forecasting revenue of a $170 million to $180 million, slightly higher gross margin than in Q4, and total non-GAAP operating expenses of $60 million to $62 million. Interest and taxes should be similar to Q4.

Now let me turn the call over to Rick.

Rick Belluzzo

Thank you, John. Today I would like to start by providing a summary and perspective on our FY 2010 performance, and then shift to spend some time reviewing our clinical priorities for the New Year, FY 2011.

This last year was a very important year for the company. While we have been focused on transforming the company for several years, in many ways 2010 should be viewed as the year where most aspects of the transformation were completed, positioning Quantum for the future.

During the year we dealt with a number of challenges, and had significant accomplishments. All of this has positioned Quantum well, and now our primary focus is on translating these actions into growth.

One year ago we faced a number of critical issues, including a very difficult economic environment, which negatively impacted spending on storage by our customers, and wide spread out, about whether we would be able to refinance our convertible debt.

Additionally our product lines have some gaps, including a midrange NAS de-duplication offering, the need for greater strength in the entry level, and enterprise tape automation offerings, and important features and functionality in our StorNext offering. Finally and maybe more significant, one year ago our go-to-market strategy was largely optimized around EMC.

Thorough FY 2010 these issues were addressed or clarified and the overall market environment has improved. Many of these changes came to fruition at the end of our fiscal Q4, making it very much a transition quarter. Well let me provide you with some details.

First with regard to the mark there is little doubt that the environment for IT spending and storage specifically is improving. While there is still an atmosphere of caution, budgets and spending have improved. Storage projects are highly scrutinized and competition remains challenging, but we find that opportunists are defiantly growing. This became evident in calendar Q4 our fiscal Q3, and while we saw the traditional seasonal weakness in our fiscal Q4, the environment was much healthier than a year ago.

We are particularly encouraged by the core market strength and de-duplication, where the vast majority of customers have yet to implement de-duplication in their environments. We also see growing strength in other areas, which play to our position, including tiered storage, rich media, and consolidation, all of which relate to our current and future StorNext solution set.

Finally, although tapes role is evolving, 85% of customers still use tape in conjunction with disk or on a standalone basis according to Gardner. In short, the environment shifted during the year, and Quantum is well positioned in markets that have fundamental growth potential.

On the product side, we had a series of strong launches during FY 2010. The most significant of these were completed during the end of the March quarter and the beginning of the current quarter. These include a DXi6500 family of mid-range disk based de-duplication and replication products, optimized for NAS environments. StorNext 4.0, the entry-level scale of i40/80 tape libraries, and LTO5.

Most recently we launched our new Scalar i6000 enterprise library, and Quantum Vision 4.0 monitoring and reporting software. These products give Quantum a competitive advantage that we haven not enjoyed for some time, and establish the foundation for building revenue momentum. Capitalizing on this opportunity, and growing revenue will clearly be the priority in coming quarters.

Turning to our go-to-market strategy, we continue to drive the volume part of our business throughout our traditional channels in FY 2010. However we’ve made a dramatic shift in our go-to-market focus for the rest of our business as the EMC relationship changed from a partner to a competitor in the area of de-duplication. This element of our business changed rapidly requiring us to respond aggressively.

At the quarter of this transition are several priorities, including a greater emphasis on building our midrange business to the independent bar channel, with the DXi 6500, as well as related tape products, while focusing our enterprise business and channel programs on accounts where we have competitive advantage. This involves not only the DXi 7500, but also StorNext and our Scalar i6000 tape libraries.

Next we are pursuing tighter alliances with ISVs, as well as strategic partners. For example, Symantec selected Quantum as a pilot offering in there new Symantec alliance network, which promotes, educates and rewards the channel for selling joint solutions. In addition Netarc recently worked with us to certify their disk with StorNext, and a new disk OEM recently began shipping a product based on our DXi software.

With the full line of our 65,000 family only shipping for a couple of months, we are now in the early phase of our go-to-market transition. We fell that we are gaining solid traction with new partners, aided in-part by the EMC acquisition of Data Domain, and the Oracle changes with Sun; both of these disruptions have created opportunity for Quantum in the storage industry.

Finally as Jon said, we have continued to improve our financials over the last year. In fact during FY 2010 we delivered increased non-GAAP and GAAP operating income, and net income on both the dollar and margin percentages basis, in spite of a meaningful decline in the EMC revenue, and salary non-GAAP operating margin for fiscal 2010 increased to 12% from 8% in 2009.

We believe our business model now resembles a system company, and further improvement will come from growing our higher margin revenue, both branded sales and disk systems and software. This is our focus for FY 2011. Also from a balance sheet perspective, I would add that we worked our way though our convertible debt refinancing challenge, generated cash of $100 million during the year, and we will continue to strengthen our balance sheet in FY 2011.

So let me just reemphasis that FY 2010 was a good year in terms of improving our results, but more importantly working through a series of transitions to position the company for even stronger performance through revenue growth. We completed a number of critically product launches at the end of fiscal Q4, and we are now focused on growing revenue and continuing to improve our product competitive position.

So as we start the New Year we intend to capitalize on the actions taken during FY 2010, and on the improved external environment to build revenue momentum. In order to achieve this we have focused our several priorities. This starts with products, where we fell we are very well positioned from a competitive perspective.

The DXi 6500, our third generation de-duplication products, offers an unparallel combination of simplicity and value for midrange users and is optimized for channel partners. This week we also announced two new DXi 4500 appliances that provide affordable, non-disruptive de-duplication and replication to small and medium size businesses, and remote offices, with DXi software licenses included as standard at no extra cost.

In addition our StorNext 4.0 release announced earlier this year is now shipping, delivering new functionality for high performance data sharing and management. It expands our opportunity in both current StorNext markets and other areas where customers are struggling with the huge growth of unstructured data that is critical to their business.

On the tape side, in the last six months we have introduced our new entry level Scalar i40 and i80 library, and our new enterprise Scalar i6000 system, building on our number one position in open systems tape automation. In doing so we have not only extended our iLayer intelligent management software to the entry level automation market, but enhanced it to provide enterprise customers with a long term archive and data retention solution optimized for the evolving role of tape and data protection.

The enhancements include a new feature, media data integrity analysis that proactively scans archived cartages to detect potential media issues, so that they can be addressed before they become a problem, and thereby maintains there integrity.

Finally with our Quantum Vision Software, also recently enhanced conversion 4.0, we can link our disk and tape offerings together, and manage them from a single pain of glass, whether it involves a since site or multiple site expanding the edge of the network to the core of the data center. As we move forward this year we will continue to expand and further improve our product portfolio.

Next we are very heavily focused on expanding our VAR channel. Our edge-to-core disk and tape offering is very strategically with independent VAR's, and we are seeing improved engagement as they become more excited with our product offering, and looking for better alignment given the changes with Data Domain for de-duplication and Oracle with enterprise tape.

The engagement is key towards improving our go-to-market leverage and scaling our business. We have solid program, a strong product line, and strategic alignment with this channel. We are now executing a plan that includes top to bottom engagement with a select set of our. It is clearly early in the process, but we are confident that this work will yield improved performance.

As we focus on the near term products and revenue opportunities, we are also continuing to invest in our technology platform to ensure that we can extend our growth position. We have a number of key areas of opportunities, including enhancing, de-duplication/replication where it is still very early in the evolution of this technology, and extending StorNext into a broader market, as companies struggle to manage their vast growth in unstructured data.

In both cases we intend to deliver next generation technology over the coming year, to leverage the power of de-duplication more broadly in their environment, and further enhance StorNext as an enabler of Cloud storage solutions. All of these efforts and more are intended to achieve three important objectives; first to gain share in open systems tape automation; next to roughly double the size of our disk systems and software business; and finally to deliver new technology in order to extend our ability to grow.

The guidance that Jon provided reflects the results that we intend to achieve is this fiscal FY 2011, including the first year with overall growth for Quantum since we acquired ADIC. We expect momentum to grow as the year progresses given the recent series of new product launches and the changes in our go-to-market model.

We believe the environment for our products can support this goal. We are also making selected investments in sales and marketing and engineering, to ensure that we make this shift to grow. As part of this, we expect to achieve further margin growth as revenue improves. Of course our plans estimate the recent improvement in the economy, specifically as IT spending continues. The indications continue to point to growth in spending this year, where the economic uncertainty clearly exists.

I will close by saying that this last year was a successful and very important year. This New Year will be similarly critically, but the focus will be different as we shift our energy to growth and revenue momentum. Ultimately we believe that this will result in improved profitability, and make Quantum more valuable.

I will now turn the call over to the operator for more questions.

Question-and-Answer Session

Operator

(Operator Instruction) Your first question comes from Brian Freed – Morgan Keegan.

Brian Freed – Morgan Keegan

A couple of quick questions; firstly, if you look at the LTO product lines, you guys were pretty timely with your product launch, but the bigger OEMs, in particular IBM saw some pretty significant delays in their LPO-5 media and drive launches.

Can you talk a little bit about how that impacted you in the quarter in terms of did it help you from a branded side in terms of gaining share? Did it hurt you, do you think from an OEM side? And how do you think that plays out over time?

Jon Gacek

I'll start and then Bill can jump in. One of the reasons that we did our joint development agreement with HP, one of the goal was to be out early and first in market, and that was one of the things that we achieved here and we are really pleased about that.

The other goal was to get the drive into automation products also timely, and we achieved that as well. So from a branded perspective it was positive. It was unfortunate that it was in the last month of the quarter, because what happens is, these sales cycles are several months to multiple months long, and so you don’t want to hinge a deal by introducing a new technology. So I think on that one specifically, we'll see momentum starting this quarter and thought the fiscal year we'll get the real benefit from that.

On the OEM side, it’s a little bit different story. We still ship LTO4 to our OEM partners. It’s harder to know how much impacted their specific business, but in our OEM products we generally shift IBM-based drives, and so we would love to have those be available too, and we are working with IBM to make sure we can get them into the various library flavors as soon as possible.

Bill Britts

It did have a positive impact on the quarter. It was relatively small as John mentioned because of the late start and then LTO5, these were sold in new systems. So it did help actually win some business in competitive head-to-head competition against StorNext and IBM. The upgrade of our installed base, which typically will happen over time, that didn’t contribute in the quarter at all. So we will start seeing that uptick in this quarter.

Brian Freed – Morgan Keegan

My second question relates to StorNext and the 4.0 release. Can you talk a little bit about what makes StorNext unique among file systems in terms of the features that you guys bring to the table that’s unique?

Bill Britts

I think it’s important to kind of start with kind of understanding that StorNext is both a very high performance file system with an integrated archive. So the archive ability in StorNext allows you to go up into petabyte types of archives, and certainly scale out mass provides that, but the native file system performance in StorNext is much, much higher performance than mass type of alternative.

So generally we are best positioned in very, very demanding large data, rich media entertainment, high performance competing life sciences where the performance demands are very high.

With 4.0 we added some additional features that really broaden the applicability of the technology, namely, replication, so now you can replicate from one file system to another file system for DR purposes, to have another site to be able to be connected through replication. We also have native de-duplication in the file system, which again starts to broaden the applicability of StorNext. So that’s really kind of what I would say is the key differentiator for 4.0, relative to the position we had with previous versions of StorNext.

Brian Freed – Morgan Keegan

Okay and for a less technical person, when you say you have integrated archives, does that mean that StorNext supports both the disk and tape here of the solution?

Bill Britts

The file system itself runs on disk subsystems, and we basically have the ability to scale that out to a number of clients, and then the archive piece or the storage manager pieces integrated with the file system. So that means you can have tiered storage that you can move between the disk and tape tiers at very, very high performance levels.

Jon Gacek

I would just add that a lot of the words that are used there really do speak to new opportunities in the storage landscape, and that’s the strategic area that we are working in terms of, how does some of those attribute and how can we move StorNext into more cloud-like applications, where people want to build large repositories of data, with high performance, with its integrated archives and storage management capability.

I think we referred to in a pervious call where we won one more mainstream horizontal opportunity that was very large, that was about building a private cloud. So we are clearly working that opportunity and I expect to hear more from that in future calls as we get more directed and clear about how our next releases will help position ourselves in larger markets.

Brian Freed – Morgan Keegan

Okay, let me ask my final question, and I’ll jump back in the queue. If you look at your partner relationships, in particular Fujitsu announced an expanded relationship on the tape side, and I believe they are also your OEM partner for de-duplication, but if you look at that relationship in particular, as well as your other partnerships, are they ramping as you expect, and can you kind of talk about how you see the timeline of those relationships unfolding in a material way?

Jon Gacek

Let me delink the two, because we haven’t announced anything specific about the external OEM; I understand your perception there. As we’ve talked about in the past, on these new OEM agreements, we don’t build numbers into the model, so in the guidance that we gave and how we budget, we don’t put those numbers in there, because we don’t know how big it will be and we don’t control it. Then as we get some time under our belt with those partners, we’ll have a better feel for what the opportunity is, and then we’ll talk about it more.

As Rick pointed out, the product did begin to ship recently and I think we will have some revenue from that relationship in this next quarter, but it’s not built into how we are thinking about it.

On the tape side with Fujitsu, that’s a broader relationship than we’ve had in the past. We’ve had a really strong relationship with them in Germany, in particular. This is a worldwide agreement, and we are getting engaged in both tape and disk opportunities with the Fujitsu sales force around the world. It’s still sort of a mainland Europe in focus, but we can see it broadening out from there, and it’s built into our assumption of growth and tape for 2011.

Operator

Your next question comes from Glenn Hanus - Needham & Company.

Glenn Hanus - Needham & Company

Maybe, you can talk a little bit more on the guidance side here, the 700 to 750, and then I think embedded in there, did you indicate doubling your disk business this year? Do you kind of look at the variables in there? What do you see is kind of the biggest swing factors that might make you towards the lower end or towards the upper end of the range?

Jon Gacek

Well, as Rick pointed out, this is the first time since we’ve put the two companies together, we are in a growth mode. So going from getting smaller to making that transition to going bigger, that is one of the things that we think about as, you have to move the mindset around that.

I think I mentioned that we expect to grow in tape, branded tape, and disk and software, all three of those important categories, and they are different. We think on the tape side, it’s about taking share. We think we are one of the few companies that has added actually new platforms with i6000 and i40 and i80, and with LTO5, that’s a share taking opportunity, yet we recognize that tape as a mature market.

On the StorNext side, it’s a vast opening opportunity for us. We can see certain places where we really compete well. Bill mentioned what those characteristics are, yet we find ourselves being pulled into some more broad based field. So that one probably has higher data in what the upside is.

Then on the DXi space, it’s really all built around this new products set, in the midrange that fits very well with the channel, and augmenting our current business, which admittedly is kind of lumpy, large dealed for very specific customers, which continued by the way, and that product works very well, but to grow to the level of where we are doubling the disk business. It’s all about getting velocity through our channel partners, which is really about the 6500 and now the new 4500 products.

Glenn Hanus - Needham & Company

Okay, and could you maybe just talk a little bit more about where you feel you are at with the channel then for the midrange NAS product. I don’t know if it’s some metrics on number of partners, or how far have you come in terms of having in place the partners that you intend to have and give us some color around that?

Jon Gacek

So I can characterize the adoption in the channel is really kind of accelerating in the last couple of quarter. If you think about kind of the launch of the 6500, that was 6510 and 6520 back in the December quarter, and then the 6530, 6540, and 6550, we now have a full line up, and that’s an important in terms of that fit with their go-to-market. So I think that’s one key factor.

The other factor, we focused a lot on trying to get traction with partners that are really looking for an alternative to Data Domain, and if we have very detailed deep business plans with several partners that had sold Data Domain in the past, and are looking for an alternative, and we see them in traction with them as being a critical part of this channel development.

As Rick pointed out, this is going to happen in phases. It’s about winning end-user deals, demonstrating that the product is very competitive, that we are providing a lot of value to the end-user customer. I think we had some really good wins in the last quarter that demonstrated that, we’ve done that with partners and we are building on that success to scale out across their sales force, and to do that you need to put together these business plans with these independent partners, and that’s progressing very well.

Glenn Hanus - Needham & Company

Jon on the OpEx, could you elaborate a little bit more there. You are putting in a healthy up-tick this year, just where is that going?

Jon Gacek

A couple things; we are going to invest in some growth areas around sales and marketing. It’s a combination of demand gen to actual feet on the street; although most of our feet on the street additions are really filling in open territories.

The other thing that I put in my script, and I assume somebody is going to pick up on it like you did is, that for the first time since we put the companies together, we are going to build in to our model some incentive compensation company wide, that’s one of the elements that’s in the increase, and that is to drive this growth concept that we feel is important culturally inside the company.

I think those are the two big items that are different, and I think we will continue to operate well on the COG side. Generally that’s the place where we end up doing better than we expect when we start the year.

Bill Britts

Another way to think about it too is a portion of that increase is performance related. The commissions to the sales force which are higher because of expected better performance, as well as the incentive compensation, which will also be driven by performance. So there is some regulation of that, self-regulation based on our performance.

Glenn Hanus - Needham & Company

Lastly Jon, just for fiscal ’11 non-GAAP depreciation, amortization, and CapEx thoughts?

Jon Gacek

Okay, I actually have that in front of me, so I’ll try and do the math real quick. We are going to start scaling down on the amortization, because some of the intangibles from the Data acquisition start to work their way up, so depreciation will start with that fairly flat.

The amortization will kind of move from say $12 million a quarter, down to sort of $9 million at the end of the fiscal year. Then on a CapEx basis, I think you are going to see it’s kind of in the same range of $3 million to $5 million of surplus including service parts and regular CapEx.

Glenn Hanus - Needham & Company

Okay, then the depreciation being flat meaning what?

Jon Gacek

It’s about $3 million in the quarter.

Operator

Your next question comes from Joe Feshbach - JFP.

Joe Feshbach – JFP

So a couple of quick questions. On StorNext, was 4.0 generally available in the March quarter or does the general availability begin in the June quarter?

Jon Gacek

It was available in the March quarter.

Joe Feshbach – JFP

Secondly, on the royalty, the LTO royalty number was atleast a little stronger than I expected. I’m curious whether that was impacted in any absorbable or significant way by LTO5 and how we should think about LTO5 layering into that and whether that’s a good baseline number to look for a little bit of growth out of or whether there are other variables we should consider.

Jon Gacek

LTO5 was not a big contributor, so that upside, I don’t know that I will make this the new baseline. It surprised us some as well, some of it had to do with timing. So I think you have to kind of look at the last three quarters in ’04 and kind of draw a line. I don’t think it’s going to change appreciably. It is true that LTO5 does have a higher royalty rate, and we could be surprised on the upside there, but I wouldn’t model anything different.

Rick Belluzzo

Yes, as much as anything I think we should be careful that there was some inventory time of correction, given how deeply people pulled back over the last year and I think that’s mostly anecdotal, but it’s something that we should be careful with and not get too excited about that performance.

We are actually modeling year-over-year a decline in that number, but again that’s a place where we don’t control it as you know, how we feel about that. We are trying to be judicious on how we forecasted it.

Joe Feshbach – JFP

With the 6500 being fully available in all five models for this fourth quarter that we are in, can you just make any comments? I’m sure its imbedded in your guidance to some extent already, but just any comments on how the new models are doing now that they have been out for probably close to three months. I don’t know whether there is an incline to the end of the quarter sale cycle or not, so maybe Bill can comment on that.

Rick Belluzzo

Let me start and then Bill comment. I would say a couple of things. We talked about having a sort of a 50% win rate in the 7500. We’ve seen a higher than 50% win rate with the 6500.

Secondly, that’s a channel product more so. We really don’t want our sales guys -- we’re not going to get to our number without getting leverage from the channel. So we are also focused on getting channel partners to accept and standardize and sell the product, and that also has been very good. Then I think the product has done very well when it’s been positioned in take-offs.

Bill Britts

So I mean with five models in the 6500 series, you have ASP’s ranging from $20,000 to $30,000, all the way to $100,000. So different models we’ll have different characteristics in terms of really back-end loaded sales cycles. We are definitely building a good pipeline; we are doing a lot of technical proof of concepts that will lead to kind of bigger sales.

We are also doing a lot as Jon mentioned, we are doing a lot to train the channel on kind of the differentiation of the 6500; get them to understand how the 6500 compares to other midrange alternatives. So the indicators from a pipeline standpoint kind of back to this idea of the channel enablement, that’s really our focus for the quarter, and we anticipate that that will have a positive impact, not only in this quarter but in the out quarters.

Joe Feshbach – JFP

Jon I have to ask my one housekeeping question, which was service gross margin, just helps me finish up my model.

Jon Gacek

It was 36.9.

Joe Feshbach – JFP

Great. I will say that looks to be pretty stable.

Jon Gacek

Yes, it has stabilized.

Joe Feshbach – JFP

Great, and then just thinking about the 6500 versus the 7500, it doesn’t sound like there is much susceptibility, the cannibalization of the 7500 by the 6500 because one is obviously VTL and the go-to-market approach is different, but is that the right way to think about it?

Jon Gacek

That’s right, very minimal, and the positioning you’re absolutely right, the positioning for the 7500 in the VTL space is more enterprise. It’s more likely to go into these larger shops.

Operator

(Operator Instructions) Your next question comes from [Newhall Chuckie] - Technology Insight Research.

Newhall Chuckie - Technology Insight Research

The doubling in disk revenues for a fiscal year ’11, sounds like that’s based upon a bottoms up approach. Can you also triangulate that back to how you see the addressable market growing, because I believe Data Domain was talking about also at least a doubling in their de-duplication revenues at EMC World.

Rick Belluzzo

Yes let me make a few comments on that. I’m not sure I would characterize it as bottoms-up, its tops down, but I’ll give you the top down perspective.

Yes the de-duplication market we believe is growing rapidly. There have been reports in the 80% plus percent range. There have been data on how many people had implemented and it’s very, very low. So we believe that the market definitely supports pretty rapid growth, and to be frank our base is pretty small and we really feel like that we have to be focused on that kind of result.

The StorNext piece, which is also part of that, has a good base of business, but has fundamentally good growth in those categories, but not to the extent of the de-duplication market, and there I think we’re trying to address it mostly with investment. I mean I think we believe that with the expand footprint of that technology we can pursue more opportunity, and we’re working to invest to make that happen.

So the doubling is a way to think about at the start that we’re very focused about delivering that result, and that when you couple the volume, channel based 6500 and now 4500 with the 7500 enterprise, larger deals with StorNext, that’s allowing us to get into some new areas of opportunity.

The overall growth of the market, I mean we are setting a clear direction around the company that we have to deliver result in that range, and we’re very focused on that and there are bottoms up and tops down, reasons where it hangs together. It sounds ambitious, it probably is ambitious but we have worked for a couple of years to position ourselves for this opportunity and we’re going to do everything in our power to take advantage of it.

Operator

(Operator Instructions) Your next question comes from Joe Feshbach – JMP.

Joe Feshbach - JMP

I’ve just got two more quick ones. If I look at disk and software as roughly doubling that precisely, it does seem like even the high end of your annual guidance looks a little light? I mean I’m not sure what’s going to go down, but didn’t we just do like 680, 686. I guess maybe its close enough for government work, but it strikes to me that it’s more like a 760 top end kind of thing or maybe even midpoint.

Rick Belluzzo

The way we are thinking about it is disk and software are together, and we said branded tape will grow. The downside is as I mentioned we had royalty going down and we have OEM tape going down. You have to kind of work that in to get into the...

Operator

Your next question comes from Glenn Hanus - Needham & Company.

Glenn Hanus - Needham & Company

Yes, just a quick one Jon. Your comments from the last quarter still holds with the final catch up payment from EMC heading in the first quarter?

Jon Gacek

That’s not a payment. They’ve already paid us for a year.

Glenn Hanus - Needham & Company

Right. I meant like a revenue recognition?

Jon Gacek

That’s right. We expected it and it will be in this quarter.

Operator

(Operator Instructions) At this time I have no further questions in queue. I like to turn the call back over to management for closing remarks.

Rick Belluzzo

Well, thank you. Thank you for joining us. I mean this is an important interesting call for us, and that it closed out a year that we think was really one of the best years in the company for sometime, relative to not only improving our performance, but getting the company well positioned, and we think that is really colonnaded towards the end of this last year.

As we startup this new year, I hope we get a sense from all that you’ve heard today, that we intend to be very aggressive at extending the work that we’ve done, and that we believe now that we are in a position where we talked a lot in the past about reducing revenue and improving margins, and now we believe we’re in a position where we’re growing revenues in the branded and disk business and software area, it’s really what’s going to improve our performance moving forward.

So it’s a changed horizon, and that is the area of focus. I suspect in future calls we’ll be spending more time on that; on how we are doing relative to getting the engagement that we need with our partners and the bars and how products are being received, etc. that’s our focus, and if you’ve been listening to these calls for a while, you should have sensed that change in thinking, and change in direction, really as a result again of really completing much, if not all the transformation in this last year, and now trying to focus on the opportunities that’s before us.

I would just caution all of you that hopefully the economic environment will continue to show signs of improvement and strength, and that that won’t become an issue that comes back to create difficulty. But we’re focused on what we can do, and that’s continuing to prove our product line and to build revenue momentum so.

With that, I look forward to giving you an update again in the next quarter. Thanks.

Operator

Ladies and gentlemen, this does conclude the Quantum Corporation fourth quarter 2010 teleconference. If you’d like to listen to a replay of today’s conference, please dial 800-406-7325 or 303-590-3030, and enter the access code 4286988. ACT would like to thank you for your participation and you may now disconnect.

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Source: Quantum Corp. F4Q10 (Qtr End 03/31/10) Earnings Call Transcript
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