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Quantum Corp. (NYSE:QTM)

F1Q11 (Qtr Ended 06/30/2010) Earnings Call

July 28, 2010 5:00 pm ET

Executives

Rick Belluzzo - Chairman and CEO

Jon Gacek - EVP, CFO and COO

Bill Britts - EVP of Sales, Marketing and Service

Shawn Hall - SVP, General Counsel and Secretary

Analysts

Brian Freed - Morgan, Keegan

Joe Feshbach - JFP

Brian Marshall - Gleacher & Company

Operator

Welcome to the Quantum Corporation's, first quarter 2011 conference call. 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) This is call is being recorded today Wednesday, July 28, 2010.

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. Here with me today are Rick Belluzzo, our CEO; Jon Gacek, our COO and CFO; and Bill Britts, our EVP for Sales and Marketing.

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

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

We'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 Q1 2011 results, 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 11, 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 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 first quarter of fiscal 2011 quarter results. I'm going to walk through our results for the quarterly period ended June 30, 2010, and comment on significant accomplishments and challenges from the quarter as we continue to focus on becoming a growing and more profitable storage systems company.

In the first quarter revenue was $163.2 million compared to $160.3 million in the comparable quarter of fiscal 2010. Non-GAAP gross margin was 45%, an increase of 300 basis points over the same quarter in fiscal 2010 when we reported gross margin of 42%. Non-GAAP operating profit was $15.9 million in Q1 of 2011 and $14.4 million in the comparable period in 2010. Non-GAAP EPS for the quarter was $0.04 in both Q1 of fiscal 2011 and 2010.

Clearly our revenue performance was less than we anticipated and given that one of our key goals for this year is to grow revenue my comments will be more in depth than usual about what went on in Q1. In addition, Rick will also talk about the actions we are taking to address the revenue gaps that we currently see.

On the positive side of our revenue results we had very strong growth in our branded disk systems revenue. It increased 23% sequentially and 125% year-over-year. In addition, we had a very strong quarter in acquiring new Enterprise tape customers. On a geographic basis we performed significantly above our sales plan in Asia-Pacific and in two of our four sales areas in North America.

With regard to revenue challenges, we were at 60% of our sales plan in EMEA, which we believe was a result of economic uncertainty. Also in one of our North America sales areas where have historically seen a number of significantly large deals we were at 30% of our sales plan.

Overall, EMEA accounted for about two-thirds of our Q1 revenue shortfall plan, while the North America area, I mentioned, was responsible for the remaining third. The key takeaways is that we are seeing very good growth in our branded DXi products as a whole and we are performing very well in growing in the majority of our geographies. So we recognize we have to make improvements in a couple of our geos to hit our sales plan.

As I mentioned last quarter, when we evaluate our financial performance, there are several key measures that are important to both our midterm and our 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. I will comment on each of these.

For the first quarter, our branded business represented 73% of our non-royalty revenue, compared to 71% in the same period a year ago. On a year-over-year basis, our first quarter branded product revenue grew 6% and for the remainder of fiscal 2011, we expect our branded business to continue to grow for tape, disk systems and software products.

Non-GAAP gross margin for Q1 of fiscal 2011 was 45%, up from 42%. This 300 basis point improvement reflects an increase of $6 million in gross profit dollars on revenue of $2.9 million. We continue to generate very strong gross margin contribution and believe we have more opportunity here as the year progresses.

Disk systems and software revenue inclusive of related service was $34.7 million for the first quarter of fiscal 2011 compared to $19.2 in the same quarter last year and $22.8 million reported last quarter. In total, branded disk and software revenue in Q1 was up 86% year-over-year and 40% quarter-on-quarter.

More importantly, branded disk revenue or DXi increased a 125% over the same period in fiscal 2010 and 22% sequentially. DXi OEM software increased 69% year-over-year as a result of the revenue level in Q1 as a result of the completion of the contract terms with that OEM and their timing. That DXi OEM software revenue contract is still in place, but we expect minimal revenue from it in future periods.

As we look forward to the remaining three quarters in fiscal 2011, we expect our branded disk systems and software products to be a significant driver of growth. The end user market and opportunity is very large. We have excellent products including a number of offerings introduced in the last year that have been very well received and independent channel partners, who want an alternate set of solutions to sell to their customers.

Non-GAAP operating profit for the quarter was 9.7% up from 9% in fiscal 2010. As you can see we tightly managed our operating cost during this quarter, and that gives you some visibility into the variability of our operating model and where we get leverage.

Finally $15.7 million of cash was used in operations. The cash usage which was expected was generally caused by balance sheet fluctuations. More specifically the largest contributor to the cash usage was a reduction in deferred revenue of $15.2 million, primarily related to the final utilization of the EMC prepaid royalty, and to a lesser extent a typical seasonal decline in service contract differed revenue. The majority of our service contracts renew in the third and fourth fiscal quarters.

We generated $23 million of EBITDA during the quarter. We paid down 500,000 of our senior debt and ended the quarter with a cash balance of $99 million. In upcoming quarter or the quarter we are in today we will be paying off the remainder of our convertible debt of $22.1 million with cash.

In summary, our Q1 results were mixed. We are pleased with the growth in branded disk systems and software sales and the new customer acquisition in Enterprise tape automation as well as the sales execution by our Asia-Pacific team and two of our four North American sales areas. However, we still underperformed in branded revenue generations specifically in EMEA where the economic impact either pushed out or cancel deals and as I mentioned one of our four North American sales areas.

On a positive note, we have seen several large EMEA orders come through in Q2 that we had originally expected in Q1, but we still remained cautious about the EMEA market especially with the seasonality particularly experienced there in the fiscal second quarter. We also expect strong revenue growth in the public sector this quarter.

With that I will walk through the detailed results for Q1. I would like to refer everybody to the financial statement and the supporting schedules included in the release, it will be helpful to refer those documents as I comment.

As I mentioned revenue for the quarter ended June 30 was $163.2 compared to $160.3 million a year ago. Year-over-year revenue increased $2.9 million as a result of higher branded revenue and higher OEM DXi software revenue, which was mostly offset by expected declines in OEM devices revenue.

Royalty revenue was $16.1 million for Q1 compared to $16.2 million in the same quarter a year ago. For the quarter non-royalty revenue totaled $147.1 million of which 73% was branded and 27% OEM. That compares to non-royalty revenue of $144.1 million a year ago of which 71% was branded and 29% was OEM.

The fiscal Q1 2011 percentages are over shadowed by the recognition of the remaining OEM DXi software revenue during the quarter. So excluding the effects of this revenue we would have reported 78% branded revenue in Q1.

The increase in non-royalty revenue is primarily related to increases in our branded revenue, specifically disk system software offset by reductions in our OEM revenue. As the recognition of additional OEM DXi software was offset by expected reductions in the device revenue from OEMs.

We have executed on our plan to stop doing business in areas in which we are not profitable and focus on those that positively impact the bottom line. In the past years this has a negative impact on revenue trends but our operating profit, net income and non-royalty branded share hasn't improved as expected and our non-GAAP gross margins have increased in the low 30s to the mid-40s over the same period.

Our branded revenue increased 6% year-over-year and we continue to be focused on growth of the branded business and overall revenue in fiscal 2011.

Looking further at various revenue classifications, devices and media totaled $20.5 million compared to 27.2 in Q1 a year ago. The decline is primarily attributable to anticipated declines in the OEM devices and media of $5.3 million and declines in branded media of $3.1 million offset by increases in branded devices revenue of $1.6 million.

As a point of reference OEM devices revenue now totals less than $1 million in this past quarter compared to $6 million in the prior year quarter. So a move of $5 million and really has become an insignificant piece of our overall mix.

The most significant year-over-year increase is in branded devices, which was in sales of ours and other branded LTO devices.

Tape automation systems revenue was $56.7 million, compared to $61.1 million in Q1 of fiscal 2010. The decline was due to reductions in branded enterprise and midrange product revenue primarily resulting from the below planned performance mentioned earlier in EMEA and in one of our North American sales areas. However, we did see an increase in revenue from our new entry-level products driven by our Scalar i40 and i80 products, which began shipping in the last half of fiscal 2010.

OEM automation remained relatively flat on both a year-over-year basis and sequentially. Disk systems software product and related service revenue was $34.7 million, up from $19.2 million a year ago. On a year-over-year comparison, we had a significant increase of 125% in branded DXi revenue.

StorNext revenue grew 36% and the revenue from our existing OEM DXi software agreement increased 69% as we recognized the remainder under the contractual agreement.

Much of our growth in the branded DXi revenue was driven by large deals. To give more color to the geographic differences we saw this quarter in our branded disk systems business, we were above planned in North America. We were at 94% of plan in Asia-Pacific and we were at 31% of plan in EMEA.

We continued to see a very good demand for our DXi7500, as customers like its scalability, VTL interface and tight integration with tape which are all important features in an Enterprise environments.

In the mid range Q1, was the first quarter in which all DXi6500 models were shipping for the entire quarter, and we saw growth in North America revenue from this product but declines in EMEA.

We have received very positive feedback in interest, in the DXi6500 product lines from end users and channel partners. However, our ramp in revenues has been slower than we had expected. We are still not getting the high velocity deals from the DXi6500, W1, but we did make significant progress during the quarter, in adding VAR partners and increasing opportunities in our sales front.

Service revenue, was $38.6 million compared to $38.9 million a year ago. The decline is primarily the result in a reduction of OEM out of warranty repair. Branded product service revenue increased slightly this quarter, from Q1 of fiscal 2010.

Turning to gross margin, non-GAAP gross margin in Q1 is 45%, compared to 42% in the prior year period. This is the result of both higher branded sales mix and an increase in OEM, DXi software revenue, on year-over-year basis. We are very pleased with the quarter's gross margin and continue to believe it's a great indicator of the value of the overall business.

Moving to expenses, non-GAAP operating expense totaled $57.6 million compared to $53 million a year ago. The largest driver of the increase in operating expenses was an increase in marketing and sales expenses primarily related to advertising and marketing programs for our new products and increases in sales headcount and the associated costs. R&D spending also increased quarter-over-quarter due to additional headcount as in our disk systems and software teams.

Non-GAAP operating profit for the quarter was $15.9 million or 9.7% of revenue compared to $14.4 million or 9% of revenue in the same quarter a year ago.

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

The current coupon interest rate for our remaining senior debt, which totaled $185.6 million at June 30th will be 3.85% for the quarter ended September 30th, and the average coupon rate for our total debt will be approximately 7.3% for the same quarter. We expect interest expense will be approximately $6 million for the second quarter of fiscal 2011. One thing that we are often asked and I can confirm is that we are actively reviewing options related to further improving our overall capital structure.

For the first quarter, we had net tax expense of $400,000 related to state and foreign taxes. We still believe it's reasonable to model tax expense of $1 million per quarter.

Summing it up for Q1, we had non-GAAP net income of $9.3 million with non-GAAP EPS of $0.04, compared to non-GAAP net income of $8 million and non-GAAP EPS of $0.04 in the same quarter last year.

Focusing on cash flow for the quarter and the balance sheet at June 30, I would like to highlight several key points. Cash used in operations for the quarter was $15.7 million. As mentioned earlier, we expected to use cash this quarter as result of the final utilization of the prepaid EMC royalty and the seasonality of service contract renewals. We paid down $500,000 of our senior debt in the quarter end and the composition of our debt is $186 million of senior debt, a $122 million outstanding with EMC and $22 million of convertible debt. We ended the quarter with $99 million in cash.

Non-GAAP EBITDA for the quarter was $23 million. We are in compliance with all debt covenant at June 30th and we expect to be in compliance with the debt covenant during the next 12 months. For purposes of calculating our debt covenant, EBITDA for the last 12 months was $105.2 million.

On a sequential basis, manufacturing inventory increased $2 million, accounts receivable increased $2.2 million. We also had an accelerated payment of 11.3 million from one customer.

CapEx was $2.2 million and the purchase of service parts inventory were approximately $1.4 million during the quarter. Depreciation and amortization and service part lower or cost of market expense totaled $16.9 million in Q1.

Looking forward to Q2, we are forecasting revenue of $165 million to $180 million, slightly lower gross margin and total non-GAAP operating expense of $58 million to $62 million. Interest and taxes should be similar to Q1.

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

Rick Belluzzo

Thank you, Jon. Today I would like to spend most of time my discussing our near-term plans to improve revenue performance and take advantage of the market opportunity before us. As we said during our last call, we have made numerous fundamental changes over the last few years, changes in products, margins, structure and investments to mention just a few.

This has allowed us to transition our business model to that of a systems business as evidenced by our operating margin improvement and new product releases that are positioned into more vibrant segments of the storage market. Now to further improve our performance we must deliver consistent revenue growth to generate higher profits and increase the value of the company.

As the industry continues to be evolve, we are well positioned to help customers manage and protect their data by providing tier storage and workflow solutions encompassing disk, tape, software and key technologies such as deduplication, replication and high performance file sharing.

Our plans for FY 2011 at the highest level are about continuing the delivery of new products, driving branded revenue growth in disk systems, software and tape and introducing new elements of our technology that will position us for further growth and expanded contribution.

Clearly our Q1 results were not up to the level that is appropriate given these expectations. While we delivered improved results over last year's first quarter most notably non-GAAP operating income and net income up 10% and 17% respectively, our revenue weakness held back our opportunity to deliver even greater improvement. As Jon stated, the revenue shortfall was largely centered in EMEA and where we saw deals slippage extended [approval] cycles and channel contractions across all of our product lines.

While some of the behaviors that we saw in Q1 felt like the environment we experienced worldwide during the IT [Spain] pullback just over a year ago, this time, we saw some areas of significant strength in Asia-Pacific where business was very strong and in a number of areas of North America.

In short, there were global factors that certainly impacted our business in Q1. Yet we believe that the overall market opportunity remained significant and that there were several issues that we need to address to improve our underlying position and avoid being negatively impacted by uncontrollable economic issues as we experience this quarter.

In recent quarter, a bunch of our branded, mid ranged Enterprise business has been very large deal oriented. In fact, for Q1, nearly 40% of our branded, midrange and enterprise revenue came from deals of more than $200,000.

This included a multi-site follow on DXi7500, sale to one of the top insurance companies in the US and other large wins such as DXi7500 purchase by a new DXi that is one of the leaders in the American music recording industry, and a multi-unit DXi6500 deal with a government agency.

On the StorNext side, notable customer wins above 200,000, included new business with a major manufacturer of supercomputers, several Chinese television stations, and a top university in the Middle East, as well as a follow-on sale to a large government-owned broadcast network in Asia.

We also had significant Scalar i6000, deals, including multi-unit sales of global networking company and a major European provider of information and communication technology. We are very pleased that large lead organizations around the world continue to turn to quantum, for the data protection and management needs.

However the fact that such a significant part of our branded, midrange and enterprise business comes from big deals, increases the risk of making our results lumpy from quarter-to- quarter, and makes us very susceptible to economic variation.

As I have said in the past, a key element of our go-to-market model involves the more selective in pursuing DXi Enterprise opportunities and focusing on where we are best in managed while building the run rate business that is more midrange channel-oriented with a DXi6500.

Combined with the other elements of our go-to-market model around tape automation at StorNext in both, the enterprise and midrange, we feel that this balance will allow us to build a growing business within our investment model.

In Q1, the downside of large deal opportunities was apparent in terms of being subject to delays, especially in EMEA. Compounding this was an insufficient level of midrange run rate business.

So, yes, there were clear weaknesses in EMEA across the Board. So again, point I'm making here is our overall mix of business makes it very exposed to economic downturns and this is something that we need to continue to address. The net of all this is simply that that the opportunity and strategy remains unchanged.

We have the right market and product focus, and we must grow the channel and run rate business, especially with the DXi series. While, we can not control the economic environment, we must build a more diverse foundation to provide greater stability and growth. That has been our focus over the last six months and remains so as demonstrated by the number of recent changes and some of the targets investments that we have made. Let me review some of these key areas.

First, as we have said in the past, building greater VAR channel engagement is critical. There are significant opportunity given the disruptions caused by the Data Domain EMC change and the Oracle acquisition of Sun.

We are pleased with some of the progress that we have made in capitalizing on these disruptions. For example, in the June quarter new DXi opportunities from our current top-five DXi channel partners were up nearly 50% year-over-year. In part reflecting a shift that several of them have made from selling mostly Data Domain de-duplication products.

In addition, we reached agreement with a range of VARs to lead with our DXi solutions. On the tape automation side, as Oracle has focused on a direct sales model and increased service pricing from the former Sun StorageTek business, we have seen interest from several VARs in working with us on targeting the Sun Storage Tek install base customers and transitioning them to Quantum where we can provide a significant advantage from the total cost of ownership standpoint. Despite this progress we must do more in engaging with the channel.

One data point is clear, the sales in this area that will [further align] in respect to delivery on this channel focus have had better overall revenue performance. So driving our channel program will remain our major priority.

On the product front we will continue to focus on ramping the new product launched over the last year including not only the DXi6500, Scalar i40 and i80 and StorNext 4.0 but also the DXi4500 and Scalar i6000 both of which just started shipping in Q1.

We will also be introducing new products to further expand our offerings and improve our position including additional enhancement to our DXi portfolio this quarter. In addition, we have sharpened our competitive positioning around DXi, particularly related to what we can offer customers in terms of better performance at a significantly lower cost. This will be our ongoing effort and we believe it will help increase our opportunities and win rates.

Another change we've implemented is the introduction of a series of new marketing campaigns heavily focused on our very large install base. These [multi-task] campaigns target specific segments of the install base which offers Scalar to their environments, including upgrades to existing products, expansion with new products and trade ups to current technology.

We are also engaging with key channel partners to expand these marketing activities to their customer base, providing the tools and processes to enable quick execution. We know that we perform better when we initiate the opportunity and compete in the installed base. So we are greatly expending our efforts in this area, which we believe will also help us gain greater momentum with both end-users and the channel.

Next, we recently restructured our North American organization to create a simpler overall model to drive greater focus around opportunities and align our sales team, our sales areas with seasoned leaders that have demonstrated success in making this model work in their previous area of responsibility.

Then finally, we are focused on driving more opportunity in Enterprise tape automation accounts. Our new Scalar i6000 is the best-in-class open system Enterprise library and we believe there is more opportunity than what we are currently achieving.

These five changes and initiatives are largely aligned with a program and plans we set out when we began the new fiscal year FY 2011. We have made some adjustments and moved quickly to implement them based on some of the early experiences that we had in Q1. The goal remains to grow revenue this year for the first time since we combined Quantum and ADIC in '06. We believe this goal is attainable despite the slower than expected start to the year.

We have a solid product position and we have clear evidence that the formula does work as we saw with solid success of the business, in many areas of our organization. Of course the key is to make this scalable across all geographies despite economic headwinds and the actions we've taken here are really about making this a reality.

Beyond this go-to-market actions, we have also made some structural changes over the last several months to create a more tightly, integrated and focused product organization. These changes will enable us to execute more quickly and effectively in a rapidly changing competitive environment with significant opportunities that exist.

In summary, I wanted to spend most of my time today on the revenue focus of the company. We have a strong sense of urgency to build revenue momentum beyond the 2%, growth we experienced in Q1. At the same time, we will continue to strive for other improvements in our business and in our business model, including our investments as well as our capital structures.

With that, let me turn the call back over to the operator who will be addressing your question. Thank you.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instructions). Our first question comes from the line of Brian Freed with Morgan, Keegan.

Brian Freed - Morgan, Keegan

Couple of quick questions. First and foremost as you look at EMEA for the month of July versus last year, are you seeing any improvements versus the trends you saw in the June quarter that kind of offer some rays of hope, or is it continuing to be sluggish there?

Rick Belluzzo

It's hard to get an indication of how the quarter will end. Most of the activity happens in September. Certainly, we saw some deals that we had anticipated closing in the June quarter. Those are already booked, so that's positive.

I think in terms of just how we saw the softness across all the product lines and the macro economies in Europe, Central Europe, Germany did better than, the UK and France. It's still early, but it looks like from the standpoint of executing on our plan, we think that this quarter will be better.

Brian Freed - Morgan, Keegan

My second question is. If I did my checks on the quarter, a number of times facts indicated that the ramp of LTO-5 was pacing a bit slower lower than that the LTO-4 ramp had been.

Is that your experience? Question number one. Then as a follow on to that, as some of the new technologies you are bringing out around media management, et cetera, do you think they can accelerate the adoption of LTO-5?

Rick Belluzzo

I think that LTO-5 and LTO-4, it's so early to look and say which one is going to ramp faster or slower. It is a different jump this time. As you know, there is not as bigger jump in performance, which has always been the case in the previous versions.

I think that generally speaking, when you are talking about new tape technologies, it's something to go and sell and people are interested in it, but we are selling this product and other things with those, so it's too early to declare LTO-5 is slower than LTO-4.

Having said that, we have other things like you mentioned that we think differentiate our products. We saw very good growth in i40 and i80. We are above plan in both those products and those are both, actually LTO-4 products.

So, I think it's kind of mixed right now and I think a lot of our weakness generally and then specifically in tape was really more geography-based than it was product based. I think I want emphasize one thing Bill said.

I mentioned in my remarks DXi was 30% of plan in Europe. Overall, our business was a 60%, so we saw across the Board issues that are related to Europe not just DXi, not just tape media as well.

Brian Freed - Morgan, Keegan

Then the final question I had, then I'll take the floor. If you think of the guidance you provided for next quarter, a typical kind of back of the envelope would be the [sustain] at high and low end by going on high end of the range of expenses and low end of the range for revenue. Would you foresee that happening or should we think that if you are at the low end of the range revenue you would probably would be at the low end of the range of expenses as well?

Jon Gacek

I did that purposely actually its is to the very question. Previously with this quarter, we were at the low end, we are below the low end of the range on revenue by roughly 5% and we were below the low end of the range on expenses by about the same amount. So because of our model if we miss on revenue our expenses are going to lower.

The other thing I would say on the guidance and I think you have to remember is, while it looks like the low end of the range is flat, it actually would include about $9 million to $10 million of growth because the DXi OEM contract is not going to repeat. So we are expecting growth in Q2 at the low end of the range of $10 million and at the high end of the range of $25 million.

So I just want to make sure that people model that. They have understand that's not a flat pan that's a growth plan as it relates to our goals internally. So for sure, it's not appropriate to take low end of revenue and the high end of expenses.

Brian Freed - Morgan, Keegan

Great. I'll jump out and get back in queue if I have something else.

Operator

Thank you and our next question comes from the line of Joe Feshbach with JFP.

Joe Feshbach - JFP

Just a follow up on Brian guidance question which you in part answered with the DXi EMC royalty. Since you see there's potential for $10 million to $25 million adjusted increase in revenues, I think I am thinking about that correctly or even a little bit higher, can you give us a roadmap of which categories will take up the bulk of that. Should we see considerable sequential improvement in DXi based on how you guys are planning the quarter? Do you see a big bounce back in tape and a change in your thinking on the royalty or on servicing?

Jon Gacek

So we just kind of went down the list there. I think DXi and software are key contributors. Most of the growth will be in DXi. We think tape automation, and tape media and tape devices will all be stronger primarily because we don't expect Europe up to be so far off-plan and the other areas that struggled in North America, we think that that particular area will be a much, much stronger this quarter. In fact they've already sold more this quarter than they sold last quarter.

So that makes us feel good about it. I think service will be, it's not a place for growth, I think it will be flat and I think the royalty will be in the same kind of range. So this is really about branded growth across automation, disk and software and even devices and media which, well, it's not about profit, there is some revenue there and we struggled with that in Europe as well.

Joe Feshbach - JFP

So the drop in that category, I guess, the devices and media category, that was really just geography related, it wasn't like you were continuing to walk away from low margin business or whatever. That has been stable for five quarters and that was by product categories 60% to 70% of the mix from the low end?

Jon Gacek

Yeah, so two things. Often I get asked even by you, how much more left, as there are no EMCs. So I added in my remarks that OEM device revenues is now less than $1 million.

So, that piece of the business is really gone away and it help is our margins. As it relates to, let's say if you do the sequential comparison in Europe, in particular we struggled with devices and media and those are fairly large dollar amounts, but small profit.

Joe Feshbach – JFP

Right.

Jon Gacek

If you track the results in Europe, and one reason, we know we tend to talk about some of the economic challenges. We take that segment of the business. You could just see the channel partners, really pulling back on inventory, and I think again reflecting the environment that they saw maybe tightness in their capital structure and trying to preserve cash, so that was a real indicator of what we've seen in the past when the environment pulls back. Again, we saw that in Europe, and I think that affected those numbers as well.

Joe Feshbach – JFP

So speaking about what we look for from here. You are off to a much better start for the quarter than the way you ended the last one. It sounds like at least the on branded products.

I know it's really in the early innings with your new OEM. Have they started to see a little bit of success that began to generate any results in the new quarter, and do you see expanding your strategic partnerships at all with respect to more joint ventures or OEM deals?

Rick Belluzzo

Let me start by just talking about overall. I mean, overall, we have a lot of things that we have been putting in place for the last six months. Whether it's campaigns and lead generation, whether it's our channel program, whether it's new products, whether it's new OEM, I mean there are many, many things that we put in place.

The setback this quarter was really unexpected. I think we had call a quarter ago. There was some inkling of some activity or some pullback that we saw minimal, and it really developed quickly. So, we're still going to bank on the fact that we have a lot of things going that we think will continue to put us in a position to see improvements around revenue.

I would just say that the OEM front is one, but none of these by themselves are big home runs. Their individual actions that we think cumulatively will help us continue to move the business forward.

On the quarter what I was very specific about the one North American territory is off to a much better start, but remember, we talked about this before. How we start matters, but how we finish really matters, because a lot of our branded business is in the last month. So, for us we don't know where we are going to end up until we are done.

So the teams are chasing deals and we were chasing plenty of deals to get to our number. They just didn't close. So the good news is we closed a number of those already. That's good, but still going to matter how we close at the end, and then I think somebody else mentioned a lot of the build in a lot the business in Europe is going to get closed in September.

So, this quarter again will be about how do we finish. The good news is at least in just one example, some of the deals that we thought we are going close, it didn't have closed. We know we didn't lose those and I think that's important for everybody to see the progress that we are making, but initiatives that Rick's pointed out, are the initiatives we're driving towards and we have to continue to execute and it matters the most how we finish.

Joe Feshbach - JFP

Got it, understood. Last but not the least and then I'll turn back. There's been fair amount of discussion about you guys picking up new channel partners, some of whom are dropping their Data Domain EMC. Can you give us a little bit color about when that and how that's progressed through the last quarter? How long it takes from your vantage point for them to really be up and running and delivering the goods with Quantum, just any other thoughts on that?

Jon Gacek

Bill is going to address that. I wanted to say on that point, we did our plan for this year and gave our guidance for the year and for the quarter. Bill is going to talk about the work that it takes to make this transition and some of the timeline that goes with it. That is the reason why our plan is an accelerating plan during the year. Because we see the opportunity but we know it takes work and so Bill is going to talk about where we've been having success and why and the work to going on.

Bill Britts

So Rick mentioned it earlier in his comments at the beginning the call that the two big opportunities that we see in the independent channel are people that want to find a very competitive disk-based backup appliance that's competitive against Data Domain EMC. Then the second is, partners are very disillusioned with the way that Oracle is trying to setup the kind of go-to-market and the direct sales emphasis and the way they've handled the business model with the partners that have historically sold Storage Tek.

So those are two big factors that drive kind of a more strategic alignment with partners and if you think about kind of what you have to do to get a independent channel really producing revenue and being able to kind of really build that run-rate business, it's a key part of our plan. Now we are starting with this strategic alignment and that part is going extremely well. Underneath that, it is training all of their [SEs], getting them to really understand how our products are positioned, how they are differentiated, how to actually build reference architectures that they can then take to their customers and that means that they have got to get into their sales cycles and then the follow-on to that obviously is replicating that success.

So if you kind of look at the spectrum and this is something that's happening across all the geos, North America, Europe and Asia. We are seeing partners that are coming to us, for getting alignment and we are taking them through that process of getting them capable to resell both our DXi products as well as our tape products as an alternative Storage Tek to Data Domain.

Operator

(Operator Instructions) Our next question comes from the line of Brian Marshall with Gleacher & Company.

Brian Marshall - Gleacher & Company

A question with regards to the StorNext business, I was wondering if you could comment on some of the trends that you saw in the quarter, both from the qualitative and quantitative perspective?

Jon Gacek

Bill is going to answer, the one thing we did do, I think for the first time, as we gave the growth rates for that piece of the business, and we are going to talk about it more because we see a lot of really interesting opportunities for us to have our technologies solve customer problems and that is great lead for Bill.

Bill Britts

It's a very strong quarter for StorNext number of new customer acquisitions accounts that we added in the quarter, this quarter also saw adoption of some of the features that were really instrumental in StorNext 4.0 such as replication, distributed data movers that allows to be able to scale much more effectively, partial file retrievals for some of our media accounts, rich media accounts. So, it was a very strong quarter, it sets well for this quarter in terms of continuing to build on that success with StorNext 4.0.

We also saw a number of accounts where we sold both our StorNext software with our tape products, i6k specifically. So I think there is some really good successes there, some early wins, with the 4.0 product line and yes, we feel very encouraged by having that new product into the market.

Brian Marshall - Gleacher & Company

Okay, and as a percent of disk based backup business, care to comment on whether this is great or less than 20% of that business at this point?

Jon Gacek

No, we haven't broken it up separately, but you are giving me a lot of information.

Brian Marshall - Gleacher & Company

Understood.

Jon Gacek

So, it is, you can tell us getting most and more significant, and as a percentage of the total, if I say it, its more than you going to ask me, what is less then. So do the math and then maybe on the next call, we'll be in a position to start breaking them up even a little bit more.

Brian Marshall - Gleacher & Company

My final question is with respect to gross margins. It sounds like your higher gross margin products are going to be growing little bit faster, obviously going forward, but we're talking about gross margins declining on a sequential basis slightly.

Can you talk about kind of puts and takes relative to increasing richness of the revenue mix and why we would see gross margins down little bit in the September timeframe? Thanks.

Jon Gacek

If you think about the guidance, the DXi OEM revenue is 100% gross margin, so you take that out and let's assume you replace that with let's say $15 million of our high margin branded product, you are still going to have a decline in gross margin percentage. So it's really about replacing that DXi OEM revenue that's causing that particular relationship. So overtime as that branded business grows, we would expect that gross margins will continue to increase as a percentage of [Jan to March] dollars throughout rest of the year.

Brian Marshall - Gleacher & Company

It sounds like this is more or less a one-time event and we should not see that in the future?

Jon Gacek

It's going to transition. You replace a 100% gross margin on business that's roughly $160 million to $170 million it's going to take a little bit of revenue growth. With 50% margin it would take $20 million, right? So on the dollar, but you still have the less on a percentage.

Operator

Thank you. (Operator Instructions) There are no further questions in the queue at this time. I would like to turn the call back to management for any closing remarks.

Rick Belluzzo

Okay. Thank you for joining us again today and we look forward to giving you another update in another quarter. So again, I would just summarize, it was a very interesting quarter. We certainly had some challenges but the kind of underlying pieces of the business and where are headed we believe is very, very much intact and as we continue to learn we will execute quickly to take advantage of that opportunity and I think we will have more to say about that in the next quarter. Again, thanks for joining us.

Operator

Thank you. Ladies and gentlemen, this concludes the Quantum Corporation first quarter 2011 conference call. If you'd like to listen to a replay of today's conference, please dial 303-590-3030 or 1800-406-7325, and enter the access code 4326811 followed by the. pound sign. We thank you for your participation. You may now disconnect.

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Source: Quantum Corp F1Q11 (Qtr Ended 06/30/2010) Earnings Call Transcript
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