Datalink's (DTLK) CEO Paul Lidsky on Q2 2014 Results - Earnings Call Transcript

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Datalink (NASDAQ:DTLK)

Q2 2014 Earnings Call

July 24, 2014 5:00 pm ET

Executives

Paul F. Lidsky - Chief Executive Officer, President, Director and Chairman of Merger & Acquisition Committee

Gregory T. Barnum - Chief Financial Officer, Vice President of Finance and Secretary

Analysts

Prabhakar Gowrisankaran - Canaccord Genuity, Research Division

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Eric Martinuzzi - Lake Street Capital Markets, LLC, Research Division

Aaron C. Rakers - Stifel, Nicolaus & Company, Incorporated, Research Division

Glenn Hanus - Needham & Company, LLC, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Datalink Second Quarter 2014 Earnings call. My name is Letoya and I will be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to Mr. Paul Lidsky, President and CEO. Please proceed, sir.

Paul F. Lidsky

Thank you, operator, and good afternoon, everyone. I'd like to welcome you to our second quarter afternoon conference call, and I'd like to thank everyone for joining us today. With me is Greg Barnum, our Vice President and Chief Financial Officer. Greg will discuss our second quarter and 6-month results in detail in just a few minutes, but first, I would like to provide a quick high-level view of the numbers and what they mean.

As Greg will explain, our second quarter performance improved substantially, both quarter-over-quarter and year-over-year. In addition, we exceeded the guidance that we issued in May. Some of this growth stems from closing sales that we expected in the first quarter, but that did not materialize until the second quarter because customers were spending extra time evaluating newer technologies like private and hybrid cloud and flash and hybrid converged storage. We're also continuing to increase our services revenues, and we are focusing on selling more complex data center projects to take advantage of strong customer interest in these newer storage solutions. We have already closed orders for flash storage from 5 different manufacturers and have more than tripled our flash pipeline in the last 3 months. All of these are positive trends.

At the same time, customers are still taking longer to scrutinize purchases and technology alternatives than in the past, so we have not entirely returned to a normal sales cadence after the slowdown we saw in the first quarter and this is reflected in our current guidance.

So I will turn the call over to Greg now to discuss our second quarter and 6 months results, and then I will provide some additional perspectives on our performance and I'll review our outlook for the third quarter of 2014.

Gregory T. Barnum

Okay. Thanks, Paul. Before we begin with the quarter's results, let me first remind everyone that in today's conference call, we will be discussing our views regarding future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties. Actual future results and trends may differ materially from historical results or those anticipated, depending on a variety of factors. We undertake no obligation to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise. Please refer to our filings with the Securities and Exchange Commission for a full discussion of our company's risk factors.

Let me also remind everyone that the results for the second quarter and 6 months of 2014 include the effect of the 3.8 million new shares, or approximately $0.05 and $0.06 per share, respectively, which were issued in connection with the August 2013 stock offering.

Turning to the quarter then. Revenues for the second quarter ended June 30 increased 8% to $159.4 million compared to $147.8 million in the prior year second quarter. Sequentially, we saw revenues from Q1 to Q2 increase 14%. For the 6 months period, revenues increased 6% to $298.9 million.

On a GAAP basis, we reported net earnings of $3.6 million or $0.16 per share for the second quarter of 2014, which compares to net earnings of $2.9 million or $0.16 per share in the second quarter of last year. For the first 6 months of 2014, we reported GAAP earnings of $3.9 million or $0.18 per share, which compares to earnings of $4 million or $0.22 per share in 2013.

Now for the rest of my comments on the income statement, I will be referring to non-GAAP amounts in percentages as reported in today's press release. A detailed reconciliation between GAAP and non-GAAP information is contained in the tables included in today's press release. The primary adjustments to GAAP results relate to acquisitions, stock-based compensation charges and the amortization of intangibles net of income taxes.

So in the second quarter of 2014, our product revenues increased 5% to $98.2 million and our service revenues increased 11% to $61.2 million when compared to the second quarter of last year. Within the service component of revenue then, we saw customer support revenues increase 13% to $49.2 million and professional service revenues increased 4% to $12 million. For the first 6 months of 2014, we saw total revenues increase 6%, with product revenues increasing 2% and services increasing 13%.

In addition, professional services now make up 8% of our total revenues in the first 6 months of 2014 compared to only 7% of total revenues in the first 6 months of last year. This growth is a key focus area as we need these higher-margin professional service revenues to increase as a percentage of our total revenues in order to offset any product margin pressures.

Our revenue mix for the quarter was 27% storage, 23% networking and servers, 11% software, 1% tape and 38% service.

Overall gross margin in the second quarter was 22.3%, which is up from 21.2% in the first quarter of this year. And for the 6 months of 2014, our overall margin was 21.8% compared to 22.8% in the first 6 months of last year.

While our margins will continue to fluctuate quarter-to-quarter due to new logo acquisition orders and product mix, for 2014, we still expect our product margins to be under some pressure, which will cause them to decline from 2013 levels as the first 6 months of 2014 indicate. As we have stated in the past, our strategy over time is to offset these declines in product margins by selling more services, which carry higher gross margins.

In summary then, I still expect our combined product and service gross margins throughout the year 2014 to be in the 21.5% to 22.5% range.

Turning to operating income. Our operating income for the second quarter of 2014 was $8.1 million or 5.1% of revenue compared to $8 million or 5.4% of revenue in the second quarter of last year. This decrease is primarily due to lower gross margins and as a -- as a result of the product mix changes and the ramp-up expenses associated with our Advanced Services practice.

On the balance sheet then, we ended the quarter with $78.4 million in cash and investments, working capital of $98.7 million and no debt.

With that, let me we now turn the call back over to Paul.

Paul F. Lidsky

Thanks, Greg. The numbers that Greg just outlined certainly show a positive change in the second quarter. Our revenues for the second quarter, which came in at $159.4 million, were not only 14% higher than the previous quarter, but also exceeded our second quarter guidance of $145 million to $155 million. We saw an increase in the sales cadence as a number of the orders delayed in the first quarter, while customers investigated new alternatives in storage, cloud and other technologies, were closed. Increased activity levels from the field suggested our customers are interested in investing in their data centers and we should see this evidence in future quarters.

Greg has already gone over the margin numbers, which increased from first quarter to second quarter, but declined for the first 6 months of the year as compared to 2013. As many of you will remember, we have discussed this factor -- the factors behind our margin pressures over the last few earnings calls and these factors have not changed. Therefore, these margins were in line with our guidance.

We continue to see our networking and server business growing faster than our storage product sales. While we are pleased with this growth in our server and networking business and its alignment with our growth strategies, this shift in revenues will continue to impact overall margins, but at the same time, drive significant business expansion.

We can see the reasons for lower margins if you look at the changes in our revenue mix. Storage accounted for 27% of our Q2 revenues, down from 36% in the same quarter of 2013. Networking and servers represented 23% of our second quarter revenues, up from 20% a year ago. The other major component, services, increased as a percentage of revenues from 37% to 38% year-over-year as we continue to focus on increasing Datalink delivered services revenues as a way to offset our product margin declines.

Before I discuss our services progress, though, I wanted to spend a few more minutes on the product side of the business with brief looks at NetApp, converged data infrastructure and flash storage. As you may have seen in the press release announcement yesterday, we ranked as NetApp's #1 partner in the Americas for FlexPod converged data center infrastructure and also for clustered Data ONTAP sales during NetApp's 2014 fiscal year. This is a direct result of our emphasis on complex solution sales and the advanced services required to support them. As you know, we no longer just sell storage. We now design, supply, deploy and support today's integrated data center stacks, we migrate customers' data and their storage systems from one platform to another and we deliver a range of other services that most in-house IT organizations lack the resources to do. This NetApp ranking demonstrates how well we are delivering on this business model and this is a major differentiator for us and a linchpin in our long-term growth strategy.

Another validation of our strategy has been seen in the continued sales growth of converged data center technology, which integrates networking, computer -- computing, storage, and in some cases, virtualization. These solutions generated $25 million in product revenue from 26 different customers in the second quarter of 2014. That's a revenue increase of 7% over -- quarter-over-quarter and 18% year-over-year for the comparable 6-month period.

That brings me briefly back to talk about flash storage. I mentioned at the beginning of this call that we have a large and growing pipeline for this newer storage technology. That pipeline has nearly tripled from what we had at the end of the first quarter. In addition, we have already sold flash storage solutions from NetApp, EMC, Pure, Nimble and Tintri, both from a stand-alone basis, and in a few cases, as part of a virtual data center stack. We expect this technology to continue to be a catalyst for spending in 2014 and beyond and once again create more opportunities for additional services sales. Customers will continue to need data migration and other data center transformation services that -- and we will be able to reap the benefits of higher services content.

Now let me turn to services for a few minutes before we get to guidance. As Greg told you, our services performance was strong in the second quarter, which is good for margin expansion. It's also excellent for increasing wallet share and for helping buffer the company against fluctuations in product sales.

To recap, we saw 11% and 13% year-over-year increases in total services revenues during the second quarter and first 6 months, respectively; a 13% increase in customer support revenues; and a 4% increase in professional services revenues during the second quarter. And we saw an increase in professional services to 8% of our total revenues in the first 6 months of 2014 compared to 7% in the first 6 months of 2013. Also significant is the fact that these growing percentages were significantly higher than product revenues due to our continued investments in Datalink delivered services. For all these reasons, we continue to accelerate the expansion of our services portfolio in general and our newer Advanced Services offerings in particular.

In the second quarter, we added 2 new Advanced Service offerings, one aimed at service automation and the other focusing on helping our clients assess their cloud readiness. Both are designed to help IT organizations accelerate critical cloud delivery and self-service user portals -- portal automation projects.

Within the next couple of weeks, we will be announcing another Advanced Service offering that adds a compelling new option for customers who need to accelerate their cloud enablement.

As we have discussed on previous calls, we continue to invest in Advanced Services because of the higher product -- project gross margins this type of work generates. Advanced Services also is critical in expanding our ability to participate in the entire data center life cycle. In doing so, we create increased relevancy between Datalink in our clients. Advanced Services also provides a revenue and profit stream that can be independent of product sales, while at the same time often generating significant product sales as a result of the consulting engagement. We also continue to see an increase in a number of 6- and 7-figure consulting projects that we are winning. This is proving to be a productive strategy for Datalink.

During the second quarter, for example, we were awarded a $765,000 services engagement with a well-known media entertainment company to lay the groundwork for their next-generation network rollout. We also closed a $600,000 Advanced Services contract with a global telecommunications company for data migration and storage consolidation. We also closed a $200,000 private cloud project for a health care company and a $400,000 HIPAA compliance and security project for a regional health care system. All these projects offer significant opportunities for follow-on business, including converged infrastructure deployments, virtualization and more, including more Advanced Services. Many of them also increased additional stand-alone hardware sales.

We will recognize the revenue from these engagements as we complete the work over the coming months.

And finally, in the first 6 months of the year, our base of repeat customers grew 8% from 1,783 to 1,918 year-over-year, and spending by that group increased 10%. And the number of customers spending more than $1 million with us climbed 15% from 59 to 68 as we succeeded in selling large strategic data center projects. We saw a similar increase this quarter-over-quarter.

Now to turn to guidance. With the second quarter as a background and after careful analysis of our pipeline and field forecast and after talking with several of our very large customers, we are now going to guide for the third quarter of 2014 revenues between $150 million and $160 million compared to $139.6 million for the third quarter of 2013. This represents an increase in expected revenues of between 7% and 15%. The company expects the third quarter 2014 net earnings to be between $0.11 and $0.17 per diluted share on a GAAP basis compared to $0.04 per diluted share a year ago, and net earnings of between $0.16 and $0.22 per diluted share on a non-GAAP basis compared to $0.13 per diluted share a year ago.

With that, I'd like to turn the call back over to the operator so that we can take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Prab Gowrisankaran from Canaccord.

Prabhakar Gowrisankaran - Canaccord Genuity, Research Division

Just a couple of quick questions. One, on the storage sales, you provided some color. I was hoping you could provide a little bit more on the mix that you're seeing of the new emerging flash and hybrid sales. Is it like a combo sale? Do they still buy existing storage -- traditional storage? Or how does that work in terms of the sales process.

Paul F. Lidsky

Prab, this is Paul. So far to date, what we have seen with our customers is that they are adding flash storage into their data centers for specific application requirements. There are certainly a lot of interest in replacing spinning disk with flash, and that is on the minds of our customers and we have seen some of that. But we have not had customers do a wholesale replacement of a spinning disk platform with flash yet. So right now it's more incremental.

Prabhakar Gowrisankaran - Canaccord Genuity, Research Division

Okay. And in terms of the revenue, you said you closed 5 -- you delivered on 5 orders. It's still a small portion, right, in terms of actual revenues from flash and hybrid storage sales?

Paul F. Lidsky

Yes. In the second quarter, it was approximately $3 million of revenue. So still a small number compared to the overall revenue, but gaining momentum.

Prabhakar Gowrisankaran - Canaccord Genuity, Research Division

Okay. And second question I had was if you could provide some color on the strong growth that you're seeing in the million-dollar customers. Is it mostly VDC and professional services? Or where do you see the growth in this number? Because that seems to be a nice step-up in terms of the million-dollar customers that you have.

Paul F. Lidsky

We have seen, sort of across our portfolio, expansion among those customers. We certainly have had some very large VDC sales to those customers that makes up some of the number of increase in the million dollar-plus customers. We have had some large product refreshes. We have had some -- we have had 1 customer who signed a PO for over -- almost $2 million of professional -- of actually Advanced Services in a single order. And we have had customers who have put together Advanced Services orders that, in total, have equaled greater than $1 million. So it's been a combination of all of our normal portfolio efforts and some standouts among VDC and Advanced Services and overall tech refresh. So what you'd really expect as we take a broad portfolio to market.

Prabhakar Gowrisankaran - Canaccord Genuity, Research Division

Okay. And the last question I had was for Greg. It's just on the services margin, looks like they declined a bit. Is it because of the higher customer support revenues? What's the mix there? Because it looks like, if I just look at your numbers, it's 22.3%, 22.5% for service gross margin?

Gregory T. Barnum

It really relates to the fast -- faster ramp-up of our Advanced Services business. So it's the downtime, the bench time, because we have to have people on staff because the business is growing. They grew at 36%, the Advanced Service part. So it's just bench time, which will decrease as the revenue grows. But we have to keep extra people on hand in anticipation of these orders ramping up.

Operator

Your next question comes from Chad Bennett with Craig-Hallum.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Just a couple of questions for me. Is there any way to quantify kind of the benefit this quarter from maybe business that slipped into it from last quarter?

Gregory T. Barnum

Yes, we didn't go down account by account yet, but we missed our -- we missed the midpoint of our first quarter guidance by about $17 million and we exceeded the midpoint of our second quarter guidance by about $9.5 million. So that's about as close as I can get for you there, is that we saw a good portion of that miss in the first quarter come back.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

And then, Paul, is there a way to think about how much of the business today is based on or driven by converged data center deals or VDC deals, or whatever you want to call it, kind of next-generation data center-type revenue versus maybe I don't want to call it kind of plain vanilla capacity buys, but just kind of more kind of maintenance-type storage buys or server buys or networking buys?

Paul F. Lidsky

Sure, I'll do my best. I would tell you that the -- well, I'm not sure I could peg an exact number. I would tell you that the overwhelming majority of the pipeline, that the discussions we have with our customers and the work that our field sales, and especially our field engineering does, is really around discussions with our customers around next-generation data centers of one type and another. It may be virtual data centers, it may be a discussion about a private or hybrid cloud, it may be about introducing flash technology. But most of our work is about doing something transformational with our customers and that makes up most of the conversations that we have and I would say a majority of our pipeline. And then all of the Advanced Services pipeline that we see is really about helping customers change something in the way that they run their data centers or the way that they look at their data centers. And so that really occupies most of our time and it gets translated ultimately into sales with different technologies and different combinations of product and services, but that's really what we spend our time doing.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Okay. And Paul, you spoke about -- obviously, you guys had a nice rebound quarter this quarter. When you spoke about sales cadence, I think you talked about still a little bit of lengthening, to some extent, in deals. I obviously see the guide for the September quarter and who knows what happens 3 months from now. But is there any reason that we think the December quarter isn't kind of a normal seasonal quarter for you guys from what you can see today, at least?

Paul F. Lidsky

Given that our visibility, as you know, Chad, is at best 90 days, which is why we only guide at a quarter at a time, at the same time I would tell you that we have seen no reason, no evidence to suggest that fourth quarter won't be the normal type of -- a normal -- a typical fourth quarter. I think you're asking about budget flush and the uplift that comes with that in the fourth quarter. We don't have any reason to believe that the seasonality of this year's fourth quarter will be any different than the other fourth quarter based off whatever our Q3 numbers are.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Right, okay. One last one for me. Paul, do you have any idea kind of the penetration of FlexPod in your applicable customer base today versus a year ago? Anything like that?

Paul F. Lidsky

I don't off the top of my head. I could try to figure it out, but I don't have that data with me.

Operator

Your next question comes from Eric Martinuzzi with Lake Street Capital Markets.

Eric Martinuzzi - Lake Street Capital Markets, LLC, Research Division

Just kind of a strange one, I guess, on the marketing side. It's nice that you've got that news out with the -- your positioning the top rank for FlexPod and clustered Data ONTAP. But you've been there for awhile. Why were you allowed to do a press release this year as opposed to years past?

Paul F. Lidsky

I think that the best that I can gather, NetApp just decided it would be all right for us to -- we've been asking them for years to allow us to tell our customers and our prospects and our workforce where we are in their landscape. And while we talk about that anecdotally based on meetings that we have, we've always wanted to be more up front and official about it and they came through with -- this time with the ability for us to do so. We've communicated our standing with NetApp among our internal audience fairly consistently over the last several years, but this is the first time we've been able to really communicate it publicly and I think that it was just a matter of us continuing to ask and we're a good partner and they came through for us.

Eric Martinuzzi - Lake Street Capital Markets, LLC, Research Division

Good. The persistence paid off. It's a terrific position to occupy. Second question I have here, you've talked about some of the solid-state vendors and the hybrid vendors. You mentioned Pure and Nimble and Tintri. Just curious, your position with your clients has always been a trusted adviser. Have these people been coming into that same enterprise customer on a direct relationship? And now as a customer pulls the trigger, you're getting every dollar of spend? Or is there a bifurcation in how they're gaining access to your installed base?

Paul F. Lidsky

I think that you can look at this -- the answer has sort of bifurcated itself. I think that if you have a NetApp customer, the NetApp flash discussion is going to be something that, that customer has with us. We go the same for an EMC customer or a Hitachi customer. I think, though, that in the newer entrants, as you say, the Pure, the Nimbles, the Tintris and others, they are bombarding the market with direct campaigns. And so our customers are hearing about flash alternatives from many different sources. Our jobs, as a company, what we have put in place and what our field force is doing, is we want -- because we're trusted advisers, as you say, we want to just simply have a flash discussion with as many of our clients as we can. We are more than capable with them of presenting all of the different alternatives that exist and the pros and the cons, and of course we know their data center environment better than anyone else because we built it. And so we want the spend, but we want to earn it by exposing our customers to what the flash market has to offer and how that might possibly impact them. We expect that a lot of our customers will attempt to stay within -- with the manufacturer they already have on the floor if that make sense for them. And if they determine that it doesn't make sense for them, then of course, we want to be the partner that they choose for whatever technology they bring in. And so that's how we've been approaching it. Now sometimes one of the new entrants gets to our customer first and sometimes we get to our customers first. But in most cases, our customers want to have a discussion with us about how this, over the long term, does impact their data centers.

Eric Martinuzzi - Lake Street Capital Markets, LLC, Research Division

Okay. And you've got the reseller relationships with them that when the customer pulls the trigger on that, the new entrants, you do capture it in most cases?

Paul F. Lidsky

Yes, if we have a customer who wants one of these new entrants and has decided that's in their best interest, we are in a position to take good care of them.

Eric Martinuzzi - Lake Street Capital Markets, LLC, Research Division

Okay, all right. And then next question is on the -- just sort of jumping in the time machine and going back to last year. Q3, last year, there was a negative surprise and it was tied to your ability to get EMC product near the end of the quarter. What changes have you made so that doesn't happen in 2014?

Gregory T. Barnum

Well, I think part of that was due to a ERP system glitch that they had, so I assumed they got the bugs out of that now. They were unable to ship about $100 million, if I recall, and we were about $4 million of that. So hopefully they've got the bugs. Hopefully, that's not an issue this year, yes.

Paul F. Lidsky

We really haven't changed anything that we do as that was outside our control, but we haven't seen a repeat of it so...

Eric Martinuzzi - Lake Street Capital Markets, LLC, Research Division

Okay, and then lastly, the pro services business, you said the Advanced Services was up 36%, I think year-on-year, but pro services in its entirety was only up 4%. Help me understand that.

Gregory T. Barnum

Well, it has to do with timing of installation. So we had a lot of orders come in later in the quarter. June was a very big month for us. And so we didn't have time to get that installation revenue, which we don't record until we do the work. So the actual installation revenue was down, which is just timing. That's not lost revenue, that's just timing. And that offset the growth in the Advanced Services.

Operator

Your next question comes from Aaron Rakers with Stifel.

Aaron C. Rakers - Stifel, Nicolaus & Company, Incorporated, Research Division

First question for me would be you talked a little bit about decision cycles moving forward. Maybe qualitatively, could you expand on that a little bit? How did linearity look in the quarter? And maybe how you're seeing those decision cycles play out thus far in the current quarter? And then I have some follow-ups.

Paul F. Lidsky

Well, from a linearity perspective, I think the quarter followed a fairly normal pattern. We usually get off to a fast start. The middle month of most quarters is a little bit quieter. And the last month, and certainly the last portion of the last month, it becomes extremely busy. I don't think it's any secret to anybody on the call that our clients are very much trained and attuned to the end-of-quarter capabilities that they might have in a negotiation. They certainly try to exercise what they can. Of course, our job is to hold the line on our margins and -- but it creates -- it's created an IT buying behavior that has existed for years where customers tend to hope that the end of the quarter brings them good news relative to pricing. But that creates a normal busy first and last month and sort of a medium activity middle month. So that's how I look -- we look at the linearity. I think in terms of how customers are reacting today, first of all, I think that -- I just came back from a field trip a couple of weeks out talking to customers and the field force. And my interpretation, and it's just simply that, is my interpretation, is that there is a lot of interest on behalf of customers to undertake major projects, which translates into spending at some point in time. I'm a firm believer that if your customers want to have serious conversations with you about large projects, they -- it's because they would like to do them, not because they are shopping for ideas. I think, though, that is, as we said in our prepared remarks, we still see that customers are a little more tentative in making their last-minute decisions. We certainly have examples of CIOs and CFOs and CEOs asking for one more round of, are you sure this is the right thing for us to do? I also think that there's a -- I will tell you that among the customers who are interested in infrastructure to stand-up complex solutions like private and hybrid clouds, there's an increasing understanding that infrastructure alone does not create a cloud, that there is a tremendous amount of work that has to be done around the orchestration and management of the cloud, the services catalog, the way in which customers can interact with the cloud, all kinds of things that you think about when you're running a cloud business, which is why Advanced Services has a practice around cloud services management. So we are reacting very well to the fact that our customers need more from us, but they're beginning to realize that before they pull the trigger on a purchase of infrastructure, they sometimes need to think about what it takes to make that infrastructure successful in terms of solving a business problem. And so I think that generally customers are just taking a more calculated approach to making sure they have their bases covered and that is what we see in the sales cadence. I don't see it as a long-term negative at this point because, as Greg pointed out, the business that did not get closed in the first quarter did get closed in the second. We did not lose the orders. And I think that as most things, as customers become more comfortable with what they need to think about and as we, especially with Advanced Services, have these conversations about business solutions earlier in the sales cycle, I think we'll -- over time, we'll see customers return to a more normal cadence. When that is exactly, as Greg has said, hard to pinpoint for sure.

Aaron C. Rakers - Stifel, Nicolaus & Company, Incorporated, Research Division

Very good. And I apologize if I missed it, but did you guys give the breakdown between disk and servers and networking? Again, I might have just missed that earlier.

Gregory T. Barnum

Yes, we did. Storage was -- no, that's fine. It's all right. Let's see, okay. Storage was 27%, networking and servers were 23%, software was 11%, tape was 1%, just won't die, and service was 38%.

Aaron C. Rakers - Stifel, Nicolaus & Company, Incorporated, Research Division

Perfect. And then the final question for me, I know you talked a lot about flash and kind of what you've been doing on the flash side, which is interesting. The other architectural dynamic that we hear a lot about in the market is this software defined and this role of hyper convergence outside of what's going on with FlexPod or VBlock, et cetera. So have you guys had increasing discussions with customers around software-defined hyper converged solutions? What's your opinion on that? Is that a competitive potential dynamic that is starting to show up a little bit more in your customer engagements?

Paul F. Lidsky

I think that our field engineering organization, our thought leaders of the company, are certainly having conversations with our customers about software-defined and hyperconverged infrastructure. And I know that because we're talking with them, we certainly discuss it. I can't tell you that it's turned into something material relative to our revenues, but it is a discussion that a lot of our customers want to have. I think the good news for us is that there are a couple of different alternatives, all of which we represent. And so it is a good position for us to be, given our role as, whether you call it a trusted adviser or as a data center integrator, for our thought leaders to be able to talk to our customers and help guide them towards what will ultimately be the right alternative for them. But at this point, and I think in the third quarter as well, I don't believe it's a factor in our numbers.

Operator

Your next question comes from Glenn Hanus with Datalink (sic) [ Needham ].

Glenn Hanus - Needham & Company, LLC, Research Division

So you've kind of mentioned in your press release that -- I think the way you put it was customers were completing diligence on newer technologies. Were there any conclusions that -- or observations that you kind of saw in this process? Were there any sort of significant takeaways that you kind of -- you saw from this? And any adjustments to your business or sort of tactics based on that?

Paul F. Lidsky

Well, I think as it relates to new technologies around flash for certain, we -- our takeaway is that, as I said earlier, that our customers are hearing a lot from a lot of people. In the traditional storage world of the data center, as you know, Glenn, you typically -- your customer has a singular focus on the partner they've chosen, in this case, Datalink, and you have ongoing discussions every week, really, about the evolution of their data centers. And for the first time, really, in many years, we have this bombardment of sales pitches and engineering pitches around different technologies for multiple vendors at the same time. So our takeaway from that was that we just had to be sure, tactically, that we were in front of our customers with a flash discussion, not a particular manufacturer's flash discussion, but an overall flash discussion in terms of where our customers might use it, how they might introduce it, how it integrates into the rest of their data center infrastructure. And what we have found is that when we do that, we capture our customer's attention. And not only do we sell flash, but we, for instance, have sold VDCs that have flash for their storage rather than spinning disk. So we've really changed the discussion away from a very specific technology to again, more of a business solutions discussion. And of course that yields flash sales, it also yields VDC and other things. It yields a lot of Advanced Services. But the takeaway is you've got to capture the conversation about flash as an alternative, not a manufacturer as an alternative. And that's -- and so tactically, we're focused on getting to as many customers as we can. We've already trained our engineering organization, our sales organization. Our engineers actually had their own boot camp, if you will, where they brought thought leaders in from around the country and had a week's training and discussion about how best to approach flash technology. So we've taken a lot of action right down to the fact that from a sales management cadence, we take a look at our flash pipeline and associated technologies from the newer entrants, as well as the existing partners we have, every single week. And so we've taken it very seriously, but it's really about getting back to what makes Datalink special in the market. And that's not talking about technology, it's about solving problems, and in this case, it's about helping our customers understand how to consider these different alternatives.

Glenn Hanus - Needham & Company, LLC, Research Division

Okay, got it. Last quarter, you talked about some OpEx adjustments. Has that been fully implemented at this point? And based on the somewhat of a pickup now, any changes in your OpEx plan for the year?

Gregory T. Barnum

Yes, so we implemented those May 6, so it's all part of that in the second quarter. We'll see the full impact of those changes in the third quarter. So we should see our operating expenses decline somewhere in that $750,000 or more between Q2 and Q3.

Glenn Hanus - Needham & Company, LLC, Research Division

And lastly, on the product margin there -- my computer blanked out. I think your product margin rebounded some this quarter and then from last quarter. Could you just talk about the quarter-on-quarter rebound this quarter and then should we think about it being sequentially down in the September quarter?

Gregory T. Barnum

Yes, Glenn, what we saw was a variety of factors. We saw our traditional storage vendors, which have our higher margin, their revenue was actually down, and we saw some new storage vendors' revenue up, but we saw some very high-margin deals in those accounts. So they offset each other even though the mix was a little different. But we also saw -- we earned some larger rebates in the second quarter, which caused our gross margins for product to go up. So the answer to your question is I don't think product margins for Q3 will be higher than Q2. As a matter of fact, I think the product gross margins could be down slightly from Q2 to Q3, but it is all going to depend upon product mix.

Operator

There are no more further questions. [Operator Instructions] There are no further questions. I would now like to turn the conference back over to the speaker for further remarks.

Paul F. Lidsky

Thank you, operator. I just want to close the conference call by thanking everyone for participating this afternoon. Greg and I appreciate it, and we look forward to talking to you again after the quarter is over. Thanks very much.

Operator

Ladies and gentlemen, thank you for your participation. That concludes today's conference. You may now disconnect. Have a great day.

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