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Quantum (NYSE:QTM)

Q3 2012 Earnings Call

January 25, 2012 5:00 pm ET

Executives

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

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

Jon W. Gacek - Chief Executive Officer, President, Chief Operating Officer and Director

Analysts

Brian Freed - Wunderlich Securities Inc., Research Division

Catharine Anne Trebnick - Northland Securities Inc., Research Division

Eric Martinuzzi - Craig-Hallum Capital Group LLC, Research Division

Glenn Hanus - Needham & Company, LLC, Research Division

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

Shebly Seyrafi - FBN Securities, Inc., Research Division

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Quantum Corporation Third Quarter 2012 Conference Call. [Operator Instructions] This conference is being recorded today, Wednesday, January 25, 2012. At this time, I'd like to turn the conference over to Shawn Hall, General Counsel. Please go ahead.

Shawn D. Hall

Thank you and good afternoon and welcome. Here with me today are Jon Gacek, our CEO; and Linda Breard, our CFO. The webcast of this call, our earnings release and a quantitative reconciliation of any GAAP and non-GAAP financial measures discussed today can be accessed at the Investor Relations section of our website at www.quantum.com and will be archived for 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, opportunity and priorities, anticipated product launches and plans, and future financial performance. We'd like to caution you that our statements are based on current expectations and involve risks and uncertainties that could cause actual results to differ materially. We refer you to the risk factors and cautionary language contained in today's press release, as well as to our reports filed with the Securities and Exchange Commission from time to time, including our most recent 10-K filed on June 14, 2011, and 10-Q filed on November 6 -- or November 9, 2011. These risk factors are incorporated by reference into today's discussion, and we undertake no obligation to update them in the future.

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

Jon W. Gacek

Thanks, Shawn. Thank you for joining us today as we report our third quarter results. For today's call, I'm going go to start with a summary of the quarter's business highlights, including revenue momentum and product launches. Linda will provide more financial color and detailed results for the quarter, and then I will come back to discuss our view on the macro environment and provide Q4 guidance.

Overall, we are pleased with this quarter's results and continued strengthening in our model and balance sheet. We had good momentum in both data protection and big data management and archive solutions. Here are several important highlights: First, we had branded revenue growth. This is the ninth consecutive quarter of year-over-year branded revenue growth. The expansion is being driven by adding new customers, increased channel traction and the revenue from new products. Specifically, we added approximately 140 new midrange and Enterprise tape customers. And for DXi, we added 170 new customers in Q3. This is the first time we have reported this number, and to put it into context, we added 120 new DXi customers in Q3 of fiscal 2011 and 110 in Q1 and 140 in Q2 of this fiscal year. We believe this is a very positive trend and is reflective of our product and channel efforts this year.

Our focus on both growing our existing channel and deepening our relationships with those partners continues. On a year-over-year basis, our DXi revenue through to channel increased 23%, the number of channel partners selling DXi increased 19%, and the number of new DXi customers obtained through channel partners increased 73%. All 3 of these metrics are good indicators of the momentum we are gaining with our data protection product and the positioning through the independent channel.

Second, we had a strong quarter with our big data management and archive products, with total revenue for this category up 18% year-over-year and 6% sequentially. Specifically, our StorNext appliances, which includes the StorNext Archive Enabled Library, StorNext M330 and Q-Series Storage system, were very strong, and customer interest in these recently launched products is very high. We believe that our big data strategy of continuing to invest in both StorNext as a standalone software product and new StorNext appliances is the right one and key to our overall growth objectives.

Our StorNext software offerings serves the needs of our installed base customers and our traditional use cases, where users have decided on their hardware choices and want to continue to own the productization of their StorNext solution. Our StorNext appliances enable us to significantly broaden our total available market and more deeply penetrate new market segments by allowing customers to purchase the whole solution from Quantum.

Another highlight was the continued DXi6701/02 momentum in Q2. We thought we might see a slight fall-off from the incredible Q2 launch quarter, but in fact, these products grew sequentially in both revenue and units. In addition, we saw strong traction with our new entry-level DXi4601. We provide the unique offering with our DXi data protection solutions. An analyst firm, IDC, recently completed a study of our DXi solutions, showing that for every dollar invested, customers are seeing a return of $4.75, with the typical time to payback of 7 months. In addition, further demonstrating the leverage we are -- we get as our DXi business grows, the number of customers buying both a DXi appliance and a Quantum tape system more than doubled from the same quarter last year and was up 12% sequentially.

Fourth, our virtual data protection solutions are unique, and we are pleased with the customer interest and response we had in Q3 with our new offerings, the vmPRO 4601 appliance and vmPRO software. These products were launched during the quarter and reinforce our focus on meeting customers' data protection needs in both traditional and virtual environments. Our vmPRO technology, along with our deduplication technology, is also the basis of a cloud-based data protection offering that we will be introducing in coming months.

Finally, our overall sales -- overall, our sales and overall execution have both continue to improve. For Q3, we guided to $170 million in revenue and reported $173.5 million. We had solid results throughout the world and saw a particular strength in Asia. We have made good progress in getting deals closed, acquiring new customers and working with our channel partners. We have much more to do here, but we have improved our execution in the first 3 quarters of this year.

Overall, we are pleased with Q3 sequential revenue growth and our overall sales performance. We definitely had improvement across-the-board in our revenue execution. The key to growth for Quantum is to continuing to leverage our proven expertise and our unique and intelligent solutions to provide customers unmatched value in meeting their data protection and big data management and archive needs.

Now I'll turn the call over to Linda to go through the Q3 results in more detail.

Linda M. Breard

Thanks, Jon. Before I walk through our results, I would like to refer everyone to the financial statements and supporting schedules included in the press release and on our website. It will be helpful to reference those documents as I comment.

Revenue for our third quarter ended December 31 was $173.5 million, compared to $176.2 million a year ago and $165 million in the prior quarter. As Jon noted, we are marking our ninth consecutive quarter of year-over-year branded revenue growth, which was up 3% from the same quarter last year and 5% sequentially.

Year-over-year, we grew branded DXi revenue, inclusive of maintenance, 17%; branded software solutions, including our recently released StorNext appliances, were up 18%; and we had an increase of 1% in branded tape automation revenue. Offsetting the growth in our branded business were planned declines of $5 million in our OEM business and expected reductions of $1.6 million in royalties.

Royalty revenue was $14 million for Q3 compared to $15.6 million in the same quarter a year ago. The primary driver of the decline was expected reductions in DLT royalties.

For the quarter, nonroyalty revenue totaled $159.4 million, of which 81% was branded and 19% was OEM. That compares to nonroyalty revenue of $160.6 million a year ago, of which 78% was branded and 22% was OEM. The primary contributors to the branded percentage increase were growth in our branded DXi revenue, including related maintenance and an increase in our StorNext software and appliance revenue, both of which were offset in absolute dollars by planned declines in our OEM business.

Looking further at various revenue classifications, devices and media totaled $21.9 million compared to $23.9 million in Q3 of the prior year. The primary driver of the decline was OEM devices revenue, which was down $2 million year-over-year.

As a point of reference, OEM devices and media revenue combined was less than $300,000 in the quarter. Branded devices and media revenue was relatively flat compared to the same period in the prior year. Tape automation systems revenue was $70.5 million compared to $72.5 million in Q3 of fiscal 2011. Branded automation grew $400,000 year-over-year, to the highest level in 8 quarters, but was offset by a planned decline in OEM automation of $2.4 million.

Our branded Enterprise and midrange platforms experienced modest revenue growth, while entry-level automation revenue was down slightly during the third quarter compared to the same quarter in fiscal '11. We continue to increase our market share as a result of the disruption in the channel from industry M&A activity, our strong tightly integrated product portfolio and the tape automation attach we get as we sell new DXi solutions.

Additionally, as a testament to the strength of our tape automation product portfolio, last month, Storage Magazine announced that we captured the top spot overall and in all 5 rating categories for both Enterprise and midrange libraries in its Annual Quality Award. The award assesses product features, initial product quality, product reliability, sales force competence and technical support.

This system, software and related maintenance revenue, which includes our DXi, vmPRO appliance and vmPRO software data protection offerings, as well as our StorNext software and appliances for big data management and archive, was $36.3 million in Q3, up from $30.7 million in the prior year and $35.9 million last quarter. This is a record for this product category.

Looking more specifically at disk revenue, as I mentioned earlier, we had a year-over-year increase of 17% in our Quantum-branded DXi revenue, including the related maintenance. Entry-level disk revenue more than doubled over the same quarter in the prior year and sequentially.

The recent introduction of our DXi4601, the industry's first capacity on-demand deduplication appliance, was the primary driver of these increases. In addition, we have had strong interest in our entry-level virtual data protection appliance, the vmPRO 4000, which combines our deduplication technology and technology from our acquisition of Pancetera Software last June.

We continue to have good traction in midrange disk, as demonstrated by revenue growth of 48% over the same quarter in the prior year and 8% over Q2. Big deals, defined as orders over 200k, doubled in Q3 of fiscal '12 compared to the same period last year, and were up 8% sequentially.

Our Q3 win rate in the midrange was 60%, demonstrating that the tremendous benefits we provide customers, including offering twice the performance at half the price of the leading competitor, have proven to be quite disruptive in the market.

At the Enterprise level, branded DXi revenue was down 34% from the same quarter last year and 41% sequentially. Our results last year included revenue from both our legacy products and our newly released 8500 product.

Revenue from our 8500 product increased 17% year-over-year, but was overshadowed by the decline in revenue from our legacy products. The sequential decline of DXi8500 revenue was disappointing this quarter. We believe that revenue has impacted by coming of the release of the DXi 2.1 software that occurred in mid-December because customers are waiting to see the benefits of the new software.

DXi 2.1 software improves the performance of the 8500 by nearly 40%, offers 60% greater capacity and provides industry-leading price performance. Our win rate in Enterprise disk was 53% this quarter. However, we need to continue our focus to get into more opportunities.

Reinforcing the strengths of our disk space data protection offerings for both physical and virtual environments, last week, both the DXi6701 and 02, and the vmPRO 4000, were named as finalist in the Storage Magazine's SearchStorage.com 2011 Products of the Year Award.

Turning to StorNext software and appliances, revenue was at 18% year-over-year and 6% sequentially, marking our highest level of revenue to date. We are very positive about the continued growth in our StorNext business, which was driven by the recent launches of our StorNext appliances, where revenue nearly tripled sequentially and was above plan.

The primary driver of the sequential growth was our Enterprise and midrange archive-enabled libraries, which we have found made StorNext much more competitive in places where we have not been successful in the past. We feel both channel and end-user momentum is growing around these products and our other StorNext appliance offerings, which help drive the significant increase in StorNext customer acquisition, including software and appliances, both year-over-year and sequentially.

This quarter's results do not include any measurable revenue from our StorNext reseller agreement with NetApp or Active Storage.

Moving to service revenues. It was $35.4 million in Q3 compared to $37.4 million in the same quarter of the prior year. OEM out of warranty repair and branded contract revenue both contributed equally to the decline. We believe the decline in OEM repair revenue is timing-related, whereas the reduction in branded contract revenue relates legacy Enterprise and midrange automation service contract revenue declining year-over-year. While we have continued to post increases in Enterprise tape automation revenue over the past several quarters, the service contracts related to newer technology are sold for less than service contracts on some of the legacy products.

Turning to gross margins. Non-GAAP gross margin in Q3 was 43.6% compared to 44.6% in the prior-year period. On a year-over-year basis, non-GAAP gross margin was negatively impacted by the decline in royalties, which contribute 100% gross margin, and the reduction in service revenue, which declined more rapidly than the associated service support costs.

Looking at expenses. Non-GAAP operating expense totaled $60.6 million in Q3 compared to $58.8 million in the prior year. Year-over-year, sales and marketing and general and administrative expenses contributed equally to the increase in absolute dollars, offset by reductions in research and development spend. The primary driver of the increase in sales and marketing relates to incremental salaries and benefits from additional investments we made in the team throughout the past year.

General and administrative expenses were up year-over-year due to increases of $200,000 to $300,000 in a few expense areas, including value-added tax provision and bad debt. We had a net increase in VAT provisions due to interest received on VAT refunds during the prior year that did not repeat and bad debt expenses due to lower allowance for doubtful accounts requirements last year. Research and development expense decreased over the same period in the prior year, due to reduced spending in several areas, driven by timing of projects.

Non-GAAP operating profit for the quarter was $15.1 million or 8.7% of revenue compared to $19.8 million or 11.3% of revenue in the same quarter a year earlier. The largest contributors to the decline in operating profit were the revenue decrease from lower service and royalty revenues, followed by the incremental operating expenses.

Interest expense for the quarter was $2.4 million compared to $4.8 million a year earlier. This included cash interest expense of $1.9 million and amortization of debt issue cost of $500,000. The current coupon interest rate for our remaining senior debt, $69 million at December 31, is 3.8%, and the average interest rate for our total debt will be approximately 3.74% for the quarter ending March 31. For the third quarter, we had other expense of $100,000 due to net foreign currency losses, and we recognized tax expense of $500,000, primarily related to foreign and state taxes.

Summing it up for Q3, we had non-GAAP net income of $12.1 million, with non-GAAP fully diluted EPS of $0.05, compared to non-GAAP net income of $16.4 million and non-GAAP EPS of $0.07 in the same quarter a year earlier.

Now focusing on cash flow for the quarter and the balance sheet at December 31, I would like to highlight several key points. Cash flows from operations for the quarter were $16.1 million. We paid down $200,000 of our senior debt in Q3. At quarter end, the competition of our debt was $68.6 million in senior debt and $135 million of convertible debt. We ended the quarter with $63.2 million in cash.

Bank EBITDA for the quarter was $21.6 million. We are in compliance with all debt covenants at December 31, and we expect to be in compliance with our debt covenants during the next 12 months.

EBITDA for the last 12 months was $67.6 million. For purposes of computing EBITDA for the last 12 months, the net loss of Pancetera Software for the 5.5 months prior to the acquisition has been included in the computation.

On a sequential basis, manufacturing inventory increased $8.4 million, due to increased stocking levels of hard disk drives in response to the events in Thailand. Accounts receivable increased $6.5 million, and we had an accelerated payment of $7.5 million from one customer.

CapEx was $2.5 million, and purchases of service parts inventories were approximately $300,000. Depreciation, amortization and service parts lower of cost or market expense totaled $11.8 million for the quarter.

To summarize the quarter, we continue to grow branded revenue, including branded tape automation systems and disk and software revenue, including appliances. We released several new products and added features and functionalities to other products as planned, and we have seen the ramp in sales of those products.

Our overall product portfolio is solid, and we feel we are well positioned to further expand on that. On the balance sheet, we generated cash from operations, which we retain this quarter to allow for flexibility around investment levels and inventory, specifically in hard disk drive.

To date, this fiscal year, we have paid down $36 million of the term debt. And looking forward, we will continue to focus on generating cash from operations and further paying down the term debt.

And finally, I just wanted to provide an update on the impact to our business related to the flooding in Thailand. Currently, we see minimal impact to our fourth quarter of fiscal 2012, as we have visibility into our supply chain pipeline, we have increased hard disk drive inventory levels and are continuing to use existing stock on hand. We will continue to actively monitor and manage this in the upcoming weeks and months, with the goal of supporting our customer requirements without any interruptions in supply.

Now let me turn the call back over to Jon.

Jon W. Gacek

Thanks, Linda. We are 3 quarters through our fiscal year, and so far, we have made progress in 2 key areas: first, the introduction of new and differentiated products that provide unmatched value; and second, improved sales execution and performance.

This year, we have launched a broad range of new data protection and big data products and enhancements, and expanded our partnerships. On the data protection side, this includes our DXi6701 and 02 appliances, and DXi 2.0 software. All our DXi products are now on the support generation software which provides industry-leading performance and price performance.

After acquiring Pancetera Software in June, we launched our vmPRO virtual data protection appliance line in August, enhanced it in October and also introduced vmPRO software. We believe that the vmPRO product line is a unique solution for solving data protection requirements in virtual environments and opens an important new market opportunity for Quantum.

In addition, we enhanced the scale of our i6k with dual robots and other features while expanding our tape OEM agreement with HP. For small businesses, we introduced our NDX NAS appliance and RDX removable disk library. And in the area of big data management and archive, have rapidly expanded our offering with the StorNext appliances. And we expect to get contributions from our partnership with NetApp and Active Storage too.

As a reference point, revenue from products launched this year totaled $17 million in Q3. On the sales front, we have improved our overall execution and our traction with channel partners. This is a combination of enhancing our relationships with existing partners and adding new partners. We will continue to drive improvement in both areas this quarter and next year. It is not a coincidence that our sales execution improves as our products improve. Our market opportunities increased, and our end-user awareness increases.

In a minute, I will provide guidance for Q4, but before I do, I want to give a little color on next year and several initiatives that we are working on now that will be important for our fiscal 2013 growth objectives.

In fiscal 2013, we expect to grow total revenue, with increases in both our data protection and big data management and archive solution revenue. We expect the growth to be driven by DXi, StorNext software and StorNext appliances and better-than-market performance in branded tape automation. We also think our vmPRO virtual data protection products will be very important in 2013.

In addition, this quarter, we are launching a focused plan to grow our small to medium business revenue that will be a key initiative throughout fiscal 2013. SMB is a market segment that Quantum was historically strong in through our tape devices and media offerings. However, the SMB market has evolved and, in many cases, moved to other technologies. With the introduction of the DXi4601, the vmPRO 4000 and our NAS and our RDX solutions, as well as our existing tape products, we now have a much more relevant and valuable set of solutions as to provide SMB customers.

In fiscal 2013, we will also launch a cloud-based data protection and recovery solution based on our DXi deduplication and vmPRO software. And finally, we believe this is the right time to really drive end user awareness around Quantum's data protection and big data management and archive solutions, including our upcoming cloud offerings. We have unique and disruptive technology that provides unmatched value, and we have the expertise to help customers migrate to new architectures.

Turning to guidance for this quarter. We decided to provide a range rather than a point number, as we have done in the past quarters. The reason for giving a range is that there are various factors and uncertainties that could impact our revenue performance both negatively and positively. More specifically, historically, Q4 is a seasonally weak quarter and the economic picture is not clear, particularly in Europe. But we feel optimistic about our market opportunity in both data protection and big data solutions, our strong portfolio of both new and existing products and our growth in sales channel growth initiatives. So we are guiding to a range of $160 million to $170 million in revenue, non-GAAP gross margin of 43% and total non-GAAP operating expense of $62 million to $64 million. Interest will be approximately $3 million, and we still believe it's reasonable to model tax expense of $1 million per quarter. Assume weighted average shares outstanding will be $240 million.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from the line of Shebly Seyrafi with FBN Securities.

Shebly Seyrafi - FBN Securities, Inc., Research Division

So maybe you can talk about the puts and takes on the gross margin line. Gross margin was down more than I was anticipating. How much of this was higher disk pricing? How much of this was increased competition with EMC in the marketplace? Just elaborate on the puts and takes on the gross margin line and why, additionally, you expect it to decline in the fourth quarter.

Linda M. Breard

Sure, Chebly. So the biggest drivers, like I talked about, were mostly around royalty revenue. Royalty revenue is down $1.6 million with 100% margin, and the service decline of $2 million were the primary drivers year-over-year for that decline. As far as the disk drive pricing and impacts to bond [ph] cost associated with that, that wasn't impact -- that wasn't impactful to the quarter. So the largest drivers were the items that I talked about.

Shebly Seyrafi - FBN Securities, Inc., Research Division

That was a year-to-year answer. But what about sequentially, what were the declines sequentially?

Linda M. Breard

Sure. Sequentially, the -- one of the biggest drivers of the decline was related service parts and our E&L allowance associated with that. So we look on at usage. We do a lower cost to market analysis on that based usage of service parts. And those numbers can fluctuate and that expense can fluctuate quarter-over-quarter. And it was lower than the run rate has been in prior quarters, and it hadn't flexed upward this quarter.

Shebly Seyrafi - FBN Securities, Inc., Research Division

Okay. Separately, can you talk about your outlook for the disk segment in the fourth quarter? Are you going to have 8500 for a full quarter with the 2.1 software? Do you expect that, that segment to increase sequentially?

Jon W. Gacek

I'm trying not to -- or let me say, we are trying not to manage you guys on a product-by-product basis. I do believe that having 2.0 out, and so customers can put their hands on it will, will help. What was interesting if you -- in Linda's comments, our win rate was actually 53%. And I think what we saw, as we saw deals pushed, we didn't lose deals because win rate mean somebody else won. And so I think the team is focused on getting 2.0 out and letting people see the benefits that were described in Linda's section. The challenge on the sequential, just as I mentioned, this is a historically down quarter, and there's other factors that impact, do we pass a fed budget, what happens in Europe. On whole, 2.0, 8500, 6700, those are all positives. How are those get impacted by some of these other macro things are things we don't control, it's harder for us to see. And it's actually a really good question around why we gave the guidance the way that we did, because we just -- we see variability. So -- well, I think the trends are good, but we still have to go execute on the quarter.

Shebly Seyrafi - FBN Securities, Inc., Research Division

Okay. Last one for me. When do you expect the StorNext sold by NetApp to be more material to your revenue going forward?

Jon W. Gacek

That's a good question. I'm encouraged -- others have asked me they should ask NetApp that. My view is this: Our relationship with them, our interaction with them, continues to increase. I think, my observation is this is their product that they're selling. They're trying to integrate and digest a new company that they bought in Engenio. And we're just a part of that. And I think it's a different focus for them. We have lots of positive reaction. We've got lots of activities in the field. We've dedicated resources. They've dedicated resources. We haven't built any of that into our numbers. And we view it as a good upside opportunity. And we think it's an important one. The question of when is one I can't answer you. I like the momentum. I like the interaction. I like the way we're positioned. But I don't know when it's going to take off.

Operator

Our next question comes from the line of Alex Kurtz with Sterne Agee.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

Linda, did you give a breakout on the midrange versus the high-end and the Enterprise DXi?

Linda M. Breard

We talked more about growth year-over-year in those and sequentially versus how much of the whole disk business was Enterprise versus midrange, Alex.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

Okay. So, Jon, it looks like the win rates on the midrange from last quarter were up a little bit, it looks like. And maybe the win rates on Enterprise were sort of flattish. So should we just interpret sort of the flat DXi and software business sort of just because of this, the 2.0 release, and that's really just all that's there?

Jon W. Gacek

I think that's probably the most important negative trend, if you want to call it that, or impact against the growth we're seeing. And I think there's other things in there, Alex. We added a lot of customers. People are -- that means more people are trying the technology. We had a dramatic increase, I think it was 73%, in new customers from channel. Those are all really good signs to me. I just -- as we've talked about this call, I don't think it's -- there's just an up and to the right spot that I can just point to each quarter. All the trends underneath what we’re doing are really good. I think the other one that comes into play is the StorNext appliance's launch this quarter. That has the impact of expanding deals. But also, we've seen in the past, as we launch products, in the launch quarter, we get some uptick, but we get some push as well. So there's no question that the growth of the company is going to be drived around this set of products and others that we launched in this space. And we're getting -- we've gained increase traction. We've got -- our growth in customers is great. So I think we're going directionally the right way.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

I guess, what I'm trying to piece together is -- and by the way, the DXi customers is a great data point and, hopefully, you can provide that going forward. So you had a really nice uptick sequentially on that front. Why not the flow-through in revenue? It's just that these are smaller transactions, Jon, and not having Enterprise there sort of kept sort of the upside potential out of the number?

Jon W. Gacek

Yes. So I think it's probably right. If you did all that, we didn't do this, but -- and listening to your question and the description. I would say the deal size, by definition, got smaller. But that's fine because it gives people in the technology and it's a super scalable product. If you recall, it goes from 8 to 80 terabytes. And on the high-end, we've come out with the new platform as well, with more capacity at higher performance. And so I think, again, deal size is generally in these starts smaller and grows. But at the scale we are, you're going to have lumpiness, you're going have some big deals that skew things one way or the other. I really like the 170 new customers. I like the number of customers that's being driven from the channel. And I like the fact that our win rates are good, and I want to see it translated into more revenue. And I just think it's a matter of time.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

Last question for me. You mentioned on your -- in your prepared notes about the SMB market sort of changing how they do backup, if I heard you right. And you're introducing a new cloud offering. To me, it seems like the 6700 series is really always meant for the SMB market. Are you having a disconnect on customer definitions? And you're really talking about much smaller companies?

Jon W. Gacek

Yes, we're going smaller in that. So these are the customers who historically have bought a lot of standalone tape drives and a power supply, for example. And now they're buying NAS products or something else to do backup. We've never had a NAS product, and now we've launched the low-end one. We've got this removable disk autoloader. We just haven't had products down there. And this is going back to a place of people who have standalone tape drives or people who used by servers with tape drives in them. They just don't exist anymore. So this is really about going back through the -- a very successful channel that we've had at Quantum, where we sold a lot of product to really small businesses. I think the line between medium is definitional. Certainly, an 8 terabyte DXi would be a potential product for an 8 -- or a medium business. But this is actually going below that and broadening out the number of products that our broad resellers can sell.

Operator

Our next question comes from the line of Eric Martinuzzi with Craig Hallum.

Eric Martinuzzi - Craig-Hallum Capital Group LLC, Research Division

I wanted to come at the March DXi from a little bit different angle. You've actually had pretty good sales execution, at least growth, in the DSS this December quarter, as well as September. And by that, I mean, September were up 17% and were up 18% in December. Is that -- is there a comfort zone around high-teens growth rate there? Is that -- is there a reason that might be substantially higher or lower come March?

Jon W. Gacek

Eric, we didn't -- I didn't do the math. And I’m not answering it, and I don't know. I think the point that I tried to make in the prepared comments is, I really like the progress and the momentum we have. And the things that we control, I feel good about. The parts that we don't control, I'm trying to be cautious about. And so if you use the range that we had and you thought about our traditional mix, that could be swung pretty dramatically by a number of different initiatives. So we've been doing a good job, I think, this year, of setting what our targets are and then trying to exceed those. This quarter, that seemed more difficult as we looked around the world and looked at what was going on. On those products, specifically, there's no question, if I take it more than a quarter. So go past one quarter, it's going to be down to that. But the system and software products are absolutely the growth engine behind what we're doing. And there will be -- we're going to break 40. We're going to break 50, I think, too, at some point along the line here. So if it happens next quarter or not, I don't know.

Eric Martinuzzi - Craig-Hallum Capital Group LLC, Research Division

All right. And then, if I could, just one more on the operating expense. Substantial investment here, I assume that's a human capital investment with the operating expense range of $62 million to $64 million. If I look at the mid-point of that, again, comparing it to where you were a year ago in the March quarter, it's up about 5%. And I'm just curious to know where is the investment? What's the investment focused on? Is it all sales and marketing? Is there an R&D element there?

Jon W. Gacek

Yes. So most of the increase -- I'm going to make sure I get -- Linda can correct me if I'm wrong, but I think I'm right on this. R&D is fairly flat. It's up just a little bit, I think.

Linda M. Breard

That's right.

Jon W. Gacek

Yes. And so most of the increase is in sales and marketing, and I would say, in 2 areas: It is in more people coverage, so more people touching more partners and end-users; and it is, I would say, more technical expertise as we move into these new markets. And I have felt for a while, we're spending ahead of the curve on R&D. And these are -- this is fairly nominal amount. 5% is fairly a small number for how we manage things. And I think we've managed things pretty tightly on the expense side. But there is no question around our place that we feel this is -- this next year is the year for us to grow, and we're actually getting started early. So some of those initiatives that I mentioned, like the SMB, we decided to start funding that now. The awareness campaign, we started funding now, so that when we hit April 1st, we're already ahead of it because we're really going to push our position this coming year. Some of that is investment into next year, if you want to think about it.

Operator

Our next question is from the line of Glenn Hanus with Needham & Company.

Glenn Hanus - Needham & Company, LLC, Research Division

Jon, can you talk a little bit about the competitive landscape in the StorNext appliances, and – why don’t you start there.

Jon W. Gacek

Sure. So StorNext, as we've talked about, has been a very unique technology focused in the rich media space, the government into some extent, oil and gas, or other big data segments. And we've been managing big data before. People talk about big data. And the Anna Stevens of that technology was managing the satellite download or feeds from satellites 15 years ago. So that technology has been tried through and very robust. And historically, we would compete against things as simple as an NAS boxes. People would use lots of NAS boxes store this unstructured data. But what's happened is a couple of things. One, there's been technology changes, which I will address next. But data has grown, and the needs for data have grown so much. And people's desire to monetize data have grown so much. So whether it's going from standard def to HD to 3D to streaming media to home set-top boxes, PCs, iPads, all those types of applications, to all of the data people are using for analytics today, there's just an obscene growth in the amount of data and unstructured data that people want to archive and then use. So for us, when we appliancized StorNext, what it did is it broadens out the types of markets that we can sell into, and it also deepens into the markets we already sell into we can go further. So we run into things like scalable NAS. We run into other file system companies like GPSS from IBM. We still would run into regular NAS boxes. We even will sometimes run into just block storage. The value proposition for us and why we're appliancizing is StorNext is super high performance. It's very good at large files. And we offer a tiered architecture to customers. So that we're not just going to sell them a bunch of disk. We're going to sell them a tiered architecture that's going to include a tape and disk. In the future, it will include SSDs tape and disk. We'll have other disk technologies in the future, as well as targets underneath it. So we're going to provide a tiered architecture, where we can meet or exceed the customers' performance objectives, but at a much lower costs. And that's really where we get traction. And that's how we compete against all of those different technologies. The other thing is, is that, in this big data, there's a consolidating need for having archive and data protection. And what's interesting about the way that we solve that problem, if you have a big disk archive, you got to have another big risk archive. There's no easy way to backup a scalable NAS box, and provide a data protection layer. In our solution, we can provide both. And one of our unique value proposition is the combination of an archive solution and providing a data protection layer out a very low cost. So the appliancization [ph] strategy is critical for us, and it's going to accelerate. And you're going to see us have more of this because customers get it. It's easier for channel partners to sell and position, and it's a lot easier for customers to implement. And we think we're unique this way, and we're going to drive on it hard.

Glenn Hanus - Needham & Company, LLC, Research Division

And then from a go-to market perspective there, can you leverage the channel work that you've done already in the DXi side? Or do you need to go recruit some different partners? Or how should we think about that?

Jon W. Gacek

Yes. So historically, the standalone StorNext software has been sold through a small set of partners, and it's often -- the deals are brought to us from disk vendors. Our big partners for StorNext have been disk vendors in the past. We expect to still partner with those vendors and let our StorNext software be used in different hardware configurations. But our appliance strategy is really to leverage our key, and I'll call them premium or platinum, traditional storage partners. So I was just out this week, last week, actually, at a partner meeting. And there's a ton of excitement about StorNext into our VAR channel into the accounts where we traditionally sell data protection product. And now the partner can go in and sell both data protection and big data archive. And we're going to make it easier. We have work to do still. But because of the way we've gone about this, we're very well positioned. It's easy for us to transfer that knowledge. And I think you'll -- we're going to expand our focus. And this year besides bringing our channel up to speed, we're really focused on life sciences. We think in the life science space, we have a very, very unique offering. And so we have a number of partners, for instance, who are -- data protection partners today, who have important life sciences practices. They're super excited about what we're doing.

Glenn Hanus - Needham & Company, LLC, Research Division

So, like that scenario, you try to take on Isilon?.

Jon W. Gacek

Yes. There -- Isilon certainly is in that space. They're just plain disk in that space, too. I don't know if I didn't do it this quarter I still do it in investor deck. But the use case I show where we sold a pretty large system earlier in the year, that was against traditional disk vendors, and we're about 1/3 in the cost. And the performance is actually better in that particular use case because tape is superfast for big files and so as StorNext.

Glenn Hanus - Needham & Company, LLC, Research Division

Okay. Last one for me. Just back on the 8500 for a minute. On the -- I mean, that's more of a direct sale. Do you feel like you have everything in place for a good ramp over the next few quarters now in the 8500? Or what fixes do you need to make still in the organization? Or kind of where are you in that so that we might not see significant downticks like this?

Jon W. Gacek

Well, I think the most important thing, Glenn, is we got to the new architecture. And similar to what happened in -- with the 6700 back in Q1, when you make these architectural changes, we've -- you're seeing delays for sure. I think the product is there, so I'll say it that way. We're going to continue to enhance the product, but there's no excuse on the product. At the same time, we're also trying to be thoughtful about where we compete. I mean, some of these products get into very, very large deals. And we -- our sales team needs to focus on places where we have the most differentiation. And that's clearly in the midrange. And now is again significant in 8500 with the 2.0 software. So I don't think it's a big structural thing. I think there is a -- if you drew a bell curve over DXi, there's no question that the midrange and the low end of 8500 is going to be the bulk of our revenue. But the solution is still more capable than the big guys. Yet, they tend to have more count control on those accounts. So we got to be smart about where we go compete. And we're doing that. So I'm not -- we gave the data that we gave. I always would like to sell more. But I'm not really -- I'm not disappointed about the results. It was -- the most negative thing was the fact that 8500 just didn't take off. But what I was happy about is we didn't lose deals. Our win rate hung in there. So we've got work to do to go close those deals and continue to push the technology. But I'm really pleased about being on one platform. I just think the whole messaging and how we position our customers is critical.

Operator

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

Brian Freed - Wunderlich Securities Inc., Research Division

A couple of quick ones, Jon. So first at the high-end. As you look at your success in DXi, you clearly done really well in the midrange. The high-end, it tends to ebb and flow somewhat. What is your kind of philosophy and objectives in terms of keeping that as a sold-through-the-channel business versus pursuing potential OEM strategies at the high-end?

Jon W. Gacek

That's a good question. So let me try and answer it in a slightly different way than you asked it. I think that it's clear that when we're well positioned to reach the end-user that we do well, and the technology is very good. In these big Enterprise accounts, that is -- the technology might be good, but we're not well positioned. We also have really only one OEM in this DXi space, and that's what Fujitsu and that's very specific to a set of products and it's just in Europe. I think that we're basically -- I think we're underdistributed in DXi, generally. And I think we've got a very unique solution that there are other people who don't have solutions would benefit from. Having said that, OEM business is super lumpy and you don't control it. But if the right partnership came along or the right situation that was complementary came along, and it made sense for us, we'd absolutely do it. And I think now we're in a position where the technology is such that it's very competitive and it would be a real asset for us to have more distribution. And for some of these guys, a real asset is to able to plug a hole in their portfolio. And I -- but I don't -- I would not forecast any of those kinds of things, and I'm certainly not going to build in the numbers. But we would -- we will entertain those kinds of discussions probably more so than we would the last year or so.

Brian Freed - Wunderlich Securities Inc., Research Division

I mean, you made the comment if one came along, you'd pursue it. I guess the philosophical question is: Are you in a mode that you're going to wait for somebody to come to you? Or do you think there's opportunities to actively pursue them from your side?

Jon W. Gacek

I think we'll be a little more proactive than we've been now that we're on this all in the same platform. We've got the product in a position now where we're just supporting one platform. We've done a really good job of being able to report it to other people's technology, and we're darn competitive. And so just because we're interested or we go for somebody, the reason I use those words is, we're not going to enter into deals that don't make sense. And so that's why I phrased it the way I phrased it. And we're not going to go chasing OEM deals. People know where we are and our results, and the products speak for themselves. And so we'll probably entertain that conversations more than we have in the past to the extent that they happen.

Brian Freed - Wunderlich Securities Inc., Research Division

Okay. And on a similar vein, as you look at your investments on the operational side, to drive visibility, to drive sales coverage, are you -- would you say there's a waiting of those to address more of that higher end Enterprise side? Or the more sophisticated VARs and channels? Or are you really probably more focused on your traditional midrange volume size?

Jon W. Gacek

Well, I'd say it's midrange and not volume size. I think it's our -- from an investment into both channel and end-user awareness, it's in the midrange. But when you do that, you just -- you increase overall awareness, and now I'm talking about data protection. On StorNext, StorNext appliances on the big data side, it's going to be very targeted on overall awareness, but also virtual -- or the 3 use cases that I mentioned. And then I think you'll see us drive awareness around how unique our virtualization offering is. Because there's no question that vmPRO, combined with DXi, will be a much bigger part of our value proposition this coming year. And as I mentioned earlier, our cloud offerings is based on those 2 technologies. So we're going to focus on DXi. We're going to focus on -- for data protection, vmPRO for data protection, big data awareness and then kind of overall who's Quantum. We're trying to move away from where the disk drive or a tape company for sure, and I think now is the time to do that. So I don't think it's as much focused on upper end of the market though. The big part of the market in the middle.

Brian Freed - Wunderlich Securities Inc., Research Division

Okay. And then my final question relates to guidance. You mentioned this is the first time you've given a range versus a point. But as you think of the things that you look at as risk factors or upside potential, I guess, what do you think of is the top 2 or 3 things that would drive upside potential, one of the top 2 or 3 risk factors you see that would skew you to the top or bottom end of the range?

Jon W. Gacek

Yes. So on the risk side, it’s the seasonality is Europe, and it's probably the fed budget, if you will. And that's kind of a trickle-down of -- and maybe a trickle-over from impact of Europe. On the plus side, it's StorNext appliances, DXi and the vmPRO stuff with just sort of continued execution on the tape side.

Brian Freed - Wunderlich Securities Inc., Research Division

Okay. Great. And I said that was the last one, but I do have one more. So on the tape side, if you look at the -- your -- what appears to be above market growth rate, particularly on the branded side over the last year or so, how long do you think the disruptions within the historic StorageTek installed base, et cetera, will allow you to drive that above market share trajectory in tape?

Jon W. Gacek

Yes. I think that's only one of I would say 3 things that are helping us there. One is all the product things that we've done. I don't know what the stat was, but we sold dual aisle right away. And it wasn't insignificant. So I think on the productization side, it's a part of it. The second is, is that -- and I think Linda said it and I might have said it, too. As we add new DXi customers, we sell tape. And because the way we've architected the system, and because customers are still using tape as their backup architecture, we're getting tape drag. So we added new customer that are not using the Quantum library, and you buy a Quantum library, now you can use Quantum vision software and manage the whole thing. We get benefit there, too. And then the third one is around the channel stuff. And StorageTek's installed base, they're still -- I don't know how big their business is going to be when -- their tape business when the new stats come out. But I still think there's more for us to do there. I think with dual aisle we can even be more aggressive because there's a lot of 8500 business that we just -- they're dual robot -- excuse me, I just got distracted -- dual robot. I forgot we did on the same aisle. Dual robot allows us to go after some of the big 8500 business that we just historically have not. So I don't know when it will go away. I don't think it will ever probably go away completely. But there's plenty for us to do still on the tape side.

Operator

[Operator Instructions] And our next question is from the line of Catharine Trebnick with Northland Securities.

Catharine Anne Trebnick - Northland Securities Inc., Research Division

Two questions. One is on the debt. Is there any plans to accelerate the payment of that down?

Jon W. Gacek

We'll look at the end of the year and decide. We decided to accumulate cash this quarter for the reasons Linda mentioned. We would all like it to pay it off. And it's one of our focuses. But we'll look at it at the end of the year.

Catharine Anne Trebnick - Northland Securities Inc., Research Division

Okay. And the other thing is, could -- you gave a little bit of an explanation on the service gross margins are down more so than they have in the past. Any particular color on that would be appreciated.

Jon W. Gacek

Sure. Linda talked about it in 2 different -- 2 separate things. One is the service revenue was down. So the top line was down. And then we have -- we amortize or we actually going to amortize, we do a fair market value analysis of our service parts. And that was up this quarter at a higher level than it had been, both last quarter and on a run rate basis. And those 2 things came -- coming together impacted the margin. I think you have to look at kind of over time it's going to fluctuate up and down, quarter-to-quarter. But those are the 2 big pieces this time around.

Catharine Anne Trebnick - Northland Securities Inc., Research Division

Okay. And then last question -- that helps. And the last question is around your distribution strategy. Is there any flavor you could give us or color around looking at how many of your partners contribute to the revenue, as well as separation of how many of the partners are really focused on SMB? It looks like you're very focused on that market segment go back after it since that's where the heritage of the company came. Is the any way we could dissect that better?

Jon W. Gacek

So I'm going try to give some numbers. I might have somebody correct me if I get this wrong. But we have about 4,000 active partners. Any one period, maybe 1,500 or so are selling things. And we've probably got right around 80 platinum partners around the world. So those platinum partners tend to sell the higher end solutions. Then we've got another set of partners that are gold partners. They would sell the same solutions, but not as many. And then we've got a big group that sell the smaller stuff. And so we're really going to put a focus on that bigger group. But still, the bulk of the revenue comes from that, the midrange Enterprise products. So we think we've got a lot of reach with those partners, but they don't to a lot of revenue, vis-à-vis the -- those midrange and high-end products who have been driving a lot of our growth. So we think this is an opportunity for us, and it's a place that we're starting now because the products are done. But we'll -- we're going to start rolling programs out and messaging out now and drive through the year.

Operator

[Operator Instructions] And I'm showing no further questions at this time. I'd like to turn the conference back over to management for any closing comments.

Jon W. Gacek

Thank you very much. I appreciate everybody attending. As a reminder, the March quarter is our fiscal year end, so our call will be a little later, be in the month of May, right, in May. So we'll talk to everybody then and appreciate the support. And we'll talk at the end of the year. Thanks very much.

Operator

Ladies and gentlemen, if you'd like to listen to the reply of today's conference, please dial 1 (800) 406-7325 or 1 (303) 590-3030, using the access code of 4505960, followed by pound key. This does conclude the Quantum Corporation Third Quarter 2012 Conference Call. I'd like to thank you for your participation. You may now disconnect.

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