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Quantum Corp. (NYSE:QTM)

F2Q08 (Qtr End 9/30/07) Earnings Call

October 24, 20075:00 pm ET

Executives

Shawn Hall - General Counsel

Rick Belluzzo - Executive Chairman and CEO

Jon Gacek - CFO

Bill Britts - EVP, Sale, Marketing and Service.

Analysts

Mark Moskowitz - J.P. Morgan

Brian Freed - Morgan Keegan

Glen Hanus - Needham & Company

J.D. Padgett - Boston Company

Operator

Good afternoon, ladies and gentlemen. Thank you so much for standing by and welcome to the Quantum Corporation Second Quarter Fiscal 2008 Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions). As a reminder this conference is being recorded today Wednesday, the 24th of October, 2007.

I would like to turn the conference over to Mr. Shawn Hall, General Counsel. Please go ahead.

Shawn Hall

Thank you. Good afternoon and welcome. Here with me today are Rick Belluzzo our CEO, Jon Gacek our CFO and Bill Britts, our Executive Vice President for Sale, Marketing and Service.

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 our business prospects, priorities and opportunities, our target business model, and anticipated future revenue, gross margin, operating expense, and income performance, trends in our business and the markets in which we compete, and trends impacting our media royalties and the expected timing and features of new product launches.

We'd like to caution you that our statements are based on current expectations and involved risks and uncertainties that could cause actual results to differ materially. We refer you to the risk factors and cautionary language contained in today's press release announcing our fiscal Q2, 2008 results, as well as to our reports filed with the Securities and Exchange Commission from time to time, including our most recent 10-K filed on June 13, 2007, and 10-Q filed on August 9, 2007.

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

And with that I'll turn the call over to Rick Belluzzo.

Rick Belluzzo

Thank you, Shawn. Good afternoon and thank you for joining us for the Quantum Q2 earnings call. This fiscal year is a critical year for transitioning Quantum into a higher-value storage company with a solid business model and a revenue composition that yields improved longer-term opportunity for growth and margin improvement.

This transition has been greatly facilitated as a result of the combination with ADIC, which we completed just over one year ago. To this end, we had outlined a couple of critical goals for this year, including changes in our revenue mix and continued work in improving our operate model through gross margin and OpEx improvements.

On the revenue side, we are focused on growing our branded business and the higher margin revenue it represents, while allowing lower-margin revenue to decline. At the same time, we are aggressively seeking to build a strong revenue position in our growing disk systems and software business.

On the operating model front, we established a goal to reach non-GAAP operating income of 10% and then exceed this level as we exited fiscal '08. Achievement of these goals will position Quantum well in terms of delivering consistent profitability and cash flow and playing a significant role in the growth segments of the storage industry.

This has been an ambitious plan requiring the Quantum team to continue to drive significant change.

The Q2 results we are announcing today again demonstrate solid progress towards achieving these goals. Since the merger, we have been focused on making incremental improvement each and every quarter and our Q2 results are no exception. Let me provide some detail. At $248.5 million, our revenue was up only slightly on a sequential basis, but within this our branded revenue grew 9% or $11 million, bringing our branded revenue, excluding royalties, to a historic high of 63%.

We are investing to ensure that our sales and service capability can achieve stronger revenue performance, especially as we drive revenue in the emerging disk systems and software segment. We expect the trend towards a higher branded revenue mix to continue in coming quarters.

Furthermore, in Q2 our disk systems and software business experienced sequential growth of just over 60% to $14.8 million. This was largely the result of increased momentum in our disk systems product line. Growing our disk systems and software business has been and will remain a major priority for the company.

We also made excellent progress in our business model. Q2 non-GAAP operating income came in at 8%, the highest in at least five years. This represents a significant improvement over Q1's 5% level and our guidance of 6%.

The improvement in operating income was driven by continued solid gross margins and a significant reduction in operating expenses. Non-GAAP operating expenses declined over $7 million from last quarter and reflect the continued synergy impact from the ADIC merger and more importantly the strategy and investment shifts that we have been implementing over the last three quarters.

The net impact of these results demonstrates solid progress in shifting the revenue stream to a stronger branded revenue mix, along with the increasing revenue contributions from the disk systems and software business, which we have established as the primary growth platform for the company. After John provides more details on our Q2 results, I will provide more color on the progress in building this business.

While the revenue mix shift and small overall improvement was welcome, we still feel that we are not capturing all of the revenue opportunities available to the company. This represents our primary disappointment in terms of overall performance. However, note that we have solid momentum in our operating model. We will now focus heavily on closing this revenue gap. We feel that the addition of new products, continued enhancements to our existing offerings, incremental hiring in sales and changes in our marketing structure will help us do so.

Our new products include StorageCare Vision, a new solution introduced in Q2 that automates the management of the customer's entire data protection environment, including disk and tape systems, backup applications, and San switches through a single pane of glass.

We also recently introduced the Q-EKM, an encryption key management solutions for our Scalar libraries. These management and security products reflect our efforts to provide higher value, integrated solutions to meet customers evolving backup recovery and archive needs.

In addition, in September, we began shipping the scale of 50, which strengthens our competitive position in the entry-level tape automation market. I would also add that our DXi series of disk-based systems with de-duplication, positions us to be a leader in one of the fastest-growing segments in the storage industry.

The de-duplication or capacity optimized storage market is expected to grow more than 100% this year. While we have only been in the market for two full quarters, we are seeing tremendous opportunity and we expect this to be a significant part of our revenue stream.

Our focus on this business segment can be seen across virtually the entire company, as we drive product enhancements, sales and marketing expertise and increased market awareness of Quantum's leadership in this emerging category.

In summary, it was a good quarter for Quantum. We are making solid progress in delivering on our FY ‘08 goals. To this end, the primary ongoing focus of the company will be to improved revenue performance, most specifically in branded products and the disk systems and software category.

With that let me turn the call over to John and then I will return to provide more detail on our disk systems and software business.

Jon Gacek

Thanks, Rick. I'm going to provide additional detail on individual income statement line items, as well as on significant balance sheet changes for the quarter, but before I do, I want to emphasize several key business points from Q2.

First: is our debt and refinancing. During the quarter, we successfully refinanced our ADIC acquisition debt with a $400 million term loan and a $50 million undrawn revolver. Our new debt has a seven-year term and an interest rate of LIBOR plus 3.5. During the quarter, we paid down $20 million of the new term loan, leaving a balance of $380 million as of September 30.

You will also note that during the quarter, we incurred $12.6 million of refinancing expenses from retiring our prior debt facility, of which $8.1 million related to writing off the prior debt's capitalized fees and $4.5 million was related to prepayment penalty we incurred in doing so. These amounts are secluded from our non-GAAP results.

Next: is branded revenue. At the last quarter call, we said we expected branded business to grow in total and in all geographies. In fact, the U.S. and Europe both were up and Asia was flat. Branded product was 63% of our total non-royalty revenue, up from 58% in Q1 and totaled $140 million versus $129 million in Q1. Sequentially, this is a 9% increase.

Growing the branded mix is key to our strategy and to improving our profitability. We expect to continue to invest in sales, our sales team, presales engineers, and service infrastructure to support this objective.

The third key point I want to emphasize is: growth in our disk systems and software revenue. As Rick mentioned, our product revenue in this category was $14.8 million, up approximately 62% sequentially.

This space is growing very quickly and we continue to gain traction, including the emerging de-duplication market. One item of note, in addition to the disk system and software product’s revenue of $14.8 million, we also had $1.1 million in related service revenue, which is included in our total service revenue.

Because of our scale and the significance of our service revenue, SEC rules require us to break out service separately, but to compare us to the smaller scale pure play companies you need to add the $1.1 million to the $14.8 for total revenue of $15.9 in this important and fast-growing product area.

The final key point is: our non-GAAP operating income for the quarter, which was 8% on non-GAAP OpEx of $67.1 million. Our guidance this quarter was to achieve 6% operating income. We clearly exceeded that goal. We made many changes in our expense and operating model over the past year and are beginning to see the benefits we have been discussing.

By improving the model, we have the flexibility to spend more money in areas of strategic focus. Number one: growing our branded revenue and number two: growing our disk systems and software revenue.

Now I'll move to second quarter results and go through the income statement line items and the non-GAAP amounts. Starting with revenue, total revenue for the quarter was $248.5 million. Royalty revenue was $24.5, product revenue was $185 million, and service revenue totaled $39 million for the quarter.

DLT royalties were flat sequentially and LTO royalties increased slightly as LTO-4 shipments began to ramp. As a reminder, when we look forward we expect the LTO royalty will increase as the installed base grows and the DLT royalty will decrease overtime.

For the September quarter, non-royalty revenue was $224 million, of which 63% was branded, 37% OEM. For the prior quarter, non-royalty revenue was $221.7 million, of which 58% was branded, 42% OEM. Rick mentioned previously that is ahead of our target and ahead of anything the company has done in its past.

Now let me move to the three product revenue groupings. Disk systems and software, which we began disclosing this last category as a combined category to allow you to turn our progress. Tape automation systems and devices and media. Disk and software category includes our de-duplication DXi products, our enterprise VTL products, PVX and DX, our StorNext software license, maintenance, and related disk revenue as well.

Product revenue in this category was 14.8 for the quarter. This is a significant increase over the 9.1 in Q1, reflecting growth in our midrange disk products, including the new DXi 3500 and 5500 and some strength in our enterprise VTL products. Our software revenue increased approximately 12% sequentially as well.

We plan to expand our DXi product family in fiscal '08 by adding our DXi 7500 enterprise product. Tape automation systems revenue was $110.6 million in Q2 compared to $108.4 million for the prior quarter, up slightly. Branded revenue increased some and was offset by a small decline in our OEM automation.

Final group is devices and media. Q2 revenue for this group was $59.5 million compared to $64.1 million for the prior quarter, a decline of $4.6 million. Branded devices and media were up $2.7 million, while OEM devices and media revenue was down $7.3. We will expect to see additional declines in OEM devices, as products roll off and we focus on more profitable revenue segments.

As I mentioned earlier, services now a separate line item in our P&L. It includes hardware service contracts, repair, installation, and professional services. Service revenue totaled $39 million for the second quarter compared to $40.1 in Q1. The decrease was primarily due to the decline of out of warranty repair on our legacy devices.

Now I'll move to cost of revenue and gross margin, which for the second quarter of fiscal '08 were as follows. This is on a GAAP basis. Cost of revenue was $170.2 million. Gross margin dollars generated were $78.3 million, and the gross margin percentage was $31.5 million. For the Q1 gross margin percentage was $31.8. So, on a GAAP basis, we were basically flat with Q1. On a non-GAAP basis, second quarter cost of revenue was $161.5 million.

Q2 gross margin was $87 million, or 35% compared to non-GAAP gross margin in Q1 of $87.3 million or 35.5%. The slight margin decline on essentially flat revenue, but with improved mix in Q2 is the net result of recognizing some costs and some cost savings for several clean up items from our manufacturing and operational changes, as well as the IT system integration we just completed.

We believe that, we will continue to see improvement in margin as our branded revenue grows as a percentage of total revenue, as service revenue increases, and as our disk systems and software business grows.

The non-GAAP reconciling items are included in the detailed sheet on our website and in the press release. They include stock compensation, amortization of acquisition intangibles and the debt refinancing. I'm not going to go through each of those here individually.

Moving to operating expenses, I'm going to walk through these on a GAAP basis. Research and development expenses for the quarter were $22.5 million compared to $26.4. This decline is the result of decreasing our investment in the development of tape drives and restructuring our R&D support services model, significant sequential decline.

Sales and marketing expenses were $34.3 million compared to $35.4 million in Q1. This decline is the result of lower spending on marketing, offset by increased labor costs due to increasing sales headcount.

For G&A, expenses were $18 million for the quarter compared to $21.5 million for the prior quarter. The decline here was the result of one-time accelerated depreciation on our IT infrastructure last quarter, as well as we're starting to see the benefit of declining facilities costs. Restructuring costs were $200,000 for the quarter compared to $9.1 million in Q1. Total GAAP operating expenses were $75 million in Q2 compared to $92.3 in Q1.

A few more numbers for you on the non-GAAP items: amortization of intangibles included in operating expenses totaled $4.5 million for Q2 and Q1. Stock-based compensation included in OpEx for Q2 in Q1 was $3.1 million and $2.5 million, respectively. So, excluding restructuring and transition expenses and amortization of stock comp, non-GAAP operating expenses totaled $67.1 million in Q2 compared to $74.1 in Q1.

For the second quarter, we reported GAAP operating income of $3.3 million compared to an operating loss of $14.3 million for Q1. Adjusting for the previously-mentioned non-GAAP reconciling items, we generated non-GAAP operating income of $19.9 million or 8% of revenue for our fiscal Q2. This compares to $13.2 million of operating income in Q1 or 5.4% of revenue. One more measure, EBITDA for the quarter was around, in other words 30.0 million, so that will be 30.0 million compared to 27.4 million in the prior quarter.

Moving on to non-operating items, interest income and other was $1.5 million and interest expense was $24.2 million for a net interest and other expense of $19.4. As previously mentioned, included in interest expense was -- there was $12.6 million of refinancing costs related to our recent refinancing.

Our weighted average interest rate for the quarter was 7.72% compared to 8.72 %in Q1. Our quarterly income tax expense was $1.1 million compared to a benefit of $1 million in Q1. The Q1 benefit was primarily the result of closure of a foreign tax audit and the release of a related contingency of $2 million, which offset our normal quarterly cost of $1 million for foreign and state income taxes.

Our tax rate will continue to fluctuate quarter-over-quarter, as we integrate the legal and tax structures. I actually think this is the first quarter where we’ve actually hit the million that we've estimated. So, maybe, we will be standardizing here so $1 million a quarter, for those of you who are doing models.

Moving on to the balance sheet, as of September 30, cash and cash equivalents and marketable securities totaled $83.6 million. We used $3 million of cash to fund operations during the quarter compared to cash used in operations of approximately $21 million in Q1.

Accounts receivable was $198.9 million, an increase of approximately $23.7 million from the prior quarter. DSOs were 71 days compared to 60 days last quarter. The cash collection cycle continues to be an area where we have a lot of room for improvement and candidly, we need to improve our performance here. We are working on multiple fronts to generate more velocity in this area and to pull more cash in from the balance sheet.

I want to go back to the P&L on one item; I missed an important paragraph I wanted to pass along. When you get to the bottom line, for the second quarter, we had a GAAP net loss of $0.10 per share and a non-GAAP profit of $0.04 per diluted share, a $0.14 impact for the combined intangible amortization stock comp and refinancing expenses. This is compared to Q1's GAAP loss of $0.11 per share and non-GAAP profit of $0.03 per share. So, sorry I skipped over that.

Moving back to the balance sheet, inventory was $69 million, representing a decrease of $7.3 million from the prior quarter. We continue to make good improvements in this area and we still think we have some room to further lower that number.

Since the start of the fiscal year, raw materials and work in process have declined $26 million and finished goods were up slightly by $3 million. Fixed asset purchases for the quarter amounted to $9.1 million and depreciation expense was $5.6. The bulk of the additions are related to our Oracle consolidation project and we had some engineering test equipment as well.

Moving on to liabilities, accounts payable were $84.5 million at September 30, an increase of $7.4 million over the prior quarter due to timing of payments. Total deferred revenue was $90 million compared with $84.8 million in Q1. The increase was primarily due to the growth in service contracts associated with our larger installed base of branded automation products.

As a reminder, the vast majority of our deferred revenue is generated from Quantum branded products and is the result of selling an additional service contract above and beyond the product's standard warranty, or selling ongoing software maintenance.

We expect that our deferred revenue will grow as our branded business continues to grow. Interestingly, this quarter it actually grew more than our branded business and that's just a function of how big our installed base is and how our service contracts roll over.

Looking forward to Q3, we expect increases in branded revenue and disk systems and software revenue and expect total revenue in the range of $265 to $275 million. This is for Q3. We expect non-GAAP gross margin to increase slightly and non-GAAP operating income to be approximately 10% for the third quarter.

For the year, we expect revenue in the range of $1 billion to $1.1 billion and non-GAAP operating income of 8% to 10%. This is an update to our previous annual guidance of 10%. However, this is not a change in confidence in our long-term business model, but reflects some caution on how quickly, we can execute on the necessary growth in the branded business to achieve the 10% non-GAAP operating income target for fiscal '08.

The fact is that in the first six months, we have met our non-GAAP operating plan, despite lower than expected branded revenue by having higher gross margin and lower operating expenses. But to make the next step to get to 10%, branded revenue must grow.

Finally, with the $16 million of total disks systems software and related service revenue in Q2, we believe, we can achieve a $30 million run-rate for these products and services in fiscal Q4. Our launch of DXi7500 will be a key element in achieving that goal.

With that, I'll turn it back over to Rick.

Rick Belluzzo

Thanks, John. As, I said earlier, we are pleased with the progress of our disk systems and software business and I wanted to provide a bit more detail on this progress. This business has several components.

First, the StorNext software offering, which is focused on providing high performance, data sharing and intelligent archiving for heterogeneous environments. Next, the older virtual tape libraries for both ADIC and Quantum and last, but certainly not least, the new DXi family, which combines de-duplication, replication, a high performance file system and other integrated software components in a disk-base platform that spans distributed size mid-range environments and primary data centers.

During Q2, we saw growth in all three categories, but the primary contributor to growth was the DXi series. And as I mentioned, we have now been in the market with this product line for two full quarters. And in Q2, we achieved solid progress in a number of fronts.

We now have exceeded a customer base of over 120 customers across multiple industries and geographies. In the development phase of this market, the key priority is to win new customers with typically a smaller installation of one or two systems. The goal is to then add customers at an increasing rate and then drive repeat purchases as they experienced a strong value proposition and gain confidence in the technology.

In Q2, the repeat purchases started to gain significance. In fact, about a third of our revenue was represented by repeat purchases. The average deal size also more than doubled as we made progress, especially in our installed base obtained customers. This larger account allows us to build on our strong reputation and implement larger solutions earlier in the process.

Leveraging our install base of over 60,000 branded tape automation systems and 3,600 other disk systems and software deployments will continue to be a focus moving forward. We also will continue to capitalize on the many customers that we find looking for combined disk and tape solutions. Disk positions Quantum well as we continue to deliver solid technical and business solutions that allow disk systems and tape to integrate well in customer environments.

Yet another side of our DXi momentum is the fact that a number of large accounts have standardized in our solution. These include a fortune 500 beverage company, a U.S. government security agency, a major international telecommunications provider, a regional healthcare benefits provider in the U.S. and one of the leading international broadcast companies to name just a few.

The overall revenue base with these accounts is still relatively small, but we expect this to grow and become an increasing portion of our future revenue stream as these customers deploy DXi units across their distributed environments.

We are also in the final stages of delivering our DXi7500, which provides unmatched performance and functionality for enterprise environments. Once this solution begins shipping, we will be the only company that can deliver an integrated solution from remote sites to mid-sized data centers and to primary data center environments. We are actively marketing this solution and already have a series of wins in hand.

Finally, we can't minimize the importance of our StorNext software, which is also the core clustered file system for our DXi-series. We continue to expand StorNext market presence in Q2 and with particularly strong growth in EMEA and APAC.

This was the first full quarters of shipments with distributed LAN client capability, which extends high performance and resilient data sharing beyond fiber channel SAN environments to clients connecting via NAS based networks. This let to a range of new customer wins including a major U.S. government agency, a large oil and gas company in China, and two leading defense and technology companies.

Also during this period, Quantum worked with HP, to extend HP sales and StorNext beyond the media and entertainment industry to federal government and high performance computer environments. All of this will contribute to more than a 100, will contribute to the more than 100 petabytes of data already managed by StorNext around the world.

As I mentioned earlier, the DXi product line and our overall disk systems and software business is the growth focus for the company. To this end, we have made significant decisions to prioritize this part of the business.

Furthermore, the disk systems and software business is very synergistic with our mission to grow our branded tape business and that it relies on the same infrastructure, channel model, and customer base. As a result, this represents a significant advantage for Quantum.

In closing, we feel that our Q2 results continue to demonstrate the progress on the critical priorities of the company. Changing the revenue composition into higher growth and higher margin business and achieving the business model that entails double-digit non-GAAP operating income margins. We still have a lot of work ahead of us, but our ongoing priorities are to continue the development of our disk systems and software business and grow our branded revenue base. Progress in these areas is central to achieving our overall goals.

Thank you for joining us. Let me turn the call now back over to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question coming from Mark Moskowitz with J.P.Morgan. Please go ahead.

Mark Moskowitz - J.P. Morgan

Yes. Thank you. Good afternoon, Rick and John. A few questions here first on the overall top-line. You've characterized your disappointment with the top-line in terms of maybe not capturing all the opportunities. Rick: can you maybe just put a little more context around how much of this is? Because you're still filling in some holes, or adding new products to your portfolio, and customers are waiting, versus needing to put more feet on the ground, as far as sales force.

Rick Belluzzo

Sure. I'll let Bill Britts, who is here, who will give the details, provides you more of a summary on that. I think it's a complex set of activities that we have been pursuing. We have been working to build our sales force, as you mentioned. We've been working, completing now the integration process has certainly had a set of issues associated with it.

Having said all of that, I really feel like over the last quarter, we have addressed some of the gaps that we had. And not all of them, but I think we've addressed the gaps, we've restructured and refocused our marketing teams and we’ve made really good progress on adding headcount. Our product line is really probably the strongest now than it's been since we've been a combined company, across the board between tape, as well as the disk-based products. We're heading into a seasonally better period.

So, our minds are really driven around, we've made a lot of progress, we've closed some gaps, we still have more work to do, but we're really driving the revenue piece, because the rest of the business is come together quite well.

Bill Britts

So, let me just amplify on what Rick said. First of all, we're largely through the integration phase in terms of the sales and marketing integration with the acquisition of ADIC. We're really talking at this point of expanding our investments and sales, marketing and services.

If you kind of take the customer base the side of service along with our sales and marketing, we have over 900 people in that organization. Roughly a third of that organization is in the sales that's field sales, inside sales, channel sales, presale system engineering and technical sales.

We have made significant investments in that area. We have somewhere in the order of a 30% increase in the number of sales positions that were built into our fiscal year plan. So, we're about halfway through the year. We've made significant progress on that hiring. We anticipate that we'll continue to see productivity gains from those new hires that we've added over the last several quarters.

From product portfolio standpoint, we have, as Rick said, we have a significant opportunity with our DXi products, but also the ability to sell solutions that include both disk and tape and using some of our recently introduced management tools, like StorageCare Vision in order to really pull together a complete solution. This really differentiates us from the competition that's more single point product focus.

So, we see just kind of in summary, we see a big opportunity. We need to continue to drive against the investments that we're making to take advantage of this opportunity and it's really on the basis of that position that we feel confident that those investments will pay off.

Rick Belluzzo

I would also add another thing that what it was is not an issue today, and that is we feel that the market is fine. I know there's a lot of nervousness about the economy, but we feel like the market is fine. The de-duplication opportunity and the DXi opportunity are very significant. And, even on the tape side, we think it's fine. There are certainly challenges, sometimes with sales cycles and some of the complexity issues, but I think the business is out there. So, I would not tell you that we think there's some market weakness. We view this as our opportunity, we have the ingredients to make it happen, we have to execute and we're pretty focused on that going forward.

Mark Moskowitz - J.P. Morgan

Okay. Just then you mentioned the macro, so you're saying: there has been no change to customer tone or any sort of elongation of the sales cycle?

Rick Belluzzo

I would say, let me be clear, in terms of the overall market, both for tape and -- it says we'd characterize it over the last several quarters. In terms of the sales cycle, there is an element of as people really start to try to understand what they're going to do with this new de-duplication and replication technology for disk-based backup, customers are looking at their architectures. As we mentioned in the release or in the earlier comments, we have a number of very large customers that are in the process or have made standardization decisions around what they're doing with disk-based backups. In some cases, they started that deployments in other cases those deployments will be starting soon.

But, it really is because of the economics and the fact that you've got the ability to combine WAN optimized reapplication with disk-based backup, people are really looking at the backup architectures, how they solve this problem, which has elongated sales cycles that we've been involved with during this uptake phase of de-duplication.

Mark Moskowitz - J.P. Morgan

Okay. And, while we're talking about data, can you either Bill or Rick, can you maybe help us understand, obviously it's more early stages for Quantum versus say Data Domain, but, not trying to compare your new customer reference points versus theirs. I think you guys have a little more leeway, just given you are newer to the party, but it does seem like the directional indications within Quantum are pointing in the right direction.

You've got DXi7500 coming out here later where are you in terms of having enough gas in the tank to go after the competition? And then I guess the second part would be, of these new wins: are these head to head competitions versus some of the entrenched players? Or: can you give us a little more color behind that as well?

Rick Belluzzo

So you've got a lot of questions going on there, but let me see if I can characterize it. Number one is, we actually see accelerated adoption of our DXi technology and it really boils down to several key point, one is the breadth of our portfolio and I am talking about our focus, our specialization on backup recovery and archive and the ability to sell not just a point product, but again, this idea of tape will continue to have an important roll in backup architectures. There are very, very few people, very few end users that envision a totally tapeless type of backup. And in fact, what they're looking at doing is changing the roll of that in order to improve the recovery characteristics. That's why disk-based backup has a very, very important role in these next generation backup architectures.

We win in part, because we have this broader portfolio. We win also because we have the scale, we have the infrastructure, we have a very large installed base of customers that have come to trust us for backup solutions and we have the service global scale in our service and support organizations to be able to support these larger customers that are looking at deployments that go across different geographies.

The last point, and this is an important point in understanding why we're optimistic about our position, vis-à-vis the competitors in this space is the fact that with the 7500, we really have a product roadmap for disk-based backup that really nobody else has an equivalent kind of head-to-head type of comparison.

The reason for that is because we can scale from a remote office single node, less than a couple terabytes, all the way up into a very large scale data center enterprise type of disk-based backup solution that integrates tape and allows you to scale across multiple nodes, there's really no direct competitor that has that same software platform that will enable this. So that's why we're very optimistic, as we kind of look out over the long-term how this all shapes up.

Mark Moskowitz - J.P. Morgan

Okay, great. And two more questions and then I'll cede the floor. John, can you maybe, I guess, get follow up on your prepared remarks: can you clarify? Did you say that the disk offer piece would be $30 million in revenues?

Rick Belluzzo

Yes. We've been talking since the beginning of the year that our disk-based systems and software combined, that group, would be $30 million in Q4, candidly, we did 9 last quarter and many of you are listening, asking me a lot of questions about are we going to get there. This quarter we did a just little bit south of 16, and so the gap now is from 16 to 30.

We look at our funnels, we look at our plan and we think that 30 June is achievable in Q4. The point is that at 30, 625 to 30, a $100 million business that's not even a year old in the products that are there, that's why we're excited about our position.

Mark Moskowitz - J.P. Morgan

Sure and I appreciate that. I guess the follow-on would be: as you try to get to that bogey, is that partly why you're introducing a little more caution on the gross -- on the operating margin targets? And: that you may have to spend a little more on sales and marketing, maybe a little more on R&D, to kind of get that trust behind you?

Rick Belluzzo

It's a little bit of a trade-off. Let me see if I can clarify my prepared remarks. I don’t think that we've done a really good job of reducing our OpEx across the country. And this quarter, we're quite a bit below last, $7 million. We can't continue to cut costs and grow. So, while I feel good about our ability to execute on cost cutting and I also feel good on our ability to spend money, that's also a joke. It's hard to know whether or not it's going to translate into branded revenue right away.

But, I think, the 10% is absolutely going to happen. I think it will happen this quarter for the discreet period and I think it will happen after that as well, but we have to have this business move to the next level, the branded business absolutely has to grow and the disk and software piece is a key element of that. And we see it coming, it's just a matter of when does it come and that's really what the caution comes from.

Mark Moskowitz - J.P. Morgan

Okay. And then just lastly, on the DSOs: did you say that's primarily driven because of cash collections? Or: was it because of linearity in the quarter?

Rick Belluzzo

No, it's good cash collections. The one place we've struggled internally with the IT conversion, in the last quarter we had problem getting invoices out, this quarter we have I can't remember what the issue is, some other technically issuer that we're working. So, it's just a matter of getting the cash in the door.

From a linearity perspective this quarter was pretty normal; our OEM business is pretty spread out across the quarter. Our branded business tends to be more backend loaded in the quarter this one was not unusual that way. And it really is as matters of we just have to do a better job on the collection side.

Mark Moskowitz - J.P. Morgan

Okay. Thank you, good afternoon.

Rick Belluzzo

Thanks for the questions.

Operator

Right. Thank you. Your next question is from the line of Brian Freed with Morgan Keegan. Please go ahead.

Brian Freed - Morgan Keegan

Hey, guys, great quarter! I was far impressed with your data de-duplication business. I was thinking, maybe, $12 million; $15 pretty much blew me away. So, very good job there! Real quick on, I think, you've answered most of my questions, but when you look at your operating structure and your guidance there, I think, to get to the 10% full year, it looks like you had to get to the mid-teens, maybe the high-teens in the fourth quarter to get there and I can see how that would have been a pretty aggressive target.

Is your longer-term view on the potential operating margins of the company diminished at all? Or: is it more a function of you think at this point in the company's life you're better off to balance reasonable operating margins with the growth opportunities that exist?

Jon Gacek

So, I'm going to answer that in two ways and I'll let Rick sort the cap it off. We think that we've done the things to business model that will make us a more profitable company. If you think back a year, the distance we've come is incredibly huge. And we have to transition the company to be, to think about and be a growth company in certain aspects of the business. And to do that, we've got to invest the money. We think the opportunity has never been better than either a legacy company, depending on what period you look at.

We have a great product portfolio, we have the right roadmap, we have the good cost infrastructure. So, we're now teed up, we think we can go on beyond that 10% and we know what it takes to drive that. So we're actually, I would say, more excited about the upside and more excited about the progress, it's just a matter of time for when we break through the 10%. As I mentioned, I think in my prepared remarks, I said approximately 10. I think it's very likely we'll be over 10 this quarter. We'll see how it plays out. It's a seasonally strong quarter, our cost structure is inline, but we've got to demonstrate to ourselves and to you guys that we can do that and then from there we think we can move further.

Brian Freed - Morgan Keegan

Okay.

Rick Belluzzo

Yes, I would add, I'm not sure we know how far we can drive the margin of this business. It really is going to be dependent upon how we build the revenue base of the new business. And that I think is a transition, we talk about transition a lot. That is a transition in our minds, because we're -- there are a lot of people that we've kind of gone through this very tough kind of market decline environment, we now find ourselves in the middle of the fastest growing segment of storage. And we're proud of the fact that we've been able to get there. But now, the model is going to be impacted by growing that business, because the margin on that business is so much better than the margin on other businesses that we've had.

And so, I think that still -- I think we're very positive about that, but we're pretty clear that trying to take another couple million out of our cost structure, if it minimizes or reduces our ability to grow this revenue stream would not be the right thing to do. So, we've kind of made that shift.

To Jon's point, in the last year, the changes that that we have made both from an integration perspective and our changes in strategy have been profound and we've tried to follow all of that, not just slide ware, though we've actually gone through program by program, department-by-department and worked to change everything in the company to take advantage of that opportunity. That's why expenses went down $7 million. And there are just things that we look at today and say given that the opportunity we have, we've got to drive that opportunity and as a result of that, we're leaving things out of the investment portfolio than in the past we might have taken on and that’s really why the expense number declined as much as it did. And so we just think there's a lot of positive trends that can help us improve that margin over time.

Brian Freed - Morgan Keegan

Okay. And then on the non-royalty device and media segment, I mean: that segment's been in pretty rapid decline over the last few quarters. And frankly, given that its an affordable gross margin business, I am not that too concerned about it. But what's, kind of, your view in terms of where you'd like your revenue mix to be? Or: are you more concerned about that top line or really the gross margin number you get off to top line?

Rick Belluzzo

So, I say this in each quarter and I am going to say it again, we don't have any revenue covenants. We are about making money, but that doesn't mean we're going to pursue incrementally profitable business. And, right now, the cycle is such that we're having products roll off and we're not going to reduce our margin on those products.

We have had a number of new opportunities and we've won a few new products in our existing OEMs and those are going to be better businesses for us going forward. We also are going to be launching new devices and we'll be judicious about how we do this. So I would like to see revenue grow there. I just want it to be profitable revenue and the team understands that, we're working hard at it. I give you an example of our media business, you heard me talk about it, the media team did a great job this quarter.

They, I believe, increased both margin and revenue in something that is very, very commoditized and it's really about attaching to the right types of sales, going to the right kinds of channels, and we're starting to do those things.

So, I think that it will plateau here and then it will start to build itself back up some, but it's really just about adding profitable incremental revenue, no target.

Brian Freed - Morgan Keegan

And lastly, on the de-duplication segment, your disk and software services, you're about half the size of Data Domain, who's kind of viewed as the market leader. You're three quarters in; they are three years into the market. Do you, ultimately, think you can catch up to still?

Jon Gacek

That would be a good goal. I think that’s where we, you know we're a $1 billion company, and as Bill I think talked about very well, we have a product roadmap that is unique. We have an infrastructure and scale that is unique to some of the competitors in the space, but this is a hot space. There is going to be other people joining it over time.

The big guys really don't have a play here yet and they likely will. So, there're a lot, a lot of games to be played in this particular arena. I'm not sure in the long-term, I'm going to answer it slightly different to what Bill and Rick said. I'm not sure in the long-term Data Domain is really the ultimate competition here. Some of the bigger companies will have played in here.

Rick Belluzzo

I think it's still very early on. People have talked about the fact that de-duplication will become a feature that all storage systems, primary, secondary, archiving, backup, will have. I think if you kind of looked carefully at the landscape, it mean certainly Data Domain did a very good job of establishing the category for a disk-based, NAS interfaced kind of low to mid range type of system and they've done very well in kind of proving the category and building, I think a very good and solid installed base. But if you look at the big scale of our installed base or the System OEM, or the EMCs net ups, I think to Jon's point, this competition is far from over and it's going to be important to figure out which parts of the market you're going to focus on and what you're going to leverage. We, basically, stated our strategy from the very beginning, it’s been focused on backup recovery and archive.

Already, I think in part, because of the way that they've set up their product structure or product strategy, Data Domain has said that they're going to move into some adjacent markets that are not just necessarily for secondary storage and I think that, part of this competitive landscape that we see out there is that their going to be different competitors that are going to be the strongest players in the different segment, its going to be very important to have a coherent strategy that lines up the assets of what you have for a channel, what you have for service to support, what you're really bringing to the table in terms of your installed base and the competition will really be based off of that.

Brian Freed - Morgan Keegan

Okay. Great! And then one quick housekeeping item, on the gross margin: you said there were some clean up items and kind of tossed into that. Can you give us some sense what the magnitude of those were? Because it looks like from a product perspective, your brand versus OEM, you actually should have had a slightly upward bias to your gross margin versus a slight downtick, drove with the OpEx line, so just kind of wondered: what the clean up items were in terms magnitude?

Jon Gacek

Yes. This is kind of off a top of my head. I can see there is two items: one went one way, one went the other. The net of that was around $1.5 million type of range of expense, additional expense.

Brian Freed - Morgan Keegan

All right.

Jon Gacek

So, [inaudible].

Brian Freed - Morgan Keegan

Great! Well, good job and I am thrilled with the success you guys are having in de-dup! From my perspective, looking at your valuation, I'm not sure: whether you're buying the tape business and getting an option on the de-dup business or paying fair value for the de dupe business and getting tape for free? But, when I look at you guys and Data Domain, it sure seems like a big imbalance in valuation. Would you agree?

Jon Gacek

Well, I think we've to just, I think we've made a lot of progress. I think the $16 million will definitely makes us more credible in that space and the $30 million doesn't look as far away and I think investors, we have to execute and I think ultimately investors will figure it out.

Bill Britts

You guys make that decision, we don't.

Jon Gacek

Right.

Brian Freed - Morgan Keegan

All right.

Jon Gacek

Thanks, Brian.

Brian Freed - Morgan Keegan

All right. Thanks again.

Operator

All right, thank you. Glen Hanus with Needham & Company. Please go ahead with your question.

Glen Hanus - Needham & Company

Good afternoon. Any update on Europe? I guess last quarter that was a little bit of an issue. And: how do you feel like you're executing in Europe?

Jon Gacek

Let me start and I'll let Bill continue: Europe was better. Even in a seasonally difficult quarter in Europe, third quarter is usually tough. Europe did improve. We have a new guy in there leading it. I think, he's not quite been in a quarter, but it's one of the places where we have the most open territories, I think. Do you want to add to that?

Bill Britts

Yes. We characterize Europe, as an area that we're investing and hiring has been more difficult. We have started to make some progress on that front. We anticipate we'll continue to make progress on the hiring front and that will be a key part of how we drive the performance there. We were up this last quarter and we anticipate that the branded business in Europe will be up again.

Glen Hanus - Needham & Company

How do you guys feel about the de-duplication disk? Actually eating into your tape library opportunity?

Bill Britts

I think, it's important to understand that, first of all, we don't control how the end user customers are viewing systems like tape or disk to a great extent. Disk-based backup has been a hot topic for several years. De-duplication has really made the economics, such that it really can become a vital part of these backup architectures.

One other key aspect that is important to understand, with respect to how people make decisions on tape is that at the edge, we see that the administrative costs, the management costs of getting the tapes off-site, all of those things really add additional cost, operating cost, to the model. And that's why we see tape really becoming less over the long-term, less effective at the edge.

At the core data center, you're talking about major, major initiatives. Whether you think of them as green initiatives or you think of them as how do I reduce my overall power and cooling footprint?

Tape plays a really, really critical role in the centralized data center in the consolidated storage area networking types of backup schemes and we see that as a critical part of our strategy of people will continue to buy tape systems. That the role will be a little bit different, you'll still be using tape, but you'll be using disk to manage your service levels for recovery. And that's why over the long-term, tape will continue, especially in the midrange and low-end of the enterprise with open system, nonproprietary tape formats.

Jon Gacek

Well, one of the things that drove us to reduce our investment in tape drives was the point that Bill just made, is that the edge, tape was becoming less and less relevant and out at the edge, it's typically a tape drive and a server or in a very, very small power supply, maybe an auto loader, but probably not. So that trend out on the edge, we've seen coming for a while and that was one of the key attributes that caused us to say we need to invest less money there and focus more on the place where you have differentiation, which is in the automation and more enterprise-class tape products.

Rick Belluzzo

But, I think it would be fair to say in the short-term, if we were only selling tape automation, we would probably sell more than we do now.

Jon Gacek

That's true.

Rick Belluzzo

Because we are adding complexity into the sales cycle, when we sit down with a customer, we think, of course, we replace some of that lost tape with the DXi revenue, but we probably don't replace it all. But we're building a foundation for ongoing sales and growth potential. We feel like we have to do that. We're trying to balance and optimize that well. I just think there's, historically some of these large tape purchases in a quarter. A deal could be very large that I think we are causing to be pushed at times. We think that what tape is there we'll still get, but we are changing the configuration of that because we have new technology.

We just think strategically, that's absolutely the right thing to do. It makes things a little more complex. But it ultimately is a strong hand that we can play, because we have the opportunity to be an objective provider of both systems over time like in our 7500, we have technology that allows you to integrate better with tape.

So, it's all going in the right direction, but I'm sure that we've made our key prospects more difficult than pure tape players which don't have a viable de-duplication solution. But we think that's something we'll balance carefully in order to get the best overall results.

Glen Hanus - Needham & Company

And lastly, from a “feet on the street” standpoint and ramped up expertise selling DXi, how do you -- where are you at? Is there a lot to go? Or: do you feel pretty good about where you are or can you give some sense of that?

Rick Belluzzo

I would say that -- I would characterize it as we've made a lot of progress in the last several quarters. I think certainly we've had the conversations with customers, basically, ever since we brought the ADIC acquisition in-house. We've had those discussions with customers about how they might actually deploy these types of technologies. I think we've learned a lot -- we've learned a lot in part because data de-duplication is dependent on this specific data types it depend on your retention policies. There’s actually quite a bit of consultative work that can go into some of these larger scale types of deployments, and I think we've gotten a lot better that we still have a ways to go. The other part of it is we have hired quite a number of people to go back to fiscal of Q4 of last year.

We've added some more in the neighborhood of 50, 60 people to our sales organization broadly. We've add additional people in service and support. We've add a lot of expertise. The people that we're hiring into those positions typically have come from software or solutions background. So, we are absolutely adding to our capability. I would say we've made a lot of progress, but there's still room for improvement from an execution standpoint.

Jon Gacek

So, I’d say, Glen, if you're thinking about expense, we're probably -- we're behind our plan from branded for the first six months, but we're also behind our plan for sales and marketing expense.

Rick Belluzzo

Yes.

Jon Gacek

And, I think, Bill's team still has open wrecks that they're going to pursue to fill or extend our sales territories. I think we will spend some more money there, but Bill used the execution point. We've hired a bunch of people, we expect them to get more productivity, and that's going to improve too. But, we will spend some more money here. We're just going to balance it because we've made a lot of progress on the spending side.

Glen Hanus - Needham & Company

Okay. Thank you.

Operator

(Operator Instructions). Our next question is coming from the line of J.D. Padgett with Boston Company. Please go ahead.

J.D. Padgett - Boston Company

Yes. I had a couple quick ones. One was -- I think you addressed this just with the slight negative revision on the full-year revenue guidance range. That was more, I guess, the branded effort that you're trying to get back in full momentum right now?

Jon Gacek

It's across the branded spectrum, I guess, I would say. And how much it turns out to be, obviously, we moved the range down, as you pointed out, about $100,000. But its 100 - or I just lost my trail,

J.D. Padgett - Boston Company

$100 million?

Jon Gacek

Yes, $100 million, I lost my zeros. If and that really has to do with where we are on first half and how much we can grow up in of second half. We still think we have upside there, but we don't want to build a model around unrealistic growth from here to there.

J.D. Padgett - Boston Company

Sure. And what's the trick to getting that fixed? Is it just filling the open wrecks and getting those people ramped up and productive and filling the products?

Jon Gacek

I think Bill and I we covered to one is we need to have better utilization on what we've done, we need to hire and fill open territories and we're going to -- we've made some changes in our product market and marketing organization. We think that will help as well.

J.D. Padgett - Boston Company

Is that globally or is that mostly internationally?

Jon Gacek

It's globally. Some of those will be more focused in different territories. Europe is a place we have to hire more people. I would say, in the U.S., we’re not hiring as much; we'll be hiring a few. Is that right?

Bill Britts

Yes.

J.D. Padgett - Boston Company

Okay. And…

Bill Britts

I think the other part of this and this is just natural in terms of kind of this type of product category and where we are in our cycle with the product is, as we showed this kind of, we demonstrate this kind of performance with our disk-based backup solutions, we can get a lot more leverage from channels and partners and to-date, we certainly focused on the channel and trying to basically do business through them. But a lot of that has been heavy lifting by our direct field and technical resources. We expect that over the next several quarters we'll get leverage from the channel.

J.D. Padgett - Boston Company

So, kind, of a halo effect on the de-dup stuff?

Bill Britts

And there is also the fact that because of the product roadmap that we have, because we're building that reference base and as we introduce kind of additional products, it gives us a lot more channel power to be able to get leveraged.

J.D. Padgett - Boston Company

Okay. And the other question was, if I'm doing the math right, even to get to $1 billion for the year, kind of, implies the March quarter is reasonably flat, sequentially, I think, and I know you'll probably have the de-dup stuff that will be up some, but: shouldn't that usually be a period where things are more challenged, seasonally?

Jon Gacek

We give a revenue range right for next quarter and pick your -- any number within that range, Q4 could be sequentially down and you'd still be over $1 billion.

J.D. Padgett - Boston Company

Okay. I was doing the math wrong. I was thinking it needed to be like 260 or something to be at $1 billion, so that would be down slightly.

Jon Gacek

Yes, well, if you picked the low end of the range, then that would be the case. If you did it off of 265, even at 260, you would be over $1 billion. So the $1 billion number is very, very low end.

J.D. Padgett - Boston Company

Okay. Should we be thinking about the March quarter being down seasonally?

Jon Gacek

It's seasonally a tougher quarter, Q3 I'll say it differently. Q3 is by far in a way our best quarter. I'll put a positive spin on it.

J.D. Padgett - Boston Company

Right.

Jon Gacek

Q4 is not as good. It's typically -- there's often things like product introduction cycles that make some of that stuff hard to see, but it would be unlikely that Q4 would be higher than Q3 in total revenue.

J.D. Padgett - Boston Company

Okay. Thank you, guys.

Jon Gacek

Thank you.

Operator

All right. Thank you. Management, there are no further questions at this time, please continue with any closing comments.

Shawn Hall

Well, thank you again for joining us for the call here today. We look forward to again discussion next quarter. And again, I would just summarize, we feel good about the progress, we feel it's consistent, but having said that, I think you get the sense from this team that we're also facing into some of the continued challenges we have and we'll address those as aggressively as we have thus far on a go-forward basis. So we'll look forward to updating you again in three months. Thanks.

Operator

All right. Thank you, ladies and gentlemen, this does discuss conclude the Quantum Corporation second quarter fiscal 2008 conference call. At this time you may now disconnect. Thank you for using ACT conferencing and have a very pleasant rest of your day.

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