Quantum Corporation F1Q09 (Qtr End 06/30/08) Earnings Call Transcript

| About: Quantum Corporation (QTM)

Quantum Corporation (NYSE:QTM)

F1Q09 (Qtr End 06/30/08) Earnings Call Transcript

July 29, 2008 5:00 pm ET


Shawn Hall – VP, General Counsel, and Secretary

Jon Gacek – EVP and CFO

Rick Belluzzo – Chairman and CEO

Bill Britts – EVP of Sales, Marketing & Service


Brian Freed – Morgan Keegan

Glenn Hanus – Needham & Company

John Fichthorn – Dialectic Capital Management


Good afternoon, ladies and gentlemen. Welcome to the first quarter fiscal 2009 conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator instructions) This conference is being recorded today, Tuesday, July 29th, 2008.

I would now like to turn the conference over to Shawn Hall, Vice President and General Counsel. Go ahead, sir.

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 Sales, Marketing and Service. The webcast of this call, our earnings release and quantitative reconciliation of any GAAP and non-GAAP financial measures discussed today can be accessed at the investor relations section of our Web site 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 prospects, priorities and opportunities, our financial forecasts and anticipated future revenue, gross margin, operating expense and income performance, trends in our business and in the markets in which we compete and the expected timing, features and benefits of new product releases.

We'd like to caution you that our statements are based on current expectations and involve risks and uncertainties that could cause actual results to differ materially. We refer you to the risk factors and cautionary language contained in today's press release announcing our fiscal Q1 2009 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 13th, 2008. Those 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 press release and in our filings with the SEC are incorporated by reference into today's discussion. We undertake no obligation to update these forward-looking statements in the future.

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

Jon Gacek

Thanks, Shawn. Good afternoon and thank you for joining us today. We are reporting our results for the first quarter of fiscal 2009. In our last conference call, we said we expected this quarter to look a lot like Q4 including typical seasonal factors. In fact, while our results were fairly similar to Q4 in some respects, we definitely made very good progress in key strategic areas that I want to briefly highlight.

First, we paid down $50 million of our acquisition debt this quarter. Our ADIC acquisition debt was nearly $400 million a year ago. As of June 30th, this debt is down to $290 million. Second, we launched our DXi7500 at the end of May and our disk systems and software revenue for the quarter was $20 million, up 100% from a year ago. Third, our non-GAAP gross margin was 37%, compared to 35.5% the same quarter last year. And finally, our interest expense was $8.8 million compared to $13.6 million, a year ago.

I'd like to refer everyone to the financial statements and supporting schedule included in the press release. It will be helpful to refer to those documents as I make my comments.

Starting with revenue, revenue for our first quarter ended June 30th, 2008 was $221.8 million. As a reminder, Q1 is historically our weakest seasonal quarter. For the quarter, non-royalty revenue totaled $199.8 million, of which 66% was branded and 34% was OEM.

As the year progresses, we expect our branded revenue will continue to grow in absolute dollars and as a percentage of total revenue as our new products gain traction and we leverage our branded channel and market opportunities.

Looking further at various revenue classifications, devices and media totaled $53.7 million, compared to $64.1 million in Q1, a year ago. The decline is primarily attributable to our anticipated decrease in OEM device revenue offset by a slight increase in branded media revenue. We continue to be opportunistic in our media business, and we are just beginning to see the impact of our Quantum branded LTO-4 drive on our overall business.

Royalty revenue was approximately $22 million for the quarter, compared to $24 million in the same quarter a year ago. The decrease reflects a decline in the DLT royalty, partially offset by an increase in our LTO royalty.

Looking further at product revenue, tape automation systems revenue was $85.7 million, compared to $108.4 million in Q1 of fiscal '08. Two-thirds of this decline was related to OEM products as we've anticipated and talked about over the last several quarters and one-third related to branded automation, primarily in North America.

Disk systems and software product revenue was $18.2 million, up from $9.1 million, a year ago, a 100% increase. In addition, we had $1.8 million of disk system service revenue for a total of $20 million in this revenue category for the quarter. In Q1, our DXi7500 became generally available and we had one month of shipments, as well as recognizing $900,000 of previously deferred revenue for systems that we shipped in previous quarters.

During the quarter, we also recognized license revenue from our OEM partner, EMC who also released products incorporating our deduplication and rep software at the end of May. We are very pleased with the customers' response we have received and feedback from EMC.

DXi7500 is a second generation product that enables true edge to core disk implementation with integrated tape creation and is very scalable.

We believe our Quantum branded DXi offering uniquely positions us to provide customers a complete end-to-end disk based backup solution from 1 terabytes to 240 terabytes in capacity with a NAS or VTL interface and options for policy-based deduplication, replication and path-to-tape.

Subsequent to quarter-end, we launched a 9-terabyte version of our DXi7500 that moves its smallest capacity point down from 18 terabytes to 9 terabytes, which is well suited for the mid-range data center environment. We think this is an important addition to our DXi family and complements our DXi3500 and 5500.

Just to provide some further specifics on DXi, we now have over 300 customers with a number of significant DXi7500 wins during Q1 both in the U.S. and abroad. These wins include multiple unit purchases by a top U.S. cable company, a leading supplier of broadband services in Europe and a major electrical supplier in Australia, as well as deals with one of America's most respected newspaper publishers, a large operator of luxury hotels and casinos in Las Vegas, and various government agencies.

The majority of the DXi7500 customers bought a replication license and nearly half purchased the path-to-tape option, reinforcing the unique value Quantum provides by offering a single family of disk-based deduplication and replication solutions for remote sized mid-range offices and primary data centers, and by delivering integrated tape creation for enterprise customers.

Turning to gross margin, non-GAAP gross margin in Q1 was 37%, compared to 35.5% in the prior-year period. This is a result of improving our mix through a higher percentage of branded product and service revenue, achieving greater efficiencies in our product and support cost structure and generating higher and improved margin on disk and software revenue. As we grow the branded tape disk and software business, and our software OEM growth, we expect gross margins to continue to improve.

Moving to expenses. Non-GAAP operating expenses totaled $74.5 million compared to $74.1 million a year earlier. For the quarter, R&D was $18.1 million, sales and marketing was $35.2 million and general and administrative was $21.2 million.

Included in sales and marketing was approximately $1.1 million related to restructuring North America sales positions. We believe we made important changes to our North America team and are beginning to see the benefit of those changes.

Our sales management team, including our five area directors, are driving improvements in our execution and the overall result. Included in G&A was approximately $2.8 million of legal fees related to our patent infringement lawsuit against Riverbed. The suit is pending in California and, while we can't comment on the details of the case, we can say that the claim construction hearing was held last week which should help to frame the key issues of contention. This case is scheduled to go to trial in March 2009 and we feel very good about the merits of our position.

So adding it up, non-GAAP operating profit for the quarter was $7.7 million or 3.5% of revenue, including the $2.8 million in Riverbed costs and the $1.1 million of restructuring. So a total of $4 million of unique costs are included in those numbers. This is down from $13.2 million a year ago and consistent with our Q4 results.

Net other income of $1.5 million was primarily the result of a $1.3 million recorded gain for a mark-to-market adjustment on our two interest rate callers. If you recall, we had a loss last quarter. Our debt agreement requires us to have a fixed interest rate on 50% of our total term debt. The derivatives do not qualify for hedge accounting and, therefore, we will include gains and losses and interest and other income net over the life of these caller contracts. These are non-cash gains and losses.

Interest expense for the quarter was $8.8 million compared to $13.6 million a year earlier. This includes cash interest expense of $7.6 million, amortization of debt issue costs of $700,000 and a prepayment penalty of $500,000. The coupon interest rate for our acquisition debt of $290 million at June 30th will be approximately 6.3% for the quarter ending September 30th.

For the first quarter, we recognized tax expense of $900,000 related to foreign and state taxes. We still believe it's reasonable to model tax expense of $1 million per quarter.

So summing it up for Q1, we lost $500,000 with non-GAAP EPS of zero compared to non-GAAP EPS of $0.03 in Q1 of fiscal '08. Focusing on cash flow for the quarter and the balance sheet, as of June 30th, I want to highlight several key points. Many of these came from questions that were asked after the last call.

Cash flow from operations for the quarter were $25.5 million. We paid down $50 million of our acquisition debt during the quarter, which totaled $290 million at the end of the quarter.

Non-GAAP EBITDA for the quarter was $16.2 million. We are in compliance with all our debt covenants at June 30th, and we expect to be in compliance with our debt covenants during the next 12 months. For purposes of calculating our debt covenants, our EBITDA for the last 12 months was $102.1 million. Our fiscal 2009 internal operating plan is for non-GAAP EBITDA of approximately $105 million.

Sequentially, inventory increased $2.5 million and accounts receivable decreased $33.5 million as a result of collections, lower revenue and an accelerated payment of $16 million from one customer.

Finally, CapEx was $1.7 million, purchase of service parts for maintenance were approximately $500,000 and depreciation and amortization totaled $20.8 million for the quarter.

We have no changes for our fiscal 2009 guidance of revenue of $950 million to $1.50 billion. Media royalties of $90 million to $95 million, non-GAAP gross margins of 38% to 40% for fiscal '09, non-GAAP OpEx of $300 million to $310 million and non-GAAP operating margins of 7% to 9% for fiscal '09.

We expect our interest costs to be approximately $28 million to $30 million for the year. We expect tax expense of $4 million or $1 million per quarter for the rest of the year. You take those ranges provided and do the math. This results in non-GAAP net income of $35 million to $55 million for fiscal '09.

As for the second quarter, we expect growth in our branded business and growth in our disk and software products, as we will have a full quarter of DXi7500, two months of our recently launched 9-terabyte version and a full quarter of EMC license revenue. This coming quarter of Q2 is typically seasonally stronger than Q1. Our OpEx for the quarter will – for Q2 will be comparable. This should result in improved operating profit for second quarter.

Now let me turn the call over to Rick.

Rick Belluzzo

Thank you, Jon. Our Q1 results – largely reflect the seasonality we typically see in the June quarter and the transition I described on our last earnings call related to the general availability release of the DXi7500, our expanded EMC relationship and changes we have made in engineering, sales, and marketing.

However, we continue to focus on our two key goals of building an improved operating model and delivering a stable and more profitable revenue stream through the series of short-term initiatives we've been pursuing.

First, we've been driving to shift our revenue to a greater branded mix, while deemphasizing low margin OEM revenue. This has put pressure on our overall top line results, but it's key toward achieving both operating model improvement and better ongoing revenue potential.

Secondly, we have been focused on building a growth platform based on the disk systems and software opportunity. In short, it has been critical that we develop a growth business that is synergistic with our install base, go to market model and technical expertise. These two efforts, along with the changes and improvements we've made in our manufacturing model over the past year, have been intended to significantly expand our gross margin results.

Next as a result of the Quantum and ADIC synergies and investment shifts, we have been focusing on improving our OpEx model while still allowing us to invest in the growth opportunity. Finally, while we have been focused on improving cash flow, paying down debt and reducing our quarterly interest costs.

In Q1, we made progress in most of these areas. The highlights include significant growth in our disk systems and software business, continued improvement in gross margins and improved cash generation allowing to us pay down another $50 million in debt. Our revenue performance was slightly below our plans, driven by lower tape automation revenue results in North America.

Also, the additional cost of Riverbed litigation and North American sales restructuring offset the reduction we continued to make in our expense structure during Q1. Going forward, we feel the actions we've been pursuing over the last year will allow us to grow our branded revenue, which is central towards achieving our business model goal.

In addition to the investments and changes we have made in our sales model, we are confident in our expanding position and the market for disk based backup systems with deduplication and replication technology. Our second generation product line, the DXi7500, began shipping widely in the second half of Q1 and is well positioned to allow us to extend the gains that we achieved during the quarter.

In addition to this, we will benefit from improved seasonality and growth in EMC license revenue. Over the next few quarters, these opportunities will allow us to transition our business to a more systems oriented sustainable profit model.

Let me sit back a bit and talk more broadly about our longer-term strategy. Our goal is to be a leading storage systems provider by delivering a comprehensive range of solutions. That means evolving backup, recovery, and archive demands of customers.

We are uniquely positioned to do so through our ability to provide an integrated systems solution from the edge of the network to the core of the data center with a single scalable architecture that embraces disk-based deduplication and replication system, tape automation and data movement technology with a common management – with common management and security.

This value proposition has been well received by customers in that it provides for lower cost, more reliable and well managed offering. In contrast, through our integrated edge to core approach, our competitors generally have different solutions for different segments of the market, leading to greater costs and complexity.

Our scalability also plays to our advantage and the fact that we embrace tape as part of the solution aligns well with the realities of the vast growth in data and increasing focus on lower costs and lower energy demands.

There are five key elements to executing on our strategy. First, we will continue to build a highly scalable and flexible set of leading disk-based deduplication and replication solutions. Our DXi product family scales from just over 1 terabyte to over 200 terabytes. This allows for deduplicating and protecting data with disks in small offices and in remote offices and then replicating only unique data to a larger or centralized data center, where it can be consolidated and seamlessly moved to tape for long-term retention and disaster recovery.

AFC's selection of our software speaks to the strength of our technology and further positions Quantum to capitalize on this rapidly expanding market. This segment of our business is in investment mode, as we intensely focus on building a growth platform.

Next, we will continue to leverage tape as a critical part of the solution. We find that customers continue to have different approaches on where tape fits based on a multitude of factors. But in almost all cases, tape remains a critical element of the customer storage environment

Having said this, the tape automation market is definitely maturing, so we're working to leverage our investments and ensure that our tape offering embraces the evolving market environment. As a result, our tape-based businesses will have become more profitable as we have executed on the strategy.

Third, we will grow our StorNext file System and Data Management Technology and deploy this platform as a key differentiator of our effort to integrate solutions and deliver scalability. In addition to this, we will strive to deliver leadership security and management solutions that provide improved effectiveness in the backup, recovery and archive process.

These includes our Q-EKM encryption solution, our iLayer tape automation system management and our recently enhanced Quantum Vision global management and reporting tools. All this is intended to provide customers with a superior experience using Quantum solutions which work seamlessly with ISV storage offerings.

Next we will continue with our leverage go to market model using a combination of end user touch along with partners. Our focus is primarily branded, but includes a select group of OEM partners that can reach segments of the market that are not available to Quantum.

And then finally, all of this is intended to build a systems like business model with non-GAAP gross margins in the 40% plus range and a revenue stream that is stable and more profitable, as some segments decline and others grow. Along with this is a very disciplined operating expense and investment management approach.

As we pursued these elements for our strategy over the last year, we fine-tuned our approach and will continue to do so moving forward. But, we are very clear that this is what we need to do to deliver – and to execute on our strategy for increased value for Quantum.

As we enter Q2, we look to complete the transition we began in Q1, including our branded revenue. Increasing our branded revenue will remain a top priority with a significant focus on growing our disk business and software business and addressing the revenue shortfall in North America.

This includes ramping our new DXi7500 9-terabyte model and supporting the launch of EMC's third product incorporating our deduplication and replication software, which they announced in May. All this will help us – will help in our efforts to continue building a high margin business and combine with our continued pursuit of opportunities to improve our operating expense model will be key to near-term profit improvement.

I will close by saying that, while we have a number of priorities to execute on, we are all very excited about the opportunity we now have at Quantum. As we've said in previous calls this is the first time in years that we are so well-positioned in a very strong growth segment of the industry. Deduplication is clearly one of the hottest set areas of storage and we have the essential ingredients to capture this opportunity.

In Quantum, we now have a second generation product, while most of our competitors and potential competitors only have limited first generation offerings that don't provide nearly the flexibility or business value that we do. We have differentiated core technology including our deduplication engine and StorNext cluster file system.

We hold the key patent for variable length deduplication. We have an expanded partnering opportunity, as evidenced by the EMC success. And finally, we have a large installed basis of customers that are in the very early stages of embracing this technology. This all translates to significant opportunity for greater success.

Well, thanks for joining us. Let me turn the call back over to the operator for your questions. Operator?

Question-and-Answer Session


Yes, sir. We will now begin the question-and-answer session. (Operator instructions) And our first question comes from Brian Freed with Morgan Keegan. Go ahead please.

Brian Freed – Morgan Keegan

Good afternoon. Thanks for taking my call. Great quarter on the dedupe side. As you look at the breakout of your disk and software, I know in the year-ago period there was still a fair amount of legacy ECL product in there. I know it's a little hard to break it apart, but as you look at the non-legacy, the dedupe product year-over-year, it looks like the growth rate was probably more like 160%, 170% year-over-year. Is that kind of ballpark correct?

Jon Gacek

You're right, we had fair amount of legacy product back, a year ago. And we didn't actually calculate it this way, but quickly, it's probably in the 150% range if you take the DXi product.

Brian Freed – Morgan Keegan

And within that segment are we now to the point where the legacy product is very diminutive as a percentage of – ?

Jon Gacek

It's de minimis.

Brian Freed – Morgan Keegan

Okay. And secondly, you mentioned that you got royalty revenue from EMC in the quarter. Would you describe that royalty revenue as material?

Jon Gacek

Let me see how to answer that. I would say that we were pleased with it. How about that? Brian, as you know from following us, we'll talk about EMC revenue in total once they become a 10% customer annually, so I don't want to give too much color on their products. But we were pleased with the uptick that they had and the one month they had in product and we were pleased with the result for us.

Brian Freed – Morgan Keegan

And you mentioned in terms of timing of the ship with the DXi7500, given that it's an enterprise product, I'm kind of – the assumption end up being that eval and approval cycles tend to be a little longer than the lower end product. Were you particularly impressed with how fast some of these were recognized? Was it due to the seed units out there? Or can you talk a little about what the sales cycles looks like in the quarter and how that bodes for the future?

Rick Belluzzo

Yes. We gave a few examples, I think both Rick and I did, different customers that purchased the product. I would say that because the enterprise product and the edge to core strategy is unique that sometimes makes sales cycle longer. It also makes implementation much larger, so the deals are just bigger. Let me turn over to Bill and let him add some more color.

Bill Britts

So the important part of this is absolutely the solution is a longer sales cycle because the customers looking at their overall data backup requirements and recovery requirements and this is a much more complex solution. Not only just because it's introducing both disk and tape into a new backup redesign architecture, but also because of the flexibility of our system. You'll hear us talk a lot about policy based deduplication and this ability to be able to select the deduplication process on a partition by partition basis, which allows you to over large databases for example, to be able to do just straight ETL disk-based backup optimized around performance. They can be optimized around capacity for file and print. So we're talking about a very, very flexible system and we have engaged with some customers in redesigning how they're actually thinking about the backup.

That's longer sales cycles, but I would characterize that as true enterprise backup redesign where customers are valuing not only the deduplication technology, but the ability to do an end-to-end solution, disk, tape and the tools to be able to manage that and the ability to integrate all that with customer – I mean, with consulting services and PS. So we had several large customers that had already preordered 7500s, and it was just a matter of doing the GA software with them and turning on those systems.

Another case we had a couple of examples where they were surprisingly short sales cycles, where the customer basically wanted to see that the system that they installed was up and running. In one particular case, a customer was waiting for GA of the 7500. They had already evaluated the Data Domain enterprise product. We ended up closing three large systems in that particular situation. So I would say again it's lumpy because of the size of some of these deals, the implementation, ASPs were $150,000 for just these early installations. But we see a very, very strong pipeline of customers that are looking at true enterprise capability that's offered with the 7500.

Jon Gacek

I think we'd also add that we just recently started shipping the 9-terabyte version and that allows it to position a bit lower which hopefully makes us more competitive for some of the shorter sales cycle opportunities.

Brian Freed – Morgan Keegan

Okay. And with respect to competition out there, when you do find yourself engaged in a competitive situation, what have your win rates tended to look like? And as you tend to look at your win rates over the course of the last 12 months, what has been the general trajectory there?

Bill Britts

I would just emphasize that with the 7500, with less than a quarter of experience with it, win rates were extremely high. I would say that I can't think of any particular deal where we did a head to head comparison with Data Domain or other competitors where we lost. So I just start with that. I think if you go back prior to the launch of the 7500, it was really around the emphasis on our overall road map, the fact that we had an end-to-end solution that we are really focusing on having a true enterprise core in the data center that would enable customers to be able to replicate from the edge to the core. So it's really – with the 7500 it's the completion of or at least the initial demonstration of a true implementable edge to core strategy. And I think from that standpoint, the point to point product comparisons that we saw prior to the release of 7500, our win rate was significantly lower than what we experienced with the 7500.

Brian Freed – Morgan Keegan

Great. And then turning just for a minute to other businesses, and then I'll cede the floor. Automation tends to be a segment where stability is somewhat hard to gain. Can you talk about what steps you've taken, what initiatives then and from a macro perspective why you remain confident the automation business is something that's stable?

Rick Belluzzo

I'll start and Bill can jump in. We define our problems in automation as being pretty specific to a geography. We've made a number of changes. But even within that geography, we have a number of our territories and our sales people who are doing quite well selling automation. So we agree that the roll of tape is changing, that tape automation isn't growing rapidly. If there is anything that's growing, it's the mid-range base and that's where we think we have the best product. We really are focused on execution and I refer to it in my call. We have a different leadership structure. We have five new area directors who are both close to the business and close to Bill. We are – changed our comp model some. We're trying to partner with all our channel partners. I think the other thing that happened is our initial disk offering, our first generation product wasn't differentiated enough for our partners. And we think this new product, the DXi7500 is, we've seen a lot of our interests in both getting demo units and sharing of leads. So we think selling more disks will also help sell more tape. And then I'll just finish with, we really think our automation execution is really about us more so than the market.

Brian Freed – Morgan Keegan


Bill Britts

The one part I'd emphasize is the fact that we have people that are being very successful selling backup solutions and those include disk and tape. In certain situations, we have overplayed kind of the overall kind of adoption of disk and customers perhaps in some cases just needed to be able to satisfy their backup requirements with tape. And we've tried to expand the deal or try to make the solution kind of a longer term kind of fix as opposed to satisfying the immediate requirements. I think we've made some of the changes in the sales model and how we're working with customers to make sure that we're basically being more consultative in the sale as opposed to trying to solve the global problems all at once. I think that's something that should drive better balance in our overall business. Absolutely, tape – the roll of tape is changing. It's becoming a longer-term retention and disaster recovery type of medium. And our overall solution, if you look at the way that we're positioning our DXi products, 50% attach for a tape option that basically integrates disk and tape much more closely. And we see the customers continue to value the ability to bring these different types of tiers of storage together.

Brian Freed – Morgan Keegan

Great. Thanks.


Thank you. (Operator instructions) And our next question comes from Glenn Hanus with Needham & Company. Go ahead, please.

Glenn Hanus – Needham & Company

Good afternoon. John, can you – on the break out there within the disk, was StorNext up sequentially or flat or what's your outlook in that?

Jon Gacek

We actually had some growth in StorNext. We had some nice channel partners. I think we talked about it's on HP's price list now. And it was up sequentially and year-over-year. The vast majority, though, of the 100% growth was with DXi.

Glenn Hanus – Needham & Company

Okay. And then on your overall reiteration of the revenue guidance, were you willing to give us some color on how to think about the automation number versus the disk/software number for fiscal '09.

Jon Gacek

Sure, let me just say, I'll reiterate some things that Rick and I said earlier on our last conference. And then Bill and Rick can weigh in. People have asked us, is this the year for these products? And it was hard to talk about until we got the product launched. At a conference recently Rick and I said this needs to be at least a $100 million business for the year. And I think your model is around $70 million if you add it all up. So we started out with the first quarter of 20. We will be up next quarter too from that 20, so we're well on our way and our seasonally strong quarters are coming, so I think if I just looked at your model, that 70 or 72 is pretty low relative to this 20 we just put out. But from there, you guys are going to have to sort of tweak your model I guess. And I think we get another quarter under our belt, a fourth quarter, and we might be able to give a little better guidance. It's hard after only one month.

Glenn Hanus – Needham & Company

And on the automation side, we think of that as sort of flattish going forward?

Jon Gacek

Yes, that's what we said on the last call. The upside or the range between our $950 million and our $1.50 billion is really around how strong our disk and software business is. And we have some upsides in automation. We tend to not talk about it, but we just launched our LTO floor drive. It's just now in the channel. We think if differentiate it, we think we'll get a bump from that. We have some new OEM products. We have stuff going on there, too. But we're really trying to optimize our results in our investment there.

Glenn Hanus – Needham & Company

You mentioned your decline sequentially in tape had sort of more to do with OEMs than on the branded side. How far are we along now in terms of their being more sort of incremental downsteps in OEM. Is most of the OEM decline behind us or are there still some programs that are going to fade out and we have some chunks of revenue that are going to come out.

Rick Belluzzo

There's still some revenue that will come out. They're definitely slow, but we're still shipping LTO 2, for example, into at least one OEM. Eventually, there won't be much of that. So there's still some, but generally speaking, those are low margin – very low margin products and I think our overall health of our business and profitability will be better a year from now than it is today. So our model really is about growing the branded and replacing some of that OEM that's rolling off. We've been pretty good at forecasting OEM. I'm looking at Bill. We probably hit it each of the last four quarters. So we understand where that business is going. It's just a matter of getting the branded business growing at the rate that we think it's capable of.

Glenn Hanus – Needham & Company

Back on the disk and software or the disk system, there were some product maturity issues earlier on, et cetera, with the new system. How are you feeling about reliability, maturity of the code base and that you're really ready for prime time this time around?

Rick Belluzzo

I'll make a few comments and then Bill can add his piece as the service organization. I would say that after our first generation product, we implemented pretty significant efforts into our next generation products. We took a lot longer time to develop it. We took all the lessons learned. Any failure mode we found at the wheel [ph] we wrote a test against the new platform. The number of tests we ran, the test cases we learned probably increased three or four times in this process. And so the product is installing well. It's again very early but we continue to get good feedback. I believe that this, in fact, is a second generation product. We've made substantial improvements and a lot of it has to do back with the scalability message is that architecturally, we have a lot of capacity. If you know anything about storage products, the way they typically work is that they start to fill up. Any kind of storage product starts to run out of margin. And we start at the bottom and had a floor – or had a ceiling, I should say, to that. Now we have almost virtually no ceiling, given the fact that it's scaled such a large footprint. So we feel good about all of that. And thus far, are making good progress.

I would also add that EMC took us through the testing process as well. They did duplicate testing and it met their standards. So we feel – I'll never say it's perfect or we won't have issues. But I would say we feel substantially better. We think early results indicate that. We think EMC indicate that. So that's why you probably sense a bit of bullishness in this call about the results in that business after one month of that product. And the belief that we have in this market is very hot. There are lots of opportunities. We feel well-positioned with the right product and the right strategy. The sales course up to speed. The service organization in place. Second generation product. EMC behind us. We think we have a lot of things going for us that we haven't had in the past that we think will allow us to capitalize on this opportunity.

Glenn Hanus – Needham & Company

Maybe just lastly with the disk system, maybe you could just talk about who you're really seeing from a competitive standpoint, the extent you're competing head to head with Data Domain or not and who else is in the picture, and that sort of thing?

Bill Britts

I would say the majority of the cases where we're competing head to head are Data Domain by far. Certainly, the partnership with EMC and the large EMC accounts, and I think that you can image than EMC has very, very good understanding of what's going on in those accounts. EMC will lead the charge in that area and I think that will cause Data Domain some problems in some of those very large enterprise accounts. Where we see more of the kind of longer term competition is where people like Network Appliance and some of the system houses are just now starting to bring products to market, but as Rick says, we're on our second generation. We really have a true enterprise solution. We have a partnership with EMC that brings a lot of credibility around the overall enterprise capability that we have in the product. So I would say that, from an enterprise standpoint, we are seeing Data Domain. We see the normal system houses. We think that we've got a very good position there. In the mid-range and the lower end of the market, it becomes a little bit less – there's competition that's more indirect. It comes from different types of solution, and I think from that standpoint, the overall edge to core solution and have the ability to be able to replicate from the small sites, remote offices to that core data center. That'll be the way that we will try to compete in that particular area of being able to provide a solution that scales from a terabyte to over 200 terabytes.

Glenn Hanus – Needham & Company

Thank you.


Thank you. (Operator instructions) Next question is a follow-up question from Brian Freed. Go ahead, please.

Brian Freed – Morgan Keegan

Hi, guys. If you could do one thing for me. You guys have really been transforming the business over the last 12 months. Could you talk through a little bit about the specific initiatives you've taken and the success you've seen in terms of R&D, I believe you stepped up your test and network. And what specific steps you've done in the sales organization to improve your position on a go forward basis?

Jon Gacek

Let me start really quickly at the top on the ops. You didn't ask ops, but I know that's kind of in there. We have one global operational site now in Colorado Springs. And then we – for most of our enterprise products and then we outsource everything low end. All of that's cleaned up. We have a little bit of work to do in repair. We are on one integrated IT system for Oracle and Agile and PeopleSoft. So most of that plumbing stuff is all done within the operating structure.

Rick Belluzzo

Let me start by making a comment. 18 months ago, shortly after the completion of the merger, we had a series of strategy meetings with our team. And we just got really excited about the opportunity we're talking about today. Edge to core, backup, recovery and archive, single scalable disk architecture with well integrated tape, branded business, et cetera, et cetera, integrating StorNext. We thought we had the assets, we saw this opportunity. We made or we started in process at those offsites, a series of aggressive changes to get the company fully aligned around that opportunity. That included, as John indicated, we had multiple manufacturing sites, we had vertically integrated manufacturing. We changed all that. We out – sold our vertically integrated factories. We're focused on integration of systems because we're going to be a systems company. We, in R&D, did the HP relationship for LTO development. We ceased our own drive development because we felt like the opportunities existed in other places. I could go on and on. It's really driven around being more of a systems oriented company. We hired software people. We started our development center in India. You know, pretty aggressive.

And I'll let Bill comment on sales and marketing, but we put in place a lot of actions. I would say that we are 80% of the way there. I think in sales and marketing and capitalizing on the revenue side is mostly what remains. There's still 20% more tuning that we have around the company whether it's in ops or in R&D or in other segments. But that strategic change really started 18 months ago, when we took a look at what we felt was an opportunity to really deliver value in the Company. In some ways that transition's been difficult as we de-emphasized lower margin revenue, we've had revenue challenges, it's been a challenging transition and we refer to it as a couple quarter transition.

But we're really – feel like we're at the latter stages of that work. Now we have to capitalize with revenue improvements in our branded revenue that's largely concentrated in North America. We've got to find the right sweet spot, frankly, about our channel and our disk and software and tape and where we put emphasis in a lengthy sales cycle. I mean, the complex model, but the opportunity underlying that we believe is profound, as we see already in the industry from players like Data Domain that there are opportunities. It's a very hot market. And so we feel our strategy – we feel just 100% committed and confident in what we're doing. We recognize that while we've made a lot of execution changes, we still have more to do, but we believe we're at the tail end of that really heavy lifting in terms of the transition.

Bill Britts

I'd just make a couple points on the sales and marketing side. It's really a transformation from a point product, highly differentiated, very, very significantly differentiated tape automation product to now transforming the sales and marketing, the go to market itself, the channel relationships to a solution positioning.

If you look at the capability that we bring in this backup, recovery and archive space, from a product standpoint, but also from a services standpoint, we're very uniquely positioned to be able to provide this kind of expertise and consultative selling approach to the solutions, which necessitate changes in the sales people and the capabilities, particularly in the presale system engineering and the technical resources that we bring into a customer engagement and then the specialization that happens on the solutions marketing and the relationships with ISPs and the actual rest of the ecosystem to be able to get the full leverage from the model. So it's really around transforming from a point product, go to market to a solution positioning where we have the ability to link our products, integrate the solution to provide more value to the customer.

Brian Freed – Morgan Keegan

Okay. Great. And one other question, and then just a final comment. In terms of you guys have put out your property and are looking to do a reverse split, obviously that doesn't change the fundamentals, but can you talk a little bit about, have you got any sense what the investor view of that is, and is that something you – timing when you would like to pursue such a – ?

Jon Gacek

Sure. We put it in there – obviously it's cheaper to do it at the time of the annual meeting than to do it special. Our thinking there is really around we see a future where we're a positive EPS Company and having an EPS that is more relevant or higher, the difference between $0.01 and $0.02 and $0.03 sort of starts getting lost on people. We also want to attract a different set of investors. And there's some people have a $2 limit, some have a $5, some have – they're all market cap based. So it's really in there as an opportunity as the business begins to grow and, as many of you know on the call, we're a little bit unique as a technology company with such a unique capital structure with 60% of our capitalization in debt. That hurts when the stock's going down. But on the way up, it's great. You get a lot of leverage. So we want to be positioned for potentially and I'll use the word potentially, doing that kind of a split to really focus on, hey, we're an earnings company now and our EPS is relevant.

Brian Freed – Morgan Keegan

Great. And then my final comment is it was a good quarter. I was impressed with the progress in dedupe. But I would say from an analyst and shareholder perspective, if you wanted to punctuate your confidence with an exclamation point, we'd love to see some insider buys down here.

Rick Belluzzo

Thanks for the compliment.


Thank you. (Operator instructions) Our next question comes from John Fichthorn with Dialectic Capital Management. Please go ahead.

John Fichthorn – Dialectic Capital Management

Yes, hi. This is somewhat in line with the final question asked by the previous caller. Now that you are an EPS company, as you said, any thoughts as to why you might not, from a corporate standpoint, be buying stock with this cash flow you've been generating, which we'd love to see as opposed to buying back debt, because you're confident you're able to maintain this kind of profitability and could handle this debt load and you could refinance it and (inaudible) and really at these stock levels drive leverage going forward to the stock price.

Rick Belluzzo

Right. So our current – great question – our current debt agreement precludes us from buying back stock until that term debt is paid back. And one of the things we're obviously looking at is capitalization of the Company, because of our convert that's about a year and a half out. So as we look at alternatives, we'll be thinking about those kinds of things, but right now we're really precluded from doing any stock buybacks.

John Fichthorn – Dialectic Capital Management

And secondly, you laughed when the last caller suggested that insiders buy stock and it's something that, as buyers of small cap stocks, we've been beyond slightly frustrated with the lack of insider ownership at a lot of our companies. So since we're all out here buying stock and we've been buying tons of it ourselves, why wouldn't you as a management team be buying stock down here at these prices?

Rick Belluzzo

So currently our window's been closed, that's number one. And I don't want to speak for – I won't speak for everybody, but each of us has a different sort of position within the Company of our equity holdings versus our other holdings. So all of us kind of balance that on their own. I do think the stock has been hurt on the down side by having a leveraged model. Our actual enterprise value hasn't gone down that – nearly as much as our stock price has. So we hear you guys. I was chuckling only because – that was me that was laughing. Because Brian likes to spend my money for me so–

Jon Gacek

I'll make a comment. We did have some board insider buy I think recently. I frankly don't – we don't put pressure on the management team on this topic, because frankly, over the last few years that we've been working through the transition, we've been pretty restrained on the cash front. I mean, we – there are lot of companies – comparable companies who have continued to pay bonuses during times of performance that isn't to model. And our policy had been not to do that. So we haven't paid bonuses. And people have, therefore, been well under – people who we've asked to come in to turn the company and lead this transition have been well under from a cash compensation perspective. So, I frankly am just reluctant to put pressure on people to do additional stock buying when, as many of us feel, we're very well protected on the upside and believe that we have great return for driving the value of the company up. And so any insider purchasing would improve the optics, no doubt about it. But I think after several years of limiting cash compensation, it's a tough thing to really require people to do. That's my view.

John Fichthorn – Dialectic Capital Management

And I'd like to see the board buying stock then would be acceptable to me too.

Rick Belluzzo

I got you.

John Fichthorn – Dialectic Capital Management

And so I'd just like to send that message to the board, that seeing the board just incentivized the same way as shareholders is of great importance to us as shareholders of distressed equities.

Rick Belluzzo

We will deliverer that message.

John Fichthorn – Dialectic Capital Management

Thanks a lot. Good luck.


Thank you. And that concludes our question-and-answer session for today, ladies and gentlemen. And I'd like to turn it back over to management for any closing statements.

Shawn Hall

Well, thank you for joining us and look forward to talking again in the next quarter and giving you an update on our business. Thanks a lot.


Ladies and gentlemen, that concludes the first quarter fiscal 2009 conference call. You may now disconnect and thank you for using ATT conferencing.

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