Quantum Corp (QMCO) 2005 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Quantum Corporation first-quarter earnings release conference call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. If anyone needs assistance at any time during the conference, please press the star, followed by the 0. As a reminder, this conference is being recorded today, Tuesday, July 27th of 2004. I would now like to turn the conference over to Lisa Ewbank, vice president of investor relations. Please go ahead.

Thanks, Eileen. Good afternoon, everyone, and welcome. With us today are Rick Belluzzo, CEO, and Ned Hayes, CFO. A webcast of this call, along with a quantitative reconciliation of any GAAP and non-GAAP financial measures discussed today, can be accessed at the investor relations site of our website, www.quantum.com, and will be archived for 1 year. During the course of today's discussions, we will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements include our financial projections and prospects, including our outlook for the second fiscal quarter of FY '05, our products, their features and benefits, market share expectations, new product releases and expected ramp cycles, our business prospects, priorities and opportunities, anticipated actions to improve our operational platform, and the general business and IT spending environments.

I'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 Q2 results, as well as to our reports filed with the Securities and Exchange Commission from time to time, including pages 38 to 49 of our most recent 10-K, filed on June 14, 2004. Such reports contain and identify important factors that could cause actual results to differ materially from those contained in our forward-looking statements. We undertake no obligation to update these forward-looking statements in the future.

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

Well, thank you, Lisa. Good afternoon, and thank you for joining us for our Q1 conference call. We began our fiscal year with very mixed results. On one hand we continued to make good progress on improving the operational foundation of the company. We were successful in driving our operating expenses below our target and ahead of schedule. We improved gross margins and produced non-GAAP earnings toward the better end of expectations. But at the same time, we were disappointed by lower-than-expected revenues, which was caused by a combination of external and some internal factors. Let me provide some detail.

First, non-GAAP operating expenses declined more than 10% sequentially, to $56 million, well below our $60 million target, and ahead of schedule. GAAP OpEx came in at $64 million, with all functional categories contributing to the reduction. The restructuring actions we've taken are producing results. We continue to make progress on gross margin rates, which improved to 35% non-GAAP, and 34% GAAP. The improvement was driven by a higher percentage of high-margin media royalty revenue, and an increase in margins in the systems business. On a non-GAAP basis, we were at breakeven on the bottom line, versus a 3 cent loss in Q1 of last year. GAAP loss per share was 6 cents, which included 6.4 million in special charges and 4.4 million in intangibles amortization. Special charges were higher than expected, due primarily to more restructuring related to reducing headcount and streamlining the business.

Now to revenue, which came in at $173 million. There were 3 primary reasons for the lower than expected revenue. About two-thirds of the revenue shortfall was due to weaker-than-anticipated business in the last 2 weeks of the quarter, particularly with two OEMs for tape drives and automation, which appeared to result from underlying demand softness in the OEMs' businesses. We also saw weakness in some branded channel business in the system segment, which was off due to an atypical quarter end, when customers pushed out projects to later in the year. The weakness was spread across almost all product lines and both business units, and based on feedback we have received, it appears that Quantum saw the same kind of end of quarter softness that affected many technology companies in the June quarter.

Next, to a lesser extent, media revenue was lower than anticipated, due to lower Quantum-branded media sales and a shift to more royalty revenue. This fluctuation happens frequently, and given that on a gross margin dollar contribution basis we're indifferent, we're therefore very content to have most of our media revenue coming from royalties. And then, finally, the ramp of our SDLT 600 super drive has been slower than we had anticipated, due primarily to longer than expected qualification cycles with system OEMs and automation partners. This affected the tape drive business, of course, but had -- also had some impact on the systems business.

Now let me -- now let me begin with business highlights with storage systems, which produced $67 million in revenue. We feel good about the progress we've made in improving the foundation of the systems business. And we are excited about our new products. During the quarter, revenue was weaker than expected in most areas, in both product and service. We were successful in reducing expenses and costs, with gross margins increasing significantly. The improvement in margin was driven by an unusual combination of several positive factors, including a more favorable OEM and product mix, as well as higher service margins.

Sales of the PX720 enterprise library more than tripled from last quarter, granted from a small base, but still reflecting strong customer interest in the leading capacity and technology of this new product. We continue to see significant customer interest and enthusiasm with the DX100, and are seeing more and more validation that our tape emulation approach is on target. At the same time, however, customers are taking longer to evaluate solutions and complete a purchase, given the many different products on the market and also the end-of-quarter general weakness that we saw. We are confident that the very positive ROI dynamics that the DX100 provides to customers will show greater acceptance and growth as an addition to the backup and recovery architecture. We also continue to see the DX enable us to expand customer discussions into libraries as well.

On the revenue side, our results were negatively affected by both OEM and channel weakness, especially in the end of the quarter, as well as by lower service revenue than a particularly strong Q4. While external factors were the primary driver, we do -- do recognize that we need to continue to strengthen our channel sales program. Our priorities for the system business remain clear. Grow the business through ramping of new products and improvement of our channel business, reduce costs, and drive the business to profitability.

Now let me turn to tape drives and media. It was a tough quarter for the drive business. We did make some good progress on reducing operating expenses, a direct result of the restructuring actions we have taken. We also reduced product costs, an improvement that is not visible in the gross margin rate -- rate, which has increased for 6 straight quarters, due to the disproportionately lower revenue this quarter. But drive revenue was disappointing, decreasing to $62 million. The tape drive market in general was weaker than many companies expected, and the end-of-quarter softness significantly affected our drive business, which is mostly OEM. The lower-than-anticipated revenue reflects lower unit shipments of almost all drives.

In particular, sales of older DLT8000 drives decreased significantly. While this was expected, given the approaching end-of-life status, we had expected DX and super drive sales to make up for this decline in Q1. But the overall weakness, particularly with two OEMs, produced reduced sales. To a lesser extent, we also saw a lull in purchasing some products in anticipation of the next generation. Because qualifications for the SDLT600 are taking longer than we anticipated, the product ramp is also taking longer. We anticipate that as we complete customer qualifications and more partners begin ship, we should see a solid product ramp.

On the media side, Q1 revenue was $44 million, reflecting lower Quantum-branded media sale, with a shift to more licensee sales and corresponding royalties. Pricing in the quarter was roughly as expected. Unit shipments for Tape IV, the media used for VS and older DLT drives, increased sequentially, while SDLT shipments were about flat. We believe our DLT Tape IV media royalty volumes were higher than would normally be expected, due to a media company which was planning a changeover in manufacturing locations and needed safety stock for a smooth, risk-mitigated execution. We expect this to affect this company's purchases in Q2 and -- and -- excuse me, in Q3 and Q4.

At this point, I'd like to turn the call over to our new CFO, Ned Hayes, for some additional financial details, and also to talk a little about his priorities as he joins the Quantum team. Ned?

Thanks, Rick. We're all disappointed that revenue was weaker than anyone anticipated this quarter, but I don't want to lose sight of the significant improvements we've made on our business foundation and the potential this creates. With the improvements seen in gross margins and OpEx, we were still able to produce this quarter non-GAAP earnings at the better end of expectations. This gross margin improvement observed in the quarter was driven by an atypical combination of factors, including a higher percentage of royalty media, favorable OEM and product mix, and higher service margins in the systems business. We do anticipate a more typical set of drivers to result in a pull-back in gross margin rates in Q2. We plan to build on the cost improvements we've made to date, and we will continue to drive toward sustained profitability.

We drove OpEx below our 60 million non-GAAP target, ahead of our own internal schedule. This significant improvement was driven by the restructuring actions we took in November and again in April, lower legal expenses, and continued streamlining of our cost structure and processes. But we're not done in that area just yet. And I'll address that in a minute. We continued to generate cash, with positive cash flow from operations of about $6 million. We ended the quarter with cash and short-term investments totaling $269 million. DSO for the quarter remained at 54 days.

Now, as I began my tenure at Quantum, I wanted to talk for a moment about my priorities. Rick brought me here to do a couple of key things. They are: leverage my operations and general management background to supplement our focus on execution within the company; support the strategic planning process, both in terms of direction and of driving strategy into our daily operating and financial metrics by which we will run the company on a day-to-day basis; drive incremental costs and expense reductions across the enterprise through an unrelenting focus on quality, process simplification and organizational streamlining; and, finally, play a leadership role in driving the actions required to get to sustained profitability, while optimizing cash.

Though formally only on the job since July 1, I have accelerated an exhaustive look at our costs and operating expenses across the firm, with a clear intent to drive them to more optimal levels. As a result, we do anticipate taking restructuring charges in Q2 and in Q3. While we're not ready to quantify or identify specific amounts or timing of the charges, we anticipate being in a position to articulate these expectations later in the quarter. Excluding the impact of any cash restructuring charges we might take, we anticipate being a small user of cash in the second quarter. I believe we have a lot of opportunity as a company, with new products and an optimized organization to take advantage of any increase we see in the IT spending. And I am partnering with Rick to intensely focus our collective energy on execution, drive, financial -- financial and process efficiency, achieved sustained profitability, and accelerate our efforts to put us back on a winning track.

And so with that, I'll turn the call back over to Rick, who will provide the outlook for the next quarter.

Well, thank you, Ned. Our priorities for Q2 and the rest of the fiscal year are clear. First, we must drive revenue growth through the proliferation of our new products, like the SDLT600, the MAKO PX720, and the DX100, by continuing to focus our sales and channel programs and by expanding our efforts in emerging markets, such as China and India. Second, we will continue to improve gross margins, with the intent to get our immediate target of mid-30's on a sustainable basis. Third, continue to improve our cost structure. We've made a lot of progress here, but still have more work ahead of us. And finally, focus our technology resources on developing innovative next-generation systems.

I believe we have the talent and foresight to provide customers with highly effective backup recovery and archive solutions that will serve them well into the future. We continue to believe that we're making the right changes and moving in the right direction, but the short term we are aware that there are some limitations, given the uncertainty around the IT spending environment. We're looking forward to the second half of our fiscal year. We are hopeful that a confluence of positive factors will exist, solid ramping of our new products, positive seasonal factors, and a sustained improvement in overall IT standing.

With that backdrop, I'll provide guidance for the fiscal second quarter ending in September. We expect overall revenues to be roughly flat, reflecting caution, given the surprising weakness at the end of Q1, typical summer softness and the fact that our new products are in the early stages of shipping. As mentioned earlier, non-GAAP gross margins were unusually high in Q1 because of an atypical combination of positive factors. We expect non-GAAP gross margins in Q2 to be approximately 32 to 33%.

We expect non-GAAP operating expenses to be in the $57 to $59 million range, with the increase from Q1 levels primarily reflecting approximately $1 million in increased expenses associated with Sarbanes-Oxley compliance. As a result, we expect non-GAAP bottom-line result to be in the range of breakeven to a loss of 4 cents share. Other than the expected $4.5 million in amortization of intangibles, we are unable to quantify our GAAP expectations at this time, as a result of the cost reductions we are evaluating. We do expect restructuring charges during Q2. We will provide an estimate of those charges and GAAP expectations once those plans are finalized.

Let me close by saying that I'm enthusiastic about our company. We continue to make progress in reducing costs, our past moves are taking effect, and we intend to continue our work to drive costs down even further. We generated cash for the second consecutive quarter, and we're excited about our new products and are focused on execution to ensure a successful product ramp.

At this point, I'd like to open it up for questions. Operator?

Thank you. Thank you, sir. Ladies and gentlemen, at this time we'll begin the question-and-answer session. If you have a question, please press the star, followed by the 1 on your pushbutton phone. If you would like to decline from the polling process, press the star, followed by the 2. If you are using speaker equipment, you will need to lift the handset before pressing the numbers. One moment, please, for the first question. Our first question comes from Rich Kugele with Needham & Company. Please go ahead with your question.

Thank you. Hi, Rick. A -- a large library vendor recently cited a continued share shift from DLT to LTO. I was just wondering if you could give us on update on where you see your market share in the tape drive market, and where you expect it to go over the balance of the year, following Super DLT600 ramping?

Yeah, I would just start by saying, you know, the -- the -- the large library company who said that certainly has -- has their own self interests, because they do not promote SDLT, so I -- I would -- you know, I really think that a lot of that is a reflection of their own performance, in addition to -- to some potential market factors. So, first of all, the way we look at the overall market, we have for some time continued to be in this -- this leap-frog situation, where as we introduce advantage products, we gain share, as we -- as the competition introduces, we lose share, etc., so we -- we have been doing that. We have been, because of that, in a position that we've been behind the last 6 months or so, and as a result of that, we've been under share pressure for sure -- there -- there -- you know, which is typically the pattern. We believe that changes -- the dynamics change with the SDLT600, which is a very good product with some very good innovative features like DLTSage, which we introduced a year ago. Last week we introduced this WORM capability called Ice. And the capacity and performance, it's a -- it's a very good product that we intend to see shift those share dynamics once again.

And secondly, if -- if you could provide us a little bit more color on how the Super DLT600 qualifications are going, and what -- what type of feedback have you been getting from the OEMs that has kind of led to this lengthened -- lengthened qualification process?

Well, the -- the qualification process is always very complex, and -- and with some of these new features that we put it in, it actually in some ways makes the qualification more complex, because a lot of this functionality, you know, needs to be addressed through a library and through a system. So it -- it does -- because of that, it all -- it does vary by customers. There's, you know, always a variety of issues you go through when you go through qualification. We think we are very much on track today to be able to complete those qualifications and, you know, and I -- I -- I think that, again, as those feature get integrated and -- and as the issues have continued to be worked, we -- we believe, you know, we'll start to see that ramp-up -- ramp up very shortly, but -- but we think the feedback from customers is they're very excited about the product. They think it -- it delivers advantage as -- as -- as tape drives move to this new capacity and performance point, we think it changes a lot of aspects of the industry, and -- and, you know, we're excited to be a part of that.

Would you anticipate LTO having to face the same type of lengthened qualification cycles as this -- just as this -- as the drives get more and more dense that they have to spend that much more time qualifying?

I would -- I -- I would say for sure for us that the increase in density, capacity, etc., made these programs more challenging. There's no doubt about it. So -- I -- I can't predict and say that they will also have those problems, but as drives become more powerful and more intelligent and -- they do become -- they do become more complex, and there is the risk of longer integration cycles/ But I can't predict what their outcome will be.

Okay. Great. Thank you very much.

Thank you.

Our next question comes from Mark Moskowitz with J.P. Morgan. Please go ahead with your question.

Yeah, hi, guys. Thanks. A couple questions. Can you first comment on the revenue -- revenue movements within your top customers, and particularly with respect to your top 10% customers?

This is Ned. If you take a look at revenue percentages for our top customers, HPQ, HP Compaq, was again 24% of our 10% customers. Dell was, of course, an additional 1 of our 10% customers, so very consistent with last quarter's performance.

Okay. And then could you give us some more context around the -- the overall gross margin? Obviously you -- you did see some better-than-expected seasonality in the trends there to have higher gross margins. Could you comment maybe on -- on how that offsets the general pricing dynamics, or what the general pricing dynamics were? And I have a follow up on that

Well, I'll start with the pricing dynamics. It's -- it's a competitive market. I -- I think that business is hard -- is more difficult to close. There's no doubt that pricing becomes more competitive. And -- and so -- so that is something that we --we expect. I mean, we -- we -- we've -- we've always lived in that environment. We -- we think that continues. On the gross margin side, there are a lot of things going on. We have had a long-term program, you know, for the last couple years, of improving our cost effectiveness, and so we've been consolidating factories and outsourcing and reducing overhead spending and improving quality and doing all of those change -- changing our product line, etc., and -- and it's been a very, you know, long challenging process as we've worked to get on a common set of systems, and consolidating our procurement. I mean, a whole bunch of things like that, that in the foundation has really delivered great results. I think what happened -- so those things certainly had some impact this quarter, but on top of that I think we had some other generally favorable things, like mix of the business. Even though our revenue was way down, some of the revenue that was most down was the one with the less -- the least gross margin. Our royalties were strong this quarter. So there were a combination of those factors, some of which are definitely sustainable, some of which we feel you certainly can't -- you know, can't count on every quarter.

Okay. And then -- then lastly, I was just wondering if you could comment maybe perhaps beyond the September quarter. Obviously, you know, you have these broad product refreshes still in the early stages. How -- how should we think about gross margin in terms of maybe getting an early bang there as the volumes start to really ramp up? Could we see gross margins begin to trickle up to 34, 35% here by the end of the year, or is this more of a calendar 2005 event?

Well, I'm not sure I can comment on the timing, but our commitment, as we said, you know, in the script here and and we said over and over again, is we really want to drive this business model to a 35% gross margin. And we hit it this quarter, and we -- you know, we -- we still have to do more work to sustain that, and that is going to be the driving force that we have in the company, because we think a 35% gross margin in a hardware business is a very good gross margin, and that as we work our expense structure, we then have what it takes to deliver sustained profitability. And so that -- that's our focus. I really can't comment on -- on timing.

Okay. Thanks.

Ladies and gentlemen, if there are any additional questions, please press the star, followed by the 1 at this time. As a reminder, if you are using speaker equipment, you will need to lift the handset before pressing the numbers. Our next question comes from Ben Neyham [ph] with David Greene. Please go ahead with your question.

Hi, gentlemen. Rick, just again along the lines of how we ought to think of the company -- the company's potential longer term. The OpEx goal, would that -- do you think you can get that under $50 million longer term, per quarter?

I -- I -- I'm not going to predict that we can get it below $50 million. I can just say that we will continue to work on our strategy, our investment profiles, our -- you know, our overall cost structure. We -- we have several initiatives that we are pursuing to both take advantage of tactical opportunities, but also strategic opportunities of where -- you know, where to invest and where to get the most return on that investment. And that will deliver a certain OpEx profile that -- that we hope is -- you know, improves continuously, and that's something we haven't just worked on now because revenue was weak, this is something that -- that we have reinforced through a strategy process we went through a number of months ago where we looked at our business, looked at where we should go, and -- and there's a bunch of inherent changes and moves in investments and tradeoffs and -- and, etc. that we need to go there, which will result in -- in reduced OpEx as we make those shifts. So I -- I can't predict -- I can't predict $50 million as a goal or -- or our timing, but, you know, you'll be hearing more from us on -- on where we intend to -- to take our investment profile, and what areas we think are important to -- to invest in to deliver growth as well.

All right. If I can just take a cut at this a different way. Can you perhaps -- or why would you not go public with what a gross margin ought to be for the systems business? Because to a certain extent, the gross margin target that you have of 35% is very nice, but we all know that there's some very rich revenue in that. Why not create a hurdle rate for the businesses that to date have been a drag on the margins?

Well, on the systems business, we have done an incredible amount of work. You have to -- to remember that our systems business today consists of a fairly complex product line, very broad, that came largely out of acquisition, in -- in many cases, and so we've had a complex structure of supply chain, manufacturing, logistics, etc., that we have continued to work. Our restructuring has been high, because we have been closing factories, consolidating manufacturing, moving to outsourcing, etc. And we're starting to see the benefit of that in our -- in our gross margin results this quarter, but, you know, we're not ready to declare victory on that, and we'll continue to -- to -- to work the business, ultimately streamlining the product line in -- in fewer, more leverageable platforms that share parts, that share supply chain logistics, all of that work. It's not -- the good news and bad news is -- is, it's -- the good news is it's not magic or rocket science, the bad news is it takes time to get all of these big, physical things to change. And --and we're -- we're in the middle of that and are making progress that will result in better gross margin dynamics for that business. So I'm actually positive about that business, because I -- I can see the work that can be done to continue to make improvements, some of which we saw this quarter.

Yeah, but why would you not commit to a gross margin target for that particular business, or a return on capital target for that particular business, given its -- its history?

We just haven't historically set those -- those -- those objectives externally. I think that's something we should continue to discuss, because I do think investors view that business in -- in a way that -- that's somehow different than I view the opportunity there, and -- and maybe that's something we should do. I'll have to take that under advisement and see what, you know -- what kind of ongoing communication we give about it around that, but -- I -- I think that's -- that's a good point.

Okay. Thanks.

Our next question comes from Brad Burde with Sandler Capital Management. Please go ahead with your question.

Yes. I have 2 questions. The first -- the second one will follow on to the last gentleman's. But given your guidance, or -- or -- or the -- the little guidance that you gave, suggesting that revenue would be flat quarter-over-quarter, and I assume that the royalty amount in that revenue is going to be somewhat lower, since you said it was surprising this quarter, it seems like to get to a 32 to a 33% average margin, your gross margin on product is going to have to fall, you know, to 19% from, I guess, around 22% or -- it just seems like there's a huge drop there. Can you explain what's happening?

Well, first of all, I -- I didn't think we indicated that we saw media changing next quarter, so I -- I don't -- I don't think we provided any specifics on that. And -- and we have typically not provided guidance around -- around individual businesses -- individual businesses like that. So beyond that, I'm not sure I copy all of your math. I -- I would just say on the revenue side what was -- what happened last quarter was really quite unprecedented, at least in my experience, where we saw throughout the industry a very weak end of the quarter, very nontypical, etc., so we're cautious about establishing any revenue goals that would be more aggressive, given the -- you know, that circumstance, and the fact that it is the summer -- you know, the summer period and there are there are some seasonality weaknesses as well.

Well, -- I -- I -- I guess I'm -- I'm still somewhat confused here. You did say to sort of, you know, that given that you don't have much, you're -- you're saying hey, assume it's going to be flat, right?

On revenue side?

Yes.

Yeah, yeah, we said -- we said roughly flat.

Roughly flat.

Roughly flat.

But then you're -- then -- then we're speaking about, you know, gross margins between 32 and 33%, right?

Right. And we -- we said gross margins are going to be down slightly because of some of the -- the -- what we called atypical factors that we had in the systems business around shipment mix and other things, so we -- we want to be -- we want to be cautious about that as well.

Okay, so, there's a mixture, so in other words, there -- the -- were -- the base of the -- the decline in gross margin, which is substantial, is coming from a mix shift in the systems business, for lack of better visibility?

It's -- it's coming from a variety of factors. You want to -- you want to respond --

Yeah. Brad, this is Lisa. So what we're seeing in Q1 is really an unusual mix of very positive factors, including mix with OEM and products, including a higher percentage of higher-margin service revenue, and then also a higher percentage of royalty. So what we're saying is in Q2, we expect a more typical mix, so that is driving that decline.

Okay. But you -- now you said a higher -- a higher percentage of royalty, which gets back to the idea that the royalty will be down quarter-over-quarter.

We're looking at mix.

Okay. I -- I guess I'll take that offline. Following up on the -- the question of the gentleman before, why shouldn't you be targeting in the systems business margins similar to your competition?

We should.

Which they do on product, right? And I believe, what is it, am -- am I wrong in that StorageTek has product margins, you know, roughly in the -- you know, greater than 45% range?

Well, first of all, I -- I -- I think that we absolutely need to drive to be, for our class of products, to be best in class in gross margins, so that is something that -- that we -- you know, we shouldn't be doing anything that's different from that. We are in the process of transition, so we're not fully there, as we bring factories together and as we introduce new products, but we -- you know, we believe we have a good formula and a set of programs that will get us there. With regards to StorageTek, they really have a different business model, because they're very much -- it's a very high-end mainframe- oriented, high -- they have very high gross margins, they also have very high operating expenses because they have largely a direct sales model, so you can't use the StorageTek comparable completely, because we have less sales and marketing, we spend -- you know, we sell more through OEMs, etc.

Okay.

So we have -- we will have lower gross margins, and we have to have lower operating expenses, as well.

Okay. Well, thank you. I'll follow-up offline. Thank you.

I'm showing we have no further questions at this time. Please continue.

Okay. Well, thank you very much for joining us. It was an interesting first quarter. I hope -- I hope you get a good sense for the priorities that we have going forward in the company, and we look forward to being back here in -- in a few months. Thanks.

Ladies and gentlemen, this concludes the Quantum Corporation first-quarter earnings release conference call. If you would like to listen to a replay of today's conference, you may dial 1-800-405-2236, or you may dial 303-590-3000, and enter the access number of 11002750. Once again, if you would like to listen to a replay of today's conference, you may dial 1-800-405-2236, or you may dial 303-590-3000, and enter the access number of 11002750. Thank you for participating. You may now disconnect.