Quantum Corp (QMCO) 2005 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to Quantum's fiscal fourth 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 zero. As a reminder, this conference is being recorded today, Tuesday May 10, 2005. I would now like to turn the conference over to Shawn Hall, General Counsel. Please go ahead.

Good afternoon and welcome. Here with us today are Rick Belluzzo, CEO, and Ned Hayes, CFO.

The Webcast of this call, our earnings release, a quantitive reconciliation of any GAAP and non-GAAP financial measures discussed today can be assessed at the Investor Relation section of our Web site, 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. These forward-looking statements include our financial prospects and projections including our outlook for the first fiscal quarter of FY 2006, our products, their features and benefits, new product releases and expected ramp cycles, our business prospects, priorities and opportunities, including anticipated R&D spending, investments to grow outside of our traditional take products and cost reduction efforts, our acquisition of Certance, including expected synergies and benefits of the transaction, and the general business and IT spending environment. We'd like to caution you that our statements are based on current expectations and involve risks and uncertainties that could actual results to differ materially.

We refer you to the risk factors and cautionary language contained in today's press release announcing our fiscal Q4 results, as well as to our reports filed with the Securities & Exchange Commission from time to time including pages 38 to 49 of our most recent 10-Q filed on February 2, 2005. 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 risks factors identified in our press release and in our filings with the SEC, including our most recent 10-Q, are incorporated by reference into today's discussion. We undertake no obligation to update these forward-looking statements in the future.

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

Thank you, Shawn. Good afternoon and thank you for joining us.

This quarter's focus continued to be guided by the following strategic priorities. First, capitalizing on our leadership position as the independent volume leader in the tape drive and media market by offering the broadest range of products for customers at all levels.

Next, driving continued market penetration in our storage systems business and making the necessary R&D investments to transition to new leadership tape automation platforms. Third, making selective investments to innovate and grow beyond our traditional tape products such as disk-based backup. And finally, continuing to improve the cost effectiveness and execution strength of our underlying infrastructure.

In pursuing these priorities we have been specifically focused on executing our new product program, improving our competitiveness, completing the Certance acquisition, and driving sales momentum across the combined Company. Our Q4 results show that we have continued to make good progress in these critical priorities, but we still have a series of efforts underway in order to complete our transition.

The March-ending quarter was a tough quarter for many in our industry. While we certainly are not immune to the macroeconomic trends affecting our space, we were able to deliver revenues at the top of our guidance at $240 million.

This is particularly noteworthy given the typical seasonal weakness in the quarter compared to the December-ending quarter, and the task of integrating the Certance acquisition. Already the strategic acquisition is proving to be a positive revenue and cash generator for Quantum.

Storage systems, while entering a typically seasonal sequential decline, grew on a year-over-year basis continuing the recent quarter's trend of solid growth. We greatly strengthened our tape drive and media business in fiscal Q4 with the addition of the legacy Certance product lines, and increased momentum for our SDLT 600 and VS160 products.

Non-GAAP gross margins declined slightly to 30%, primarily due to a higher proportion of revenues coming from OEM sales, a mixed shift towards lower margin products and services, and a higher percentage of media sold under the Quantum brand as opposed to royalty revenue. Operating expenses were contained, despite the spending for new products, Certance integration, SOX compliance, and litigation defense being at a typically high level.

We generated positive cash flows from operations in fiscal Q4 as we have done now for the last five consecutive quarters. The mix of reasonably good top line revenues, lower non-GAAP gross margins, and non-GAAP op ex at the high end of guidance translated to $0.02 per diluted share profits this quarter on a non-GAAP basis.

Now I would like to go through some of the business highlights, then Ned will cover the financials and I'll come back with going forward priorities and guidance.

Let me begin by acknowledging that there is a tremendous interest in the legacy Certance performance in the quarter, however, we do not plan to report on Certance separately today or on a go forward basis. Certain results are completely consolidated into Quantum and fit neatly into our existing segmentation for external reporting purposes.

We can share with you that we are pleased with the legacy Certance contribution for the quarter, especially in light of the tremendous effort required and potential issues that can arise in integrating and acquisition. Overall revenues from legacy Certance products, including the LTO-2 Half-Height tape drive, and LTO royalty were well within our expectations as were margins and operating expenses.

We were quite pleased with the legacy Certance contribution in this first quarter as a combined Company.

Let me begin the business highlights with storage systems, which generated $78 million in revenue. While this represents a 7% sequential decline reflecting the seasonally weaker fourth quarter, revenue was up 6% on a year-over-year basis with particular strength in product revenue, which grew 12%.

For several consecutive quarters we have grown our systems business at rates higher than those of our competitors when comparing year-over-year results, and during our fiscal Q4, we extended this trend.

We again saw strong growth in our P-Series products where unit shipments grew 37% year-over-year, and the PX 720 library in particular experienced six times increase in shipments during the same period. On a sequential quarter-over-quarter basis, growth was 12% and 11% respectively.

Our sales of DX series disk space backup products were soft relative to expectations as customers delayed new purchases pending the release of new features such as the much demanded partitioning capability and the advantage of Optyon hardware compression. These features were added toward the end of March.

Our continued focus on approving margins in storage systems translated to a slight increase in both GAAP and non-GAAP gross margins even in a very competitive pricing environment.

Last quarter we spoke to you about how excited we are with what is in our pipeline this year. As we work towards completing our automation platform transition, as we've said, our goal is significantly lower product cost structures, while delivering increases in core performance and capacity specs, overall features set, and product reliability.

We expect to make several product announcements in the coming quarters.

Now let me turn to tape drives.

Drive revenue was $101.4 million in fiscal Q4, a sequential increase of $34 million largely due to the expanded product line and customer base as a result of the Certance acquisition. Revenue for legacy Certance product was on plan as we begin to see the positive impacts of the LTO-3 and LTO-2 Half-Height ramp.

Limited OEM shipments of these products have begun and more qualifications are expected during fiscal Q1.

The SDLT 600 continued to gain further momentum as shipments rose 16% sequentially and nearly 100% year-over-year. Likewise, the VS160 shipments increased 19% sequentially, and nearly 270% compared to Q4 of last fiscal year.

During the quarter HP began shipments of both the VS160 and the SDLT 600. We expect additional qualifications for the SDLT 600 to be completed during the first quarter.

We continued to be excited about the new tape drive products that we have in the pipeline for the fiscal year, and we are moving forward aggressively with all aspects of introduction planning. These products are targeted for both OEM and channel partners.

The new products will enhance our tape drive offerings with products that will provide value added feature sets and extremely competitive price positioning. The new product suites will enhance multiple product lines and expand multiple segments, DAT, DDS, Value DLT, and Super DLT.

And we expect that the inclusion of features such as DLTSage for manageability and DLTIce for compliance, as well as enhanced interface offerings will provide an even more compelling solution to a broad range of customers.

Now to Media.

Q4 revenue was a solid $60.8 million demonstrating strong sales of Quantum-branded products which were up 25% sequentially, and solid royalty revenue for LTO Media. Driven by the ramp of the SDLT 600, unit shipments of the branded Super DLTtape II Media increased 73, excuse me, 37% from Q3 to Q4 and over two times from the previous year.

Likewise, Super DLTtape 2 royalty volumes also increased significantly during these same time frames.

We saw a corresponding growth in the VS160 Media product with the increases install base of our VS160 drives in the quarter. Since its introduction in Q1 '05, VS160 tape unit shipments, both branded and royalty, have grown sequentially every quarter, with Q4 sales increasing almost 40% from that of Q3 '05.

In summary, our Media business entered the year with solid performance.

So at this point I'd like to turn the call over to Ned for some additional financial details.

Thanks, Rick.

Again, we're very pleased with our top line results in the quarter, with revenue increasing 19% sequentially to 240 million, including the contribution from legacy Certance results. As Rick mentioned, we're quite pleased with the overall performance of the legacy Certance team in its first quarter under the Quantum umbrella, and we believe that this acquisition will continue to enhance our cash and profit generation capabilities.

I'd like to add just a bit more color at the macro level regarding the business in the fourth fiscal quarter.

The sales channel revenue splits for the quarter saw 51% of sales generated with our OEM relationships, and 49% with our other sales channels.

The OEM percentage is up sharply from the past three sequential quarters where it averaged about 45 to 46%. 10% plus customers included HP at 20% of revenue, and Dell at 19% of revenue, reflecting our robust relationships with these market makers.

Geographic splits of revenue saw 58% of sales generated with domestic U.S. customers, and 42% generated with non-U.S. customers in the quarter which is roughly consistent with the previous quarter's performance.

Non-GAAP operating expenses were $67.6 million, or 28% of revenue, which was at the high end of our guidance range of 66 to 68 million. Non-GAAP op ex increased 14.3 million over the 53.3 million of non-GAAP op ex observed in Q3, largely due to the inclusion of Certances' operations in the fourth quarter.

The remaining increase in non-GAAP operating expense quarter-over-quarter was mainly due to costs associated with tape drive, and automation product development ramps for legacy Quantum platform transitions, Sarbanes-Oxley compliance expenses with outside firms to conclude the year-end audit and 404 attestation, and legal costs with outside firms as well. GAAP op ex came in at $68 million for the quarter.

If there was one disappointment with the quarter, it was our expense levels. We have been working aggressively to manage expenses over the last several quarters and we didn't distinguish ourselves here despite the rational explanations for being at the high end of the range.

We remain dedicated to achieving a $60 million non-GAAP op ex quarterly run rate by the end of the fiscal year.

The non-GAAP gross margin rate in Q4 was roughly 30%, slightly lower than in Q3, primarily due to the revenue shift in OEM customers previously noted, aforementioned strong performance of Quantum-branded Media, and lower margin mix of products and services sold in our tape drive categories. GAAP gross margin came in at slightly over 27%.

On a non-GAAP basis, the Company earned $0.02 per diluted share this quarter, compared to $0.05 per diluted share in the third quarter of 2005, which is our seasonally strongest quarter for the year. GAAP EPS per diluted share was a loss of $0.02 versus an $0.08 profit in Q3.

You will remember we had a one-time tax benefit in the earlier quarter of a little over $12 million. GAAP results include 5.7 million in intangibles amortization, a one-time charge of 1.8 million of acquisition-related amortization of inventory valuation, a one-time 1.3 million in special charges primarily related to previously announced cost reduction plans, and these were all offset by a one-time benefit of 2.5 million resulting from an expired liability.

Now for modeling purposes, the Certance acquisition resulted in an additional 1.2 million in intangibles amortization for the quarter, with the overall balance of unamortized intangible assets now totaling 68 million at the end of the quarter, of which 25 million was attributable to the Certance acquisition. There was zero goodwill booked for the acquisition in light of the transactions valuation and purchase price.

Cash flow from operations for the quarter increased almost four-fold to $11.4 million, compared to about 3.2 million in Q3. We ended the quarter with cash and short-term investments of approximately $250 million after taking into account the $40 million initial installment payment for the acquisition of Certance.

We made another installment payment of approximately $14 million for the acquisition in this fiscal Q1, and we'll make a final payment into escrow of about 6 million in the September time frame. We expect to continue to generate positive cash flow from operations in Q1 this year.

On the working capital front, we continued to demonstrate rigorous focus and management. DSOs improved markedly to 48 days, down from 51 days in Q3.

Inventory turns improved to 12.1 in Q4 versus 11.7 turns in Q3. Days payable declined slightly to 38 days in Q4 versus the previous quarter.

We were very pleased to deliver this kind of arbitrage between DSOs and DPOs, especially in light of our internal credit and collections transition following the acquisition.

So with that, I'll turn the call back over to Rick, who will comment on our near- term priorities and provide the outlook for the next quarter.

Thank you, Ned.

We are pleased with the progress we've made but as I stated earlier, we still have work ahead of us.

Moving ahead our near-term priorities will be focused on the following: we will continue to focus on delivering top line performance. We expect fiscal year '06 to be an outstanding product year for Quantum as we focus on delivering on the R&D investments that we have made during the last two years.

We will launch new automation platforms, new tape drives in almost every segment, expansion to our DX feature offering, as well as products that represent new categories. We truly believe the prudent investments today will enable us to capitalize on our market leadership and position us well for future growth.

We will continue to integrate Certance into our operation so that we can take advantage of the inherent synergies of the combined organization by further increasing our sales outreach capability and product lines, as well as improving our expense structure.

And finally, we will be even more focused on improving our gross margins through new standardized platforms, better product quality and cost synergies from contract manufacturers and our own vertically integrated capabilities that we acquire from Certance.

Now, let me turn to guidance. We generally only provide guidance for the current sequential quarter, but I thought it would be important to provide a more holistic view of the business and strategy for the coming fiscal year.

We view the first half of the fiscal year as one of transition on several important fronts as we execute against the priorities that I just outlined, namely new products and several, and to complete several projects relating to SOX compliance and personnel and systems integration. This focus on new products will result in planned increase in R&D spending for the first half as we approach the introduction of these products we will continue to incur higher costs for tooling, evaluation units, testing, and other engineering costs.

As a result of this continuing investment in our operational platform and strategy, we see the Company operating at breakeven to slightly profitable on a non-GAAP basis, and generating positive cash flow from operations for the first two quarters of the fiscal year. We expect continued GAAP losses during this period.

We anticipate that following this transition period we will begin to see the benefits of more efficient costs of good sold levels resulting from the standardization of product platforms, the improved synergy from the Certance acquisition, both above and below the gross margin line, reduced R&D investment in light of the transition product platforms, and improved product quality. We expect that these benefits will result in improved operating margins on a non-GAAP and GAAP basis and positive non-GAAP and GAAP EPS.

We remain committed to delivering a quarterly non-GAAP operating expense run rate in the $60 million range by the end of the fiscal year. We remain committed to driving the Company to 8 to 10% non-GAAP operating margin in the intermediate term, specifically we are committed to delivering this through continued expense management should anticipated margin improvements not materialize.

So we have six months of tremendous effort and change ahead of us to be able to begin delivering on these commitments.

Regarding the first fiscal quarter guidance, we expect the June quarter to be seasonably weaker than the March quarter especially given the difficult macroeconomic environment that we have recently observed in the entire sector. We expect overall revenues to be in the range of 230 to $240 million. We expect non-GAAP gross margins in Q1 to be roughly flat.

Non-GAAP operating expenses are expected to be in the 65 to $67 million range as we strive to manage our system integration efforts following the Certance acquisition, effectively managing our litigation efforts, embarking on bringing Certance under SOX Compliance, and our drive, to drive our new product platform transitions to a successful and timely conclusion. Again, all of this involves setting the stage for the second half of the year.

As a result we expect non-GAAP earnings per diluted share to be roughly in the range of a breakeven to profit of $0.04 per diluted share for the fiscal first quarter.

We expect GAAP gross margins in fiscal Q1 to be roughly flat sequentially, and GAAP operating expenses to be in the 67 to $69 million range. The GAAP to non-GAAP difference reflects estimated amortization of acquisition-related intangibles of $5.4 million.

We do not anticipate any significant restructuring charges in the fiscal quarter, the first quarter. As a result, we expect GAAP bottom line results to be in the range of a loss of $0.04 per diluted share to breakeven.

So to close, Q4 was an overall tough quarter for our industry, and we are pleased that we were able to deliver the revenues and profitable non-GAAP performance that we did.

We are excited about the upcoming opportunities in front of us as we complete the integration of Certance and introduce new products to the market. I am looking forward to working with the team to continue building a company based on innovation and on an operating model of sustained profitability.

With that I will open it up for any general questions that you might have. Operator?

Thank you. [Operator instructions] Our first question comes from Glenn Hanus with Needham and Company. Please go ahead.

Good afternoon, guys. Maybe just a few quick ones. If you do have a small profit tax rate for modeling purposes for the next few quarters?

We don't see any significant federal tax obligation in the foreseeable future given our NOL position. We probably have anywhere between 300 and $400,000 a quarter for withholding taxes given, that are remaining for state and local kinds of things, but really no negligible tax rate going forward here.

Okay. Maybe could you talk about gross margins. You gave a target for exiting on the operating expenses so we're sort of flat grows margin-wise for a quarter then can you give some sort of a range that you think you might be able to get to by the end of the fiscal year or talk about sort of plus and minus factors that might be affecting you and any color you can give there?

The specific guidance we've given for next quarter is roughly flat to what we've observed in the most recent quarter. I think the real leverage that we have here going forward between now and the end of the fiscal year have been articulated in what Rick was talking about.

Number one, we are able to, we are looking very much forward to transitioning to new standardized technology platforms and product platforms that allows us to have some considerable leverage in terms of COGs.

Secondly, we are really embarking with renewed focus on quality, and we think that there is some considerable leverage within the gross margin line of being able to improve from a warranty perspective and from an inventory perspective our quality as we manage that.

Thirdly, through some very hard work in the first six months of the year, we work our way through our Certance synergies and were able to benefit from that in the last half of the year. So that affords us an opportunity there as well in terms of the improved profitability.

I think Rick it said best to the extent that we are able to deliver that on the gross margin line the bottom line will take care of itself. To the extent we don't, for whatever reason might be out there, market driven or otherwise, we are certainly all about making sure that we manage expenses to bring about an 8 to 10% operating margin in the intermediate term.

This is Rick. Let me just add, what are the challenges that we have faced in the last year plus is the fact that a lot of our product platforms have been a bit aged. They were designed for a different time in this industry and for different market segments, and it really has limited our ability to aggressively drive the kind of improvement in cost and cost structure that we need to deliver, and so that's why we have over and over communicated the importance of investing into these new platforms so we have an extensible offering that allows us to improve cost and quality for the foreseeable future, and that's just not what we've had to work with.

As the industry has become more price competitive, we've worked very hard to respond to that and in fact we've been able to manage the gross margin reasonably well. But we just haven't had the capability to be able to do all that we want today to do and we think we'll be able to do in the second half of this year as we start to introduce those new products and already start with a lower cost position, but then have the opportunity where you can invest in engineering and vendor work to further bring those costs down to keep up with the competitive environment.

So it's really very fundamental to the way we look to the future cost competitiveness of Quantum.

Do you think exiting this fiscal year sort of a gross margin improvement of 2 to 400 or 2 to 500 basis points might be kind of the range you're thinking?

Well, we have, you know, we're not going to give guidance at this point on that. The factors, there are two other important factors that are a little hard to pin down at this point, and one is the competitive pricing environment, and secondly, is we are also very heavily impacted by mix.

The fact that we have some parts of our business that like the media royalties which have very, very high gross margin and other parts of our business that have very low gross margins. At this point in time I don't think we have enough clarity about the mix of those businesses looking on later into the year.

And maybe I could lastly, you talked about Certance synergies. Could you kind of maybe be a little more granular where specifically you see the best opportunities for synergies there?

I think there are three of quite honestly. We're able to leverage a very, very broad product portfolio now with sales team that is now all about expanding upon a combined Quantum brand. And so when you take at look at our OEM relationships, our sales channel relationships, we think we've got some considerable synergy going on there.

Second thing is that we have the opportunity now to take a look at our sheer volume as a combined company and make some strategic trade-offs between existing contract manufacturers or leveraging the vertically integrated manufacturing capabilities that we have through the Certance acquisition. So it will be an important thing to work through as we go forward here.

And then last but not least, we continue to take a look at redundant or combinative operations like repair, like provisioning, like pack out, where we have several different locations around the world through the combined entity and we'll take the appropriate decisions there to make sure that we're optimizing shareholder value on a go forward braces.

Another way to think about these as we've worked through this, I would say I'm even more positive about the synergies that exist because of this combination than I have ever been. That's the good news.

The challenge is of course, a lot of it is work, and investment and the timing of some of those returns will take some effort. I mean if you consolidate facilities or if you consolidate systems or you leverage components or designs, I mean all of those things, the list is longer than I actually thought when we did the acquisition, but all of those efforts take work and investment to get there, and I think that's the reality that we face, and we're working to set good priorities there to make sure we don't try to do too many things, but we really capitalize on the most immediate opportunities.

And with regard to synergies below the gross margin line, Glenn, we really do articulate it there with our stated objective of reaching a run rate of $60 million by the end of the fiscal year from something that's closer to 67 or 68 today.

Okay. Thank you.

Thank you.

Thank you. Your next question is from Ben Nail with David Green. Please go ahead.

Hi, guys. Ned, you just sort of answered the question because if I took that op ex target that would sort of give me an implied gross margin objective that the Company has. But let me just add another dimension to that. How much of this requires top line growth to get to that 8 to 10% target versus just the synergies? Can you do it in a modest 3 to 5% top line environment?

We have modeled and developed plans that do not call for substantial top line growth. I think again, in this environment and in this category that would be too risky, and therefore we're driving the top line to the best of our ability but as we've modeled our financial goals we are not, in spite of all these new products introductions and everything we're doing, we're not looking for substantial revenue growth to grow our way into an expense structure, but instead, we want to get as much out as we can out of the top line but make sure we deliver on the synergies, the transition in new products and all of the other activities that we've been working on.

That's good to hear. So if you do get some top line, then that should just amplify the cost structure in the synergies, correct?

Yeah, it's absolutely true. I think in the environment in this industry the last couple of years I don't think anyone can think of building a business model that relies too much on top line growth, and the industry recovers and our products are well received, that's only a good thing and we're kind of hoping for that.

Okay. Just a couple of other questions. On the DX product you sounded, you did suggest that the customers were waiting for the new feature set. So does that mean that you continue to have a very bullish view of that product longer term, it's just a pure product transition issue in your opinion?

Well, it's a very complex market. The disk space backup market is in some ways exploding in terms of awareness and excitement and energy and as a pioneer in that segment we think that's really a good thing, but at the same time that growth and expansion creates an environment where a lot of customers are making decisions about what approach and which way they want to pursue things.

We continue to win new customers who are buying one or two units and deploying it and the real model that we're looking for, as we've seen in our enterprise library business, is for people to standardize buy support contracts and come back for more expansion, and it's just even though we've been doing this for awhile, it still is really relatively early in the process and the features we've added this quarter are, in some ways the best upgrade that we've delivered.

Partitioning gives customers the chance to be able to more flexibly deploy this platform in their environment, and the compression is unmatched in the industry. No one has in line hardware compression as we do, which gives you tremendous price performance advantage.

We're still moving forward. We have more releases planned. We're winning new customers and we're hoping to see things accelerate where customers will come back for repeat purchases at higher levels than we've seen recently.

Just one last question then on the investment in the next six months. So if I take a look at the non-GAAP op ex it's 67 to 68 and the target of 60. I would suggest that for the next two quarters the lion's share of that differential is the investment in increased R&D product launch and some of this Sarb-Ox and legal costs. So if I look at that I come up with maybe around $15 million of expenses over the next two quarters. Am I doing something? I mean the 15 million is the aggregate number and then the lion's share of that would be associated to those items that you listed.

Well, number one, the $60 million, I just want to make sure that we clarify. The $60 million target is at the end of the fiscal year.

I got you. So then I should do this for three quarters.

Right. So I think again, making sure that we conclude the various platform transitions that we've got, we want to make sure that we get them to a timely and correct closure. So we'll probably have some uptick in R&D over the next couple quarters.

Marketing and sales probably stays the same and then we'll continue to do whatever we possibly can on the G&A front from a legal standpoint and a SOX standpoint. Then getting from current run rate levels to 60, certainly G&A is going to be a huge amount of focus, a little M&S and a little bit of leverage on the R&D front. So I think you've captured from a nuance perspective the right buckets, I just can't comment on the dollar value.

Okay. How come some of these things aren't capitalized?

I don't think you can capitalize --

I was wondering in terms of the some of the product related, are these, these are basically marketing and sales expenses?

I think we expense R&D as incurred for things like evaluation units and other things. I don't think there's a case to capitalize those.

I would just sort of re-emphasize, I don't want you to think that we're sitting here planning increased spending plans for the next couple of quarters. The point I think as you can pick up in our discussion here today is, we didn't like our Q4 expense level.

Even though we can explain it, we really want to make faster improvement, and we were just realizing the fact that that level will somewhat carry-forward a bit as we make these improvements and some of the causes of Q4 to be higher than we would have liked, some of those will continue and kind of offset some of the improvements that we're making. But it's only a timing issue. It's not in any way a change in any spending priorities.

We have no incremental programs that we've developed next last quarter or so. There's been no decisions to do more. It just reflects that there's a lot of additional costs with the Certance integration and with the cost of Sarbanes compliance, and there's just a number of those things going on. It feels just a little more difficult to manage now because of that level of activity.

Lastly, the op ex, the op margin target 8 to 10%, that is something that we will see some visibility on in three quarters from now is what you're, in that third quarter?

We are characterizing that as an intermediate term goal.

That means third or fourth quarter.

I would probably say it could even be beyond that.

Okay. Don't take away the punch bowl too quickly though, okay? We sort of, we like that objective being out there on the record. Anyway, thanks, guys, appreciate the hard work.

Thank you.

Thank you. Our next question is from Kevin Oram with Presidium Investment Management. Please go ahead.

Hey, guys. Following up on the last caller's questions but kind of approaching a bit of a different way instead of kind of breaking down the expenses by bucket, kind of breaking done the expenses by business. Now, your storage, whatever you call it, your systems business, how much did you lose in the quarter on that business?

We don't comment on that right now. We'll have gross margins broken out by segment in the K .

Well in the Qs you break out the operating losses, in your 10-Qs and your 10-K, and it was kind of 8.5 million or so per quarter in the past. Can you comment on whether or not it got better or worse this quarter?

I think it was probably roughly flat.

Roughly flat. Okay. So in a sense, this forecast of 8 to 10% margins seems very, very conservative because as we've talked about off line, you think you can get that business I assume you wouldn't be in it unless you thought you can get that business to profitability. But if I were to take that business and say you ought to be able to get that to breakeven, doesn't that by itself get you to the expense kind of your cost savings that you're talking about? I actually think you're going to get more than that just by bringing that business to breakeven. Am I thinking about this correctly?

I don't have all of that math in front of me at this point in time, but.

Here's how I'm approaching it. So you had in this quarter on a non-GAAP basis indirect expenses of about 67.5 million backing into what you said that you're basically guiding in the intermediate term to about 60 million in expenses. You're losing 8.5 to 10 million or something like that in that one business. Bringing that to breakeven would get your expenses down even below that 60 million. Bringing it to profitability will get your expenses down by itself.

Kevin, you have to remember that in getting the business to profitability there's quite a bit of leverage we're hoping for coming out of these product platform transitions. So it's not dollar for dollar going just to op ex.

I didn't follow that. Can you say that again?

We think we're going to be able to improve our storage systems margin in addition to leveraging the operating expenses, so it's not getting that business to profitable using your numbers of 8 to 10 million, that's not an 8 to 10 million op ex improvement by itself. There's also, we're hoping to get some leverage out of the gross margin.

Okay. Fair enough. If I'm backing into your numbers here and I'm basically assuming kind of a 3 to 5% growth in revenue going back to your comments, I think to the first caller, so if I assume you're going to really have about 250 million of revenue, you basically back into gross margins of about 33%, which means your cost of, I guess it's what's going on is your cost of goods sold will be down even though your revenues will be up and so you're saying that some of that is coming from that.

We stand by the statements we've made, Kevin in terms of we're not betting the ranch on higher revenue. We're hoping very much that these product platform transitions and the certain synergies that we've got are going to help us improve our leverage on the gross margin line and we're committed to delivering $60 million worth of operating expense by the end of the year. I think that's pretty straight forward in terms of what we're trying to get to.

And so you said you're going to get there by the end of the year, not beyond the end of the year? I was trying to understand how you were responding to the last caller to get to the 8 to 10% we'll be there by the end of this year? Fiscal year?

We are on the record for saying the operating expense run rate is by the end of the year, the 8 to 10% vied is in the intermediate term.

I see.

We have had a bit of a kind of shift in this call kind of talking a little more about the future. The rational for that is that we have been investing and working for a couple of years now on many aspects of this business, and what provides the degree of growing confidence is the fact that we demonstrated last quarter that if we get things aligned, results look good, we're very positive about the potential of Certance, and what remains is finishing those things but also the excitement about these new product transitions and the benefit that we've said all along needs to be achieved, that we have to do this through some consolidation of platforms, lower cost, improved designs, better back-end processes.

There's a whole bunch of things that we've been working for two years to deliver. And we're feeling we could see that in the future, it's hard to tie down the exact timing, because it's still a lot of work ahead of us while we're much further down the path.

We still know that we have a lot of work and certain levels of risk to making this a reality, and then coupled with the fact that we're living in an environment today that is very uncertain with prices under tremendous competitive pressure, and we're putting all of that together and yet still saying we think we have the ingredients to go through this transition and get the business to where we've said now for a couple years that we thought we could get to.

Right. You've been operating with a tremendous headwind, and I very much appreciate the difficulty in terms of the environment that you've been working in.

Let me ask you this. If you get to the 8 to 10% op margins in the intermediate term, you back into some numbers in terms of an EPS, I'm not trying to hold you to these numbers, but you back into kind of a, maybe a 10 to $0.12 per quarter run rate eventually, and, you know, which would make a $2.39 per share stock especially when you have 70 million in excess cash after this whole Certance acquisition would make it extremely attractive.

So let me ask two questions. One is, can you comment at all on in terms of your thinking in terms of share buy backs as well as from, what's interesting is, I don't see any of you guys out buying shares yourself and it's just kind of a little unsettling to know that we're all buying shares and we don't see any of the management team or board members out buying shares at least from what I can see. Can you comment on both of those?

Kevin, let me comment on the second one. Given the fact that the senior management team and the board have been operating with some relatively material non-public information with regard to the acquisition, right up to the filing of the a/k/a and then almost immediately following that, ran into quiet period and blackout period given our quarterly results. We haven't exactly had an opportunity to really kind of go out there on a person basis whether it be the board or senior management to be able to go do that.

Well, that's kind of explaining maybe the last quarter and a half, not necessarily the last year. Fair enough.

I think at these particular levels, individuals and personalities will take it upon themselves to take a look at where they think the value proposition is and there may be differences other than that.

The second is, we're not going to publicly comment right now at least, in terms of what is it that we're going to do with cash. There are probably three alternatives out there.

Number one is, as you brought up, share repurchase. Number two, there certainly is a convertible that we have out there that brings somewhere around $11 million worth of interest and amortization charges into the income statement.

Thirdly, there may be again on a surgical basis very, very surgical basis, an opportunity to continue to acquire, as we did with Certance, intrinsic value and a terrific entities that allow us to continue to add to the product portfolio. The whole point there, though, is we need to get through this transition to be able to look at ourselves in the mirror, and look at our shareholders in the eye, and say we have a consistently cash generating, consistently profitable platform for us to be able to go out and do those strategic alternatives.

Okay. Good. Thanks, guys. Good luck.

Thank you.

Ladies and gentlemen, if there are any additional questions, please press the star followed by the one at this time. And just as a reminder, if you are speaker equipment, you will need to lift the handset before pressing the numbers. One moment please. Once again, if you do have a question, please press star one at this time. Management, I'm showing we do not have any more audio questions. I'll turn it back over to you.

Thanks again for joining us. We look forward to our next call. Thanks.

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