Quantum Corp (QMCO) 2006 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Quantum Corporation third quarter fiscal 2006 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 key followed by the zero. As a reminder, this conference is being recorded today, Tuesday, January 31, 2006. I would now like to turn our conference over to Shawn Hall, general counsel. Please go ahead.

Thank you, good afternoon, and welcome. Here with me today are Rick Belluzzo, our CEO, and Ned Hayes, our 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 section of our website, www.quantum.com and will be archived for one year.

Thank you. Well, good afternoon and welcome. With me here today is Rick Belluzzo, CEO and Ned Hayes, CFO. The webcast of this call along with the quantitative reconciliation of any GAAP and non-GAAP financial measures discussed today can be accessed at the investor relations section of our website at www.quantum.com and will be archived for one year. During the course of today's discussion we will make forward-looking statements within the means of the Private Securities Litigation Reform Act of 1995. The forward-looking statements we will make include statements regarding our financial projections and prospects including target financial metrics and our outlook for the third quarter of fiscal year 2006 and for the second half of fiscal year 2006, new product introductions, their features, competitive positions and expected ramp cycles, and our business prospects, goals, priorities, and opportunities.

We would like to caution you that our statement are based on current expectations and involve risks and uncertainties that could cause actual results could differ materially. We refer you to the risk factors and cautionary language contained in our press release issued today announcing our fiscal Q3 2006 results, as well as to our report filed with the Securities and Exchange Commission from time to time including pages 41 to 51 of our most recent 10-Q filed on November 4, 2005. Such reports contain and identify important factors that could cause actual results to differ materially from those contained in our forward-looking statements. These risk factors are incorporated by reference in today's discussion, and we undertake no obligation to update our forward-looking statements in the future. With that, I'll turn the call over to Rick Belluzzo.

Thank you, Shawn. Well, good afternoon and thank you for joining us for our fiscal third quarter earnings call. A year ago we described fiscal 2006 as a critical year for Quantum, as we aggressively pursue and agenda that has been focused on solidifying our foundation in order to be a stronger competitor while delivering consistently improving financial results.

In doing so, we have been specifically focused on completing the integration of Certance, continuing to streamline our organization, embarking on an unprecedented new product introduction program, and capitalizing on the last three years' effort to improve the company fundamentals. Given the priorities we have laid out, we have also characterized our fiscal 2006 financial results as two divergent halves, with the first half slightly profitable on a non-GAAP basis, and the second half achievement of an inflection point as we begin to see the benefits of a more competitive product set, continued operating expense improvements, and a more integrated organizational structure.

We are pleased that our Q3 results reinforce this commitment. In Q3 we delivered improved revenues across all segments, increased our non-GAAP gross margin rate from 28% to 31%, and managed expenses to 26% of revenue. As a result of these improvements, we reported $11.7 million in non-GAAP profit, or $0.06 per diluted share. This was the best non-GAAP net income performance in four years.

During Q3, we continued to manage through significant transition challenges including the integration of systems and the addition of several new product introductions and ramp-ups. Yet these results reflect solid progress in creating the second half inflection point that I described. In addition, they demonstrate the leverage inherent in our operating model whereby continued improvements on the costs and expense side extend the benefits derived from a newer, highly competitive and lower-cost product portfolio.

Q3 revenues improved to $218 million with particular strength in tape drives and media and well within our guidance range of $210 million to $225 million. On a year-over-year basis, revenues grew more than 8% mostly due to the inclusion of Certance results. While we continue to experience product transition challenges and with declining sales of older products and OEM transitions, we benefited from higher service and branded media revenue as well as strong sales of our newly introduced SuperLoader 3 and PX500 series products.

The non-GAAP gross margin rate rebounded to 31% from 28% in Q2. This strong improvement reflected increased service revenues, which generally carry a higher gross margin rate; a mixed shift towards more branded product; as well as the sale of newer higher-margin products. This was slightly offset by a higher percentage of media sold under the Quantum brand as opposed to royalty revenue. The GAAP gross margin rate was also up 3 percentage points from Q2 increasing from 26% to 29%.

Non-GAAP operating expenses improved slightly to $55.8 million during the quarter reflecting a decline in R&D expenditures as we complete investments on new products. This decrease was offset by higher sales and marketing costs associated with the launch of these new products and higher G&A costs related to performance-based incentives. GAAP operating expenses were $60.7 million.

We generated positive cash flow from operations in fiscal Q3 as we have done now for seven of the last eight quarters. The mix of solid top-line revenues and improved non-GAAP gross margin rate and slightly lower non-GAAP opex translates to a Q3 non-GAAP profit of $0.06 per diluted share. We were slightly profitable on a GAAP basis.

Now I'd 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 the business highlights with storage systems, which was up slightly sequentially to $69 million in revenue. Growth in the automation business occurred across almost every new product line that began shipping during the quarter. Furthermore, in Q3 we continued to experience growth in our branded product sales for the segment. In fact, sales within our branded business have no increased for three consecutive quarters, and this growth was reinforced with successful acceptance of our new products.

Offsetting the growth in new product sales was continued declines in our older products, particularly the M series tape libraries. Product transition challenges such as product availability issues had a negative impact on system sales growth, but these were largely resolved by the end of the third quarter. Total sales for auto loaders increased 19% sequentially, mostly due to the robust sales of our new SuperLoader 3. Likewise, sales momentum for our new PX500 series products continued to gain strength during the quarter. And, finally, sales of our enterprise library, the PX720 experienced sequential sales growth of 13%. In fact, in Q3 we sold our first five-frame installation of the PX720 to a Fortune 10 company.

While total sales of our DX series disk-based backup products declined sequentially, we did see growth for our DX100 product as we received a significant DX100 order from a U.S. military customer. In Q3 we launched a major expansion of our disk-based product offering, including new midrange solutions and the disk-based solution that is based on Microsoft Data Protection Manager. We are very encouraged by the initial reception of our new DX3000 product, which began shipping in December. Our priority in Q4 is to continue to ramp-up our sales and marketing efforts, especially as the DX5000 and the DPM5500 begin to ship.

The initial progress we have made in transitioning our new products was reflected in our gross margin as both GAAP and non-GAAP gross margin rates for this business increased this quarter over Q2. In addition, a stabilization of service revenue, which generally carries higher gross margin rates, contributed to the improvement. In Q4 we will continue to drive efficiency improvements in our new product platforms.

Now let me turn to tape drives. Drive revenue was $89 million in fiscal Q3, a sequential increase of 10% largely due to a healthy recovery of both service and product revenues. This increase was offset by continued declines and pricing pressures related to our older products including the VS 80 and the DAT 24. GAAP and non-GAAP gross margin rates both increased sequentially in Q3 as we benefited from a more efficient product line and manufacturing platform. In addition, a recovery of service revenue for the quarter contributed to the rise in gross margin rates.

For the quarter, shipments of the VS160 increased 31% sequentially and over 43% compared to Q3 of last fiscal year. We also saw solid momentum with our new DLT-V4 tape drive. We believe that the value proposition of this product is unmatched. It includes enterprise-level manageability features through our DLTSage architecture such as monitoring, diagnostics, and WORM for meeting regulatory compliance requirements.

In addition, we announced in December that in Q4 we will be adding DLTSage tape security to DLT-V4. This is part of a comprehensive, multi-layered security framework that we have created to address the growing concern about information security. In its simplest form, DLTSage tape security uses an electronic key to prevent or allow reading and writing of data on a tape cartridge. To further leverage these value-added features of the V4 and the advantage we have at being able to combine our tape drives and automation, we have begun to shift this tape drive within the SuperLoader 3 automation platform providing customers enterprise-level performance at superior price levels.

In the super drive area, sales of LCO2 Half Height drives remain strong, growing 21% over Q2's level.

One of the highlights of the third quarter were the strong sales of the SDLT 600. Unit sales of this product rose over 40% sequentially and 59% year-over-year. Meanwhile, the SDLT 600A, which was specially developed for the broadcast and professional video market and will be launched later this quarter continues to win industry awards for its innovative and visionary technology.

We continue to be excited about the new tape drive products that we have in the pipeline including the DLT-S4, the company's new super drive. It will provide industry-leading capacity, high performance, the lowest cost per gigabyte of storage, and the benefits of DLTSage including the DLTSage tape security. We will also be increasing our focus on bringing our tape assets together to provide customers and integrated solution that offers greater value and a better user experience for all of their storage and archiving requirements.

Now to media -- Q3 revenue was a solid $60.3 million. Strong sales of Quantum-branded media products for both the DLT and LTO platforms drove a 13% sequential increase in branded media revenue. Royalty revenues relating to LTO media, which experienced strong sequential growth, have contributed to the stability of our media business. Driven by the increase in the SDLT 600 drive volumes, total shipments of super DLT tape 2 media increased 36% from Q2 to Q3, specifically, super DLT tape 2 royalty unit volumes doubled during the timeframe. DLT tape VS1 media volumes grew 25% from Q2 to Q3 driven by the growing installed base of DLT-VS160 tape drives.

In summary, our media business ended the quarter with solid performance. So at this point I'd like to turn the call over to Ned for some additional financial details.

Thanks, Rick. Given that we had some remaining operational challenges in the third quarter as we worked through the complicated transitions to our new tape automation product sets, and then geared up for our next-generation tape drives, we are generally pleased with our top-line results in the quarter with revenue increasing 7% sequentially to $218 million, squarely in our guidance range.

The improvement was witnessed across the board with higher product sales of both storage systems and tape drives, a rebound in service revenues, and stronger branded media revenue. Now to give a bit more color regarding revenue for the third fiscal quarter, the sales channel revenue splits for the quarter saw 42% of total sales generated with our OEM relationships and 58% with our branded sales channels. Dell, NHP, remain 10%-plus customers for the company at 18% and 17% of revenue, respectively.

We will continue to attempt to optimize our OEM portfolio while continuing to build our branded sales direct sales channels, both with an eye toward improving gross margins.

Geo splits of revenue saw 68% of sales generated within domestic U.S. customers, and 32% generated with non-U.S. customers in the quarter, which is consistent with the previous quarter's performance.

The fundamentals that led to an increase in revenues for Q3 also had a corresponding positive impact on gross margin rates in terms of mix. Mix plays a very important role in how our margins are delivered quarter-to-quarter. Media, service, high-end automation, enterprise drives, and branded sales all contribute positively to margin rate. In Q3 we began to benefit from the market adoption and sales of newer, higher-margin products replacing older, less cost-effective platforms, especially in our low-end and midrange systems business.

This margin improvement was offset slightly by a higher percentage of media sold under the Quantum brand as opposed to pure royalty revenue. The company's non-GAAP gross margin rate in Q3 was 31%, 3 percentage points higher than that observed in Q2. GAAP gross margin rate was 29% in the quarter. Both of these measures were better than provided guidance.

We continue to manage operating expenses in the question. Non-GAAP operating expenses, despite the improved revenue picture, declined slightly to roughly $56 million, or 26% of revenue. Having a number of the product platform transitions behind us, allowed us to begin the anticipated dialing-down of the R&D spend. This was offset by a higher G&A spending and, to a lesser extent, increases in sales and marketing as we ramp up our product launches.

I'll remind everyone that our stated intermediate business model maintains mid-30% gross margin rates and mid-20% E:R ratios. We delivered on the latter metric in the quarter, and we'll be driving hard to achieve the margin rate metric in due course.

On a non-GAAP basis, the company earned $0.06 per diluted share this quarter compared to $0.01 per diluted share in the second quarter of fiscal 2006. For modeling purposes, you should be aware that achieving quarterly income in excess of $8.8 million triggered the treatment of our convertible debt as if fully converted for fully diluted EPS cap purposes. Therefore, interest expense associated with the facility of $1.75 million was added back into the earnings numerator in the fully diluted EPS calculation as were convertible debt shares totaling 36.8 million shares into the share count denominator.

We were marginally profitable on a GAAP basis versus a loss of $0.07 per fully diluted share in Q2. Both measures were better than the provided guidance ranges. GAAP results for the quarter included $5.5 million in intangibles amortization, $3.5 million in restructuring charges primarily related to previously announced cost reduction plans, and $1.9 million in one-time legal settlement costs.

We got back on track with positive net cash flow from operations for the question at $1.3 million compared to a negative $1.2 million in Q2. We ended the quarter with cash and short-term investments of approximately $232 million exclusive of restricted cash. This performance means that we have generated positive cash flow from operations in seven of our last eight quarters, and we expect to continue to generate the positive cash flow from operations in fiscal Q4 this year as well.

On a working capital front, DSOs increased to 57 days from 54 in Q2, mostly as a result of a few deals closing late in the quarter. Inventory turns held steady at 8.7 in Q3, and days payable declined to 39 days in Q3 versus 44 days in Q2.

In summary, the third quarter's performance was highly reflective of the inflection point Rick and I have been pointing to now for several quarters. The choppiness of the first six months of the fiscal year reflect complicated product transitions, execution against product roadmaps and rollouts, finishing the integration of the Certance acquisition, and continuing hard work on the operating expense fronts. The third quarter clearly shows the benefits of all the hard work before it with new cost-effective drive and automation products being embraced by the marketplace, old product inventory being prudently managed through that transition, optimization of R&D expenditures now that product platform transitions are behind us, and continued vigilance on opex synergies and E-Rs With an ever-increasing focus on improving margin rate.

The senior management team is pleased to deliver on this inflection point commitment and is poised to continuously improve upon the foundation we now have at hand. 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 question.

Thank you, Ned. We are pleased with the progress we've made, and while we feel we are over the peak in terms of transition workload and risks, we will still face execution challenges given the ambitious set of activities we have planned. Moving ahead, our near-term priorities will be focused on the following -- we will complete the final stage of product introductions. In addition to the DLT-S4 we have a few other exciting products in our pipeline for release in the coming months. In conjunction with this, we will continue to ramp manufacturing of our new products and increase our efforts on the sales and marketing front. We will also continue to invest and extend our platform and expertise into disk-based systems. We now have a very broad and competitive product line.

We will also work to capitalize on our more competitive product portfolio through margin gains. We are still evaluating and implementing changes to our manufacturing capabilities with the goal of more efficient manufacturing infrastructure. We believe that this, combined with a lower-cost product platform will enable us to further improve gross margins.

And, finally, now we will begin to focus on new product roadmaps that will not only capitalize on the strength of our product technology foundation but that will also provide feature sets that further differentiate our products from the competition, thereby giving Quantum a competitive advantage. Quantum has a unique opportunity to combine media, tape drives, and tape automation to deliver a leadership value proposition. We have already begun work in this area as evidenced by our security framework announcement and the integration of our drives with our libraries at or near the introduction of the new tape drive product.

With that, let me switch to fourth quarter guidance. We expect overall revenues to be in the range of $210 million to $225 million. We expect non-GAAP gross margins to be relatively flat from Q3; non-GAAP operating expenses are expected to be in the $56 million to $58 million range. As a result, we expect non-GAAP earnings per diluted share to be roughly in the range of $0.03 to $0.06 per diluted share for the fourth fiscal quarter. We expect GAAP gross margins in fiscal Q4 to be relatively flat sequentially and GAAP operating expenses to be in the $60 million to $63 million range.

As a result, we expect GAAP bottom line to be in the range of a loss of $0.01 per diluted share to a profit of $0.02 per diluted share. The GAAP to non-GAAP differences reflect estimated amortization of acquisition-related intangibles of $5.4 million and restructuring charges of $3 million.

So, to close, Q3 was a solid quarter for Quantum. The hard work we have undertaken during the last year is beginning to provide tangible benefits. While the industry remains challenging, we feel that we are uniquely positioned to bring together our full range of assets -- tape drive systems, disk-based backup, and media, et cetera -- to deliver superior value and customer experience. With that, I will open up for general questions that you might have. Operator?

[OPERATOR INSTRUCTIONS]

Glen Hanus from Needham & Company.

Good afternoon. I missed the first introduction of your -- the intro of your call, so I'll go back through that, but I thought maybe I could just ask a broad question of what you're seeing and the tone of the library market in the first quarter. Some other companies, I think, EMC and a few others in the space, have seen maybe a little less than normal seasonality, and it seems like demand has held up okay in the first quarter. What's your pulse on the market out there?

I'm sorry, Glen, are you talking about the first quarter?

I'm talking calendar quarter.

I would just say that I think -- I'm speaking of our third quarter so going up to December I think our team felt that if you look at the funnel, and we track all the opportunities and the deals and the business levels, et cetera, I think we felt that the market is pretty reasonable. I would like to say it's solid or great, but we think it's pretty reasonable. And a lot of that is driven by the fact that we have a lot of new products, and we certainly see a lot of activity. I don't know how much I can comment on Q1. I think in this industry it is fairly typical that January starts out weak as a result of the December experience, and it's happened now in this business -- I've done this a few years -- it seems like it's almost an annual event. And so to the extent that there is a slowdown, I would suspect that's what it is, but it's really too early to tell if there's anything that's different than what we saw in our Q3.

And how about -- I don't know if you commented on StorageTek. Their numbers looked kind of weak. Are you seeing some increased opportunities as Sun goes through the integration of StorageTek? How is that impacting your outlook now?

Well, I'm not sure we have integrated in our outlook. That's a double-edged sword for us. In one hand, we count on Sun StorageTek to ramp some new products that we have -- relationship we have with them, and so if their business is weak, it affects us negatively. On the other hand, if they're not performing in the marketplace, there might be opportunities for us to get some of that business direct. So I don't know if I could call a weak performance of Sun StorageTek a good thing for us, given the fact that we have an important relationship with them.

Jon Lopez with OCA Asset Management.

Hi, thanks so much, congratulations. Can I ask you to spend a minute on operating expense? I know you sort of covered it, but can you just drill down specifically on why operating expense is -- where, specifically, you're spending incrementally in the March quarter to drive it up, potentially, a little bit? And then, beyond the March quarter, what should we look for in terms of how you're going to manage those line items?

We'll continue to manage the line items as best as we possibly can. We've got a couple of things that are going from quarter-to-quarter. Number one, I think there's some caution around it just naturally being a longer quarter. It's a longer quarter in terms of number of days, so you naturally have that particular impact going in terms of taking a look at our fiscal third quarter which ended December 26th and our fiscal fourth quarter, which will end March 31st.

The second thing is that we will have some incremental R&D expenses on the introduction of our SDLT-S4 drive, and that will be causing a bit of a blip with regard to our tape drive R&D line.

The second thing is that we probably will be anticipating some incentive compensation, performance-related bonuses and some accruals there at the year-end for the year-end year. And then there may very well be some litigation expense ramp-up as we prepare for a trial, potentially, with StorageTek.

Having said that, the vast majority of our product platform transitions are behind us. We'll continue to work that diligently. Our G&A, we'll continue to work diligently with the finalization of systems integrations, and the acquisition of -- the integration of the Certance acquisition and, again, we'll just try and manage these expenses as best we possibly can toward a 25%-ish E:R revenue, vis-à-vis revenue.

And can you just give a loose timeframe on that? Is that potentially a four-quarter -- can that be achieved within four quarters, six quarters?

Well, we delivered 26% this quarter on a non-GAAP basis. That's the way we look at it.

Okay, but you'll take a little step backward next quarter?

Not meaningfully, no.

Okay, great. The second topic is on the gross margin side -- obviously, a very nice improvement. Just looking back a couple of quarters to the early part of 2004 when the gross margin was more in sort of the mid-30s range. Can you just remind me what the set of circumstances were that you enjoyed to get it there? And is that a reasonable target level, medium term, as the mixed shift continues to be more favorable for you?

Well, if I take a look at it on a non-GAAP basis, actually, the vast majority of fiscal 2005 was in the 30%, 31%, 29% range. So I don't see a terrific degradation there. The royalty streams have stabilized nicely, the media pricing market has stabilized nicely versus some very serious dislocations that occurred 2, 3, 4 years ago. The mix, as we've described, is very, very important from any quarter to any other quarter -- just the sheer slice of the media royalty revenue pie, as that flexes, vis-à-vis the total revenue, that's important. The mix between our branded media and our media royalty stream is very important. To the extent that we have margins on high-end automation libraries being sold by our direct sales force to name customers, vis-à-vis low-end automation products being sold through the OEM channel, a vast difference in mixes. Being able to make sure that we continue to accelerate the adoption of our big enterprise tape drives -- very important. The service mix, as that continues to become more robust as opposed to not -- each of those things have very, very important flexing on what we deliver and from quarter to quarter.

I would just add to that that our transition, from a product perspective, really did start several quarters ago, and that we said in our communication consistently that we had a product lineup that was a bit -- had lost competitive advantage in a number of areas; that was continuous price reductions, which we saw in the market, continued to drive our margin down, and that's why you -- if you go back a couple of years, we have had kind of consistent gross margin decline for some of the factors Ned mentioned but also the fact that these products were under a lot of pressure.

So we think the step in Q3 was a good step but, clearly, we have to continue to work it both on the product cost side and just the nature of our revenue mix -- it is very dependent upon mix of type of business but even mix of customer -- we're working this much more diligently and much -- we have much better visibility and information about how we want to manage through that than just pursuing all the business in the market. We're probably more focused on improving our gross margin line than we are in just going and finding revenue opportunities.

Okay, great, that's helpful. Can I ask you, just on the same timeframe, call it four to six quarters, and I understand how many variables there are, but what is a reasonable inter-medium term target for that line item?

For which line item?

For the gross margin.

We said our intermediate term, we haven't really defined what that means, but we're getting -- we feel like we're getting there, which is mid-30s gross margin. I think we said we're going to drive 10% operating income, and we think we can get expenses to 25. That means we've got to get gross margin to 35, and that's the mission that we're on, and I can't tell you how fast we're going to get there, but we don't think it's -- we think we have the ingredients at our fingertips now to really work to make this happen.

Great. If I can ask one last one -- just relative to seasonality, if memory serves, the June quarter, which is obviously your fiscal Q1, you tend to see -- I think this has dropped off a little bit just based on the fact that you've just had your fiscal year-end -- I guess I'm curious, just given that you have so many new products launching, do you think that you'll be subject to normal seasonality for the next couple of quarters, or are you going to be more dictated on just when you get products in the market and how they're received?

I think the seasonality impact there are multi-faceted. There has historically been a day difference -- length of quarter -- one. Two, we have the kind of slowdown in Europe that kind of starts to develop, things start to get slow towards that timeframe. I don't know, some of the factors will be the same; some may be different. I'm not sure I'm in a position yet to really provide a lot of judgment on what to expect in the June quarter.

[OPERATOR INSTRUCTIONS]

Brian Freed with Morgan Keegan.

Hi, this is Troy Garner. Brian is on another call. Your systems business qualitatively sounded good. I was wondering if you could give us some approximation or maybe something more specific than that as to your profitability on your systems in the quarter?

I was going to say the systems business, when we do our segment reporting, will continue to show a loss. It will show an improved loss. When you look at those numbers, you have to realize that a lot of the amortization of intangibles are in that business, because it was pretty much an acquisition-oriented business. So the answer to your question -- we haven't done that reporting, but the numbers did improve based on the fact that there was a slight revenue improvement and a good, solid gross margin improvement. But we still have work to do in this business. We're not at all confused about that. We think the strength of the new products give us the opportunity to go and deliver that kind of performance.

Okay, thank you. Another one -- with your drives business, could you give us an approximate mix in the quarter of kind of how things hashed out between LTO and DLT drives?

Our business is still heavily -- I would think of three product categories of business -- there's DLT, the VS-related products, which are really in a unique category in terms of competition, they're really uniquely positioned; there's SDLT, which is our super drive -- the 600 and the 320; and then there's our LTO products. I would say that the first two still dominate the business, although the LTO business is growing, and I don't have the exact mix before me. But I would also say that all segments were up, sequentially. All product categories improved during the quarter.

Do you have an approximate mix? Because what we're trying to do is try to get a feel for some of your royalty revenues, going forward?

That won't give you the answer, because royalty arrangements are different in those three categories. So you can't just assume that royalties will respond to drive sales because they don't. In some cases they do, in some cases they don't. Maybe this is an offline discussion based on what modeling you're trying to do we can work through.

Thank you. Management, there are no further questions at this time.

Okay, well, thank you for joining us, and we look forward to next quarter's call.

Thank you, ladies and gentlemen, that does conclude our conference call for today. Please have a pleasant day.