Quantum Corp (QMCO) 2007 Q2 法說會逐字稿

Good afternoon ladies and gentlemen, and welcome to the Quantum Corporation's second quarter fiscal 2007 conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to Shawn Hall, General Counsel. Please go ahead, sir.

Thank you good afternoon and welcome. Here with me are Rick Belluzzo, CEO; Jon Gacek, CFO; and Bill Britts, Executive Vice President of Sales, Marketing and Service. The Webcast of this call, our earnings release and quantitative reconciliation of any GAAP and non-GAAP financial measures discussed can be accessed at the Investors Relations sections of our Website www.quantum.com and will be archived for one year. During the course of today's discussion, we will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements include our business prospects, priorities and opportunities, including anticipated future revenue, gross margin, operating expenses and income, our cash position, trends in the market in which we compete, the expected timing of new product launches and the expected synergies and benefits of our recent acquisition of ADIC.

We would 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 would refer you to the Risk Factors and cautionary language contained in today's press release announcing our fiscal Q2, 2007 results, as well as to our reports filed with the Securities and Exchange Commission from time to time, including our most recent 10-K, filed on June 12, 2006, our 10-Q, filed on August 7, 2006, and the final definitive proxy statement relating to the ADIC acquisition, filed on July 20, 2006.

Such reports contain and identify important factors that could cause actual results to differ materially from those contained in our forward-looking statements. All such risk factors identified in our press release and in our filings with the SEC are incorporated by reference into today's discussion. We undertake no obligation to update these forward-looking statements in the future. With that, I will turn the call over to Rick Belluzzo.

Thank you, Shawn. Good afternoon and thank you for joining us for the Quantum Q2 earnings call. On May 2, we made the announcement that Quantum and ADIC would merge to create a new Company, focused on the backup recovery and archive segments of the storage industry. This is a very transforming transaction that we believe has broad impact for the industry, while providing Quantum the opportunity to build significant economic value for our shareholders. We closed the transaction on August 22. Therefore, the results we will be discussing today including a full quarter of legacy Quantum and 5.5 weeks of ADIC operations.

When we announced the merger, we defined three primary objectives of the combination. The first objective is to expand market access. This is about building a stronger, go to market platform for the combined Company. And it's primarily focused on building a stronger branded business through a much larger sales force and service organization. This allows us to have more control over our destiny, to be closer to end users, and to innovate with new solutions. All of this leading to improved gross margins and revenue potential.

Next, the combination allows to us deliver a strong growth position by combining our technology investments. Thereby, delivering new solutions to the market in a timely manner. This remains an industry where innovation matters. And the combined Company will be in a much stronger position, in terms of achieving growth through new product introductions. Finally, by joining with ADIC, we are able to eliminate duplication, gain greater economies and improve our business model on a go forward basis.

Both companies have similar goals and business model objectives. As a combined Company, we will greatly improve our ability to achieve these goals. From the day of the announcement, we have been working to deliver tangible progress towards these three strategic goals. While very early in the process, we feel our Q2 results demonstrate the promise of the combination and the focus on these three critical goals. Our intention, is to deliver sustainable business model that allows to us achieve non-GAAP gross margins in the 35% range and non-GAAP operating expenses in the mid-20's. Resulting in non-GAAP operating income in the range of 8% to 10%.

These numbers exclude amortization of acquisition related intangibles and stock-based compensation. This business model was similar for both companies on an individual basis, but today we feel that we have greater opportunity to achieve it. With this business model in mind, we feel there are several elements that define our focus, and will allow us to achieve this model. We will focus on these areas and communicate progress to the investment community on a regular basis. It is these focus areas that we encourage you to follow in order to evaluate our progress.

First, growing our branded business is key to growth and margin improvement. On average, the branded business delivers 20 points of additional gross margin as compared to our OEM business. Our OEM business is critical, but the growth and financial leverage opportunity is with the branded business. We intend to use our expanded sales and service capabilities and product reps to drive our branded business to 60% of product revenue.

Today, the combined Company has 900 sales, service and marking employees in customer facing roles that are helping to deliver on this goal. This focus also allows us to build market momentum, leading to improved OEM success. Next, achieving our synergy goals is an important factor in delivering the business model I described earlier. We have identified a hard synergy plan of $20 million per quarter, that will be achieved in steps over the next four quarters. The third factor is maintaining our media royalty revenue. This is a very attractive element of our business model. It includes royalties for our large DLT installed base and revenue from our participation in the LTO Consortium. There are a lot of moving pieces here but in the end, our goal is to sustain quarterly royalties in the high $20 million range.

Next, we must focus our efforts on building a growth platform that is consistent with the market trends and allows to us generate high gross margin revenue. To this end, we are focused on driving revenue growth in disk-based systems and software. Our goal is to achieve quarterly revenues in the $30 to $40 million range from these businesses within the next 12 months. This will require us to deliver new products and capitalize on the combined assets of both companies.

And finally, we are heavily focused on generating cash from improved financial performance and a strong balance sheet management. Our goal is to use free cash flow to deleverage the Company. With this background, we feel like we are off to a very good start. By our closure of the transaction, we implemented organizational changes, completed our synergy decisions and insured that our sales organization structure was complete, with territories, accounts and people assigned in order to start with complete clarity. This approach was evident in our Q2 solid revenue performance.

On the synergy side, we have completed the majority of our head count reduction action and have made the majority it of our program, facilities and discretionary spending decisions. In short, we have made the vast majority of decisions that are critical to the achievement of our synergy goals. Jon will be providing you with the detailed numbers in a moment. This is a complex reporting quarter, given the inclusion of 5.5 weeks of ADIC operations, restructuring to capture our synergies, and a variety of acquisition related charges.

Having said this, we feel very good about these results, in terms of our ability to deliver on the five measurements I described earlier. The new Quantum has a number of exciting opportunities ahead, which have been further impacted by the current state of the industry. We plan to capitalize on our scale and vertical integration in paid products and to use our growing branded strength cost advantage to build a strong profitable pay business.

We are the leader in this field. And we have particular strength in the mid-range and enterprise segments, which are the healthiest segments in the market. This opportunity is also enhanced by some of the challenges of our competitors in these segments. In the stand alone drive and low-end automation segments, we will use our scale, vertical integration and go-to-market footprint to maintain our leadership position and deliver improved results.

And finally, we are very excited about the gross potential of our software and disk-based business. In fact, we will have new product launches that leverage off the combined technology of both companies within the next 60 days. We believe that the combination of Quantum disk-based technology, the ADIC file system, Rocksoft duplication technology and other value-added features will be very significant. With that background, let me turn the call over to Jon Gacek, who will take you through our Q2 results.

As Rick mentioned, this is the first quarterly earnings report of the new Quantum. And we are excited about the progress that as been made since August 22. From a financial perspective, we are pleased with the September quarter results but we recognize that the numbers are complex to understand and that it will take some effort to explain them. We have posted some information on our Website and you will be able to access that after the call. I'm going to focus on the Q2 results and compare them to the first quarter. I will go through each major financial statement caption and describe both the results and any related business points.

Starting with revenue. Total revenue for the quarter was $250.4 million. This represents a full quarter of Quantum revenues and approximately 5.5 weeks of ADIC revenue. You will note in the financial statements, we have broken out royalty revenue, which amounted to $27.8 million, and product revenue, which amounted to $222.5 million for the period. We expect to continue this presentation each quarter. Royalty revenue was flat compared to the preceding period. We -- excuse me, the DLT royalty decreased from the prior period, which was offset by the LTO royalty increasing in a similar amount. Looking forward, we expect the LTO royalty will continue to increase as the installed base grows and the DLT royalty will decrease over time. Overall, we expect royalty revenue to be in the range of $27 to $30 million per quarter.

Product revenue includes sales of our hardware and software products and service, both through Quantum branded and OEM channels. Generally, our branded products have higher gross margins and selling costs than similar OEM products. Rick mentioned the 20 point difference. Sales of our branded products also give us the opportunity to sell ongoing services. Over time, we expect the branded revenue will grow in absolute dollars and as a percentage of our product sales.

With the acquisition of ADIC, we have a product portfolio that is very broad, has very enlarging characteristics, has products in various stages of growth and has multiple channels to market. These characteristics provide us with extensive opportunities for growth but also make understanding the business more complex. As a result, we are going to give additional product revenue detail. For September, product revenue was $222.5 million, of which, 52% was branded, 48% was OEM. For the prior quarter, revenue was $159 million, of which 47% was branded and 53% was OEM. The sequential increase in product revenue is a result the ADIC and the 5.5 weeks of revenue that we added.

I'm also going to break product revenue down into three product groupings, to give you additional insight into the revenue performance of the business. The first group is systems. This comprised of tape automation, disk-based systems and software. Second quarter revenue for the systems group was $102.9 million, compared to $45.3 million in the first quarter. The increase was largely driven by the addition of ADIC and legacy Quantum automation growing in the low end, mid-range and enterprise segments. Our growth, compared to our competitors who have seen revenue declines, seems to indicate that we are gaining share in this product category.

The second group is devices and media. And the Q2 revenue of this group was $92.3 million, compared to $95.5 million in the prior quarter. Device revenue was down due to decline in our older products outpacing the ramps of new products. However, the sequential decline in device revenue was mostly offset by an increase in media revenue. Going forward, we believe that new Quantum has the opportunity to increase sales of Quantum-branded devices and media, as a result of the expanded sales force. Although revenue growth will remain challenging, given the intense competition in the industry, particularly in our OEM channel.

The final group is services and other, which includes service contracts, repair, installation, and professional services. And totaled $27.3 million for the September quarter, compared to $18.2 million for Q1. This increase is primarily due to the acquisition of ADIC. We believe our service offering will continue to be key driver of profitability and growth in future periods. So on each quarterly call, we will be breaking out these three categories so you can track how we are doing within the broader product revenue category. As we look forward, we believe that a normal quarterly run rate for the Company, royalty and product revenues combined, will be approximately $300 million in revenue.

Now, I will move to cost of revenue, gross margin dollars, and gross margin percentage for the second quarter. Cost of revenue was $179.8 million. Gross margin dollars generated or gross profit was $70.6 million. And our gross margin percentage was 28.2%. Included in cost of revenue and negatively impacting gross margin dollars and gross margin percentage were three items which totaled $7.9 million. The first, amortization of acquisition-related intangibles was $5.6 million. A purchase accounting adjustment for the write up of inventory was $2 million. And we had stock compensation expense of $300,000. Excluding these items, non-GAAP gross margin was 31.3% for the quarter.

In Q1 of fiscal '06, which did not include any ADIC results, cost of revenue was $134.6 million. Our gross margin was $52 million and 27.9%. In that particular quarter, we had two items impacting gross margin negatively that totaled $4.4 million. Those were amortization of acquisition-related intangibles of $4.1 million and stock compensation of $300,000. Excluding these items, the non-GAAP gross margin was $56.4 million, and 30.2% for the June quarter. So on an apples to apples basis, gross margin increased from 30.2% to 31.3% in this quarter.

This improvement in gross margin is primarily the result of growth in the mid-range and enterprise systems revenue and the increase in the branded product versus OEM product mix. As our branded business grows and we introduce new products, we expect our margins will continue to improve. In addition, we have identified significant synergy opportunities in cost of sales that we will begin to realize towards the end of the calendar year. The cost of sales synergies include lower product costs due to our increased scale and efficiency, facility consolidation and head count reductions.

Now, I will move on to operating expenses. Research and development expenses for the quarter were $27.9 million, compared to $21.4 million in the prior quarter. Sales and marketing expenses were $30.6 million, compared to $21 million in Q1. And G&A expenses for Q2 were $12.5 million, compared to $10.3 million in the prior quarter. The increase in each of these expense line items, and the increases in the amortization of intangible and stock compensation were the result of the ADIC acquisition and 5.5 weeks of expenses.

Let me tell you what those one-time items were. Amortization and intangibles included an OpEx for all three of those categories were $4 million in Q2 and $1.4 million in Q1. $2.5 of the intangible increase between Q1 and Q2 was actually in sales and marketing. So that as was as a result of the ADIC acquisition. The stock-based compensation included in OpEx in Q2 and Q1, was $2 million and $1.5 million respectively.

In addition to those items in our operating expenses, we had two unusual items that related to the acquisition that I want to call your attention to. The first was in-process research and development, the results of purchase accounting for the ADIC acquisition and totaled $14.7 million. This expense is comprised of ADIC projects that were under development for the i500 and i2K product lines that we had to expense as part of the transaction.

The second item is a restructuring charge of $6.7 million related to the reductions in head count and restructuring of our business to achieve our synergy goals. These costs are specific to legacy Quantum. The legacy ADIC side of the synergy equation actually gets captured in purchase accounting and you don't see it run through our P&L. So when you add it all up, you the question a Q2, 2007 operating loss of $21.7 million, compared to a Q1 2007 operating loss of $3.4 million. Included in the $21.7 million operating loss is in-process R&D of $14.7 million, amortization of acquisition intangibles of $9.6 million, restructuring charges of $6.7 million, stock compensation expense of $2.2 million, and the $2 million inventory purchase accounting adjustment.

When you exclude these items, the result is a non-GAAP operating income of 5.4% of revenue. We are very pleased with the progress we have made. While the synergies realized in the period were relatively small, at approximately $1.7 million, we expect to achieve roughly 50% and 75% of the targeted $20 million synergy run rate, respectively, in December and March quarters. So to do that math, that's $10 million and $15 million in the next two quarters we expect to realize. Moving on to non-operating items. Interest income and other was $2.1 million. Interest expense was $8.5 million. And our quarterly tax provision was $2.5 million.

Thanks for enduring the explanation of the income statement. As we move forward, it will be much easier to explain the results, as we'll have ADIC for a full quarter and we will have fewer unique items. Now I'm going to move on to the balance sheet. Most of the changes here are as a result of the ADIC acquisition or the related purchase accounting. However, I want to point a few of the more significant items.

Cash and cash equivalents and short term investments totaled $151 million at quarter end. You will see us focus on managing the balance sheet efficiently to free up as much cash as possible to delever the Company. In future earnings calls, I will provide additional cash flow metrics to measure our progress. It's difficult this quarter with the partial quarter after the acquisition.

The second item is we have reclassified our service inventories out of current assets to long-term assets. The balance sheet line item is titled Service Parts For Maintenance, and we present that net. At September 30, this asset amounted to $82.1 million. This amount or these parts included in this line item, will be amortized over their remaining estimated useful life of three to eight years.

The next item is purchase technology, which increased $92.5 million as a result of the ADIC acquisition. This amount is related to technology for the Scaler 10K, i2K and i500K automation products, as well as our disk-based product and our StorNext software. The additional asset will be amortized over an average useful life of 4.5 years. Other intangibles increased $97.8 million, as a result of the ADIC acquisition. And are primarily comprised of customer lists and trademarks acquired as part of the ADIC deal. These assets will be amortized over estimated useful lives ranging from five to seven years. And finally, goodwill increased $338 million due to acquisition of ADIC.

Moving to the liabilities side of the balance sheet, you will note the increase in long-term debt. In addition to the $160 million convertible, we have added $49.6 -- sorry -- I wish it was that much. $496.5 million of new debt, used to fund the ADIC acquisition. As a result, as of September 30, $25 million of acquisition debt was classified as current. $471.5 million is classified as long term. The debt has three traunches, $150 million revolving credit line, a $225 million term loan and $125 million second lien term loan. The weighted average interest rate of the acquisition debt was approximately 10% as of September 30.

Rick mentioned that one of the primary objectives of the ADIC acquisition is to market access and grow branded products in our service business. One financial measure of this objective is the growth in deferred revenue. The vast majority of our deferred revenue generated from Quantum branded products and the result of selling an additional service contract above and beyond the product's standard warranty or selling ongoing software maintenance. We expect that our deferred revenue will grow as our branded business continues to grow. As of September 30, we reported deferred revenue of $78.6 million, of which $59.4 was classified as current.

I will conclude on the Q2 results, by saying we clearly made progress in integrating the two companies, identifying and realizing synergies and moving towards our targeted business model. This was a great start. As we look forward, to the next two quarters, we expect total quarterly revenue of approximately $300 million, gross margins of 29% to 30%. And OpEx spend of approximately $90 million in Q3, and $81 million in Q4.

The gross margin percentage includes the impact of approximately $8 million of amortization of acquisition intangibles and $400,000 in stock-based compensation charges. While the OpEx spend includes $5 to $6 million in amortization of acquisition-related intangibles. And approximately $3 million in stock-based compensation charges. With that, I will turn back over to Rick.

Thank you, Jon. As I stated earlier, we feel the September quarter, while still very early as a combined Company, has validated the objectives and the opportunity that led us to make this combination. We will focus on the five priorities I described earlier and on moving towards achieving our business model goals. The industry is at a very interesting time, as we see a move towards significant consolidation and the associated disruption.

The overall storage industry remains solid, as we have seen some recovery in IT spending and a strong focus on storage. Within the storage industry, the backup recovery and archive segments show the most promise, as companies place greater focus on secondary storage, including backup, remote sites, integration, disaster recovery, compliance, security and more. Forecasts are for the growth to be approximately two times the rate of the overall storage industry.

Within the backup recovery and archive environment, tape remains a meaningful platform. The low end is under pressure, while the mid-range and enterprise segments are projected to be the most significant segments of the tape drive and systems market. The new disk-based backup market is beginning to show momentum, as companies combine disks and tape products with software to deliver very cost effective solutions to fit into a tiered storage environment. Within this environment, Quantum is well positioned. We have the number one position in the Opus Systems, the mid-range and enterprise tape automation segments. Also, the competitive environment creates new opportunities as consolidation, product transitions and unsustainable business models increase pressure on competitors.

We have ultimately agreed to deliver and market disk-based software solutions. As a pioneer in virtual tape libraries, we feel that we have the experience, technology, and sales channels to expand beyond this category with new capability and achieved growth as the market develops. We will be aggressive in establishing our position as the leading backup recovery and archive specialist in the industry. We will capitalize on our focus in this market, along with our global scale and deliver solutions for heterogeneous environments.

This is where we differentiate and where we believe we can deliver a sustainable business model. Before opening the calls for questions, I just wanted to announce that we are changing our stock ticker symbol from DDS to QTM, to align more closely with the Company's name, now that the ADIC acquisition has been completed. Quantum stock will continue to trade on the New York Stock Exchange and the ticker symbol change will take effect on the start of trading on Wednesday November 15, 2006. Operator, we can now take questions.

[OPERATOR INSTRUCTIONS] Our first question comes from Glenn Hanus with Needham & Company. Please go ahead.

Could -- let's see, so the guidance for non-GAAP gross margins in effect, Jon, if we do the same exclusions. So, you were up in September from 30.2, up to 31.3 in September. And then what are we looking at on a non-GAAP basis over the next couple of quarters?

32 to 33 when you do that math.

And so, what are kind of the key line items? And do you think you kind of maxed out in the 32, 33 range or is there more room for improvement beyond that?

Well, I think if we go back to the 5 points that Rick mentioned, we have the branded business growing. That helps margins. We have the synergy attainment goals, a lot of that is in COGS, that helps margin. And I think you will see margins continue to move up as branded grows and we get the synergies in there and we introduce new products. And so the target that we're shooting for, which we think is achievable is a 35% range.

And maybe more broadly, could you guys talk about, on a competitive front with Sun's StorageTek and what -- that hasn't been the strongest showing? What are you guys seeing out there, in terms of opportunities, to take share, given when has happened with your largest competitor and some of the few smaller guys are struggling too? Can you talk about that a little more broadly.

Yes, I'm going to let Bill Britts address that. He's closer to what's going on. I have think, as I said in my comments, the industry really is, in my time in the industry, at a very interesting moment with a lot of change underway. As I refer to in some business models, and people who have been working to sustain or just starting to not work going forward. And so, the results of consolidation, [Rohas] -- there's a long list of very aggressive change activities that we think has created opportunity. And so, I will let Bill comment exactly on what he sees in the market.

So, I think the first thing that's important to realize out of this is that you have to have a really strong product offering to be successful in this market. So, when Rick talked about the mid-range and enterprise market. We are talking about open systems, we're talking generally heterogeneous environments. We're talking about -- typically, when you are talking about tape it's about storage consolidated backup and it's really critical IT administrators and the management responsible for basically managing those data centers. So these are important decisions, especially when it comes to that class of products.

So from that standpoint, I think we basically out-executed the rest of the industry with respect to our product platform, our ability to integrate the management and software around this hardware platform and we're adding value that goes beyond just the library platform. And if you look at the broader vision that we have, it's really focused around bringing value with respect to key issues the customers have around integration with disk space backup. The ability to integrate with their exist existing management consoles and products. The ability to fit within their existing security frameworks.

So start to think about all of these different issues. It's about a really strong product strategy. And I think we have been executing very well against that. The other part of it. The reason that I think we're gaining share and we talked about that earlier in the call, we're gaining share because we're very focused in this environment. Distinguished from the other players in this space, we are -- this is our business. We wake up every morning thinking about how we go out and solve these customer problems. And we build a very strong go-to-market and channel capability. And the combined companies, not only do you get the product portfolio expansion, you get complimentary skills with respect to the go-to-market channels.

So this focus, combined with other players in the space, having either issues or models that they are deliberately trying to move in one direction or another has created a great opportunity. I think the partners, the channel, the people that give us leverage in our go-to-market, they are recognizing that we're a player in this space and we have the scale and product portfolio to deliver on that.

So, I would also add that when you look over the history of the last five years in the industry, StorageTek really did have the best business model and position as a large enterprise provider of tape-based products and backup recovery and archive solutions. When they became part of Sun, we deeply felt that the industry needed a large specialist, an independent player who had global scale who was built -- and wakes up and thinks about this every day and is focused on delivering the best in class products, as our only or our leading priority.

And we think that's what differentiates us. And we believe that we're the Company that can take that position as the independent player, to support multiple operating systems heterogeneous environment and be able to make the adjustments and be, in some ways, a trusted advisor to companies who are looking for these types of solutions. And that's the hole, in a sense in the industry that we want to fulfill. And we believe by coming together as a Company, being north of $1 billion in revenue, having these 900 people out there servicing customers, having good investment in new technology behind that, allows us to fill that position. It's very early in the process but we believe that things are moving in the right direction.

All right. Thank you.

Our next question comes from Brian Freed with Morgan Keegan. Please go ahead.

Good afternoon. Thanks for taking my call. A couple of quick questions. One, I might have missed it. But did you guys give Quantum revenue on a stand alone basis and specifically what is ADIC contribution during the quarter?

We didn't. We just talked about the royalties, which is the only legacy Quantum item that hasn't been commingled with ADIC.

Okay. So you can't break that out?

No.

I would say one of the reasons too is we moved very quickly to erase those factors. If we had a product from one company that was more profitable than a product from another company in a similar class, we tried to get the whole combined sales force to focus on that. So, almost immediately with the close, we started to blur the distinction between legacy Quantum and ADIC results.

Okay. Second question, can you tell us what the number of head count reductions were? So, kind of what ADIC and Quantum's head counts were going into the merger and what they are today?

Yes, I can say that we announced this, we said that, I think the reduction would be approximately 9%. It was just over 300 plus, 320 people. That plan held throughout our integration planning process. And again, we have made decisions on the vast majority of those positions and we are pretty far down. In fact, we will be finished with that process very shortly.

Okay.

So we started -- like, these are rough numbers at 3,100 pr employees as a combined Company. Take 9% off of that. And so we are just under 3,000 people.

Okay. And then just think of this with a little more clarity. As then just to give us a little more clarity. As I recall, ADIC as a stand alone company kind of bounced between the 60/40 branded OEM, up to sometimes 65/35, in strong branded quarters. Quantum, as I recall, was something near a 60/40 split between OEM and branded but that's a blended number. Could you kind of give us -- as we look to evaluate your progress, this 60% of product revenue branded, where Quantum and ADIC were individually going into this process?

Yes, let me say something here -- yes, let me say something here. Jon will be able to add the ADIC perspective. When we've talked about branded mix, it's sometimes there have been inconsistent numbers between whether you include royalty, whether you include service. Is service part of product? Is it brand? There's a lot of variables in that. So we want in this conversation here today to be very clear, that it doesn't include royalty. It does include service. And so when we talk about a 60% goal, we're talking about taking our total revenues, subtracting royalties and then ascribing that to either OEM or branded. So we're -- the conversation around that will be very consistent going forward. I think historically, you probably have different numbers and different approaches from each Company that drew you to those conclusions.

So based on the metrics you are asking us to look at the measure you use, can you talk about where each of you were going into this?

So, let me repeat what I said in the script and then I think this will answer it. So on the way we're measuring it today, we exclude products. We exclude royalties. So, that's out. And if you take the $222 million of product revenue this quarter, 52% is branded, and $48 was OEM. If you look at Q1 under the exact same measure, which only had legacy Quantum in it, it was 47% branded and 53% OEM. So that's -- those two measures are an apples-to-apples measure. The difference is you added ADIC in there.

All right thank you.

Okay.

And then the last question I had is you talked about your goal of getting more software into the mix. Can you talk, about what your run rate on software is now and what type of growth trajectory that's going to require?

Yes. What we're doing so far, what we have done, Brian, is we've categorized the automation, the disk-based product and the software into one group. And what I would say is, you know that as we -- as those things become more and more significant, we have to break them out by rule. We never broke them out at ADIC. Software didn't get broken out at ADIC because of the size of the business and now we are even in a bigger business and haven't broken them out yet.

Having said that, we plan to talk about key things that are going on. And I absolutely think as we launched this next disk platform, you will see us start to break out those products as they become significant, relevant, those types of words. But right now, they are not big enough to sort of make sense on their own.

Having said that, I want to qualify with one more thing. The software business is very profitable to us. So, you might argue on a revenue side, it's not a big number but from a profitability perspective, it's a very high gross margin. And so, that will probably be one of the drivers that will cause us to break it out sooner than later.

I thought maybe Bill could just give a little update on the software business and what we're doing there.

A couple of things that I think are important. One is that it's fundamentally different than kind of our tradition tape library business, not only because it's software and not hardware but more fundamentally, it's really targeted at the file serving and archive markets. So, this is a very specialized software that fits very, very well in very large data, high performance file serving types of applications. Typically aligned with the rich media broadcast vertical market, the government vertical, as well as the scientific and engineering vertical markets.

What we are doing with the combination, bringing technology asset, software assets from both legacy Quantum and legacy ADIC, is we are using those software components to build products in a software platform that we can now take beyond those vertical markets. And that's a very significant capability that's really been enabled by the combination of the two companies. So, as we start to talk about our software and our software content, we will be talking about the stand alone StorNext software, as well as our disk-based backups and disk-based appliances that are really built on some of the same software that's in that stand alone software stack.

But the stand alone software business is performing well. We believe that there's more growth potential there and we're making investments to decide what expanded set of vertical markets we should focus on. How do we get to that market more effectively? Because we believe -- again, if there's another set of market transitions underway, with weakness of competitors, again there's this void that we believe we have the opportunity to fill.

Okay. And then my final question, before I cede the floor, is could you give me an update on RockSoft? And especially, when you think you might be able to deliver a product to market based on that technology?

Yes, let me make a few comments and Bill can add to it. So, one of the things we got on very early in the integration planning; Was how could we bring these assets together? Both companies have done a very nice job in the early DLT markets and have focused on different segments. Early on we discovered that, wow, we have an opportunity to bring this stuff together even more quickly. So, we have several products on the RockSoft E duplication technology. Where that technology will be a component in those products over the next year. The first product will be, as I mentioned, the first 60 days -- or in the next 60 days we will have our first launch or announcement of a product that includes these software components that Bill discussed, including the RockSoft E duplication technology.

Yes, I think it's very important to understand that the RockSoft acquisition really was not just about IT and acquiring the rights to that IT. They actually have a software engine that basically enabled the duplication and very, very efficient optimized network transmission for these kind of remote backup and basically optimized replication. So as you start to think about that core software engine that we acquired through the RockSoft acquisition, now being built into our software product lines, and this disk space backup appliance, we are basically building a modular approach to being able to put this technology in a number of products. So, that's why it's significant that the initial product will be within the next 60 days will just be the first of a series products, including existing software products that we are shipping today.

Thank you, guys.

The next question comes from Harry Blount with Lehman Brothers. Please go ahead.

Hi, this is [Agra Chen] in for Harry. I have just two questions. The first was, at the time of the ADIC acquisition announcement that had been mentioned a $0.15 per share accretion number and I was wondering if there was an update to that, especially since you are expecting more OpEx synergies now? And the second question was, how should we think about the tax rate going forward? Thank you.

Well, maybe I will make a comment on the $0.15. We actually have to go back and recalculate. Two things that happened since we calculated the deal, one interest rates went up and secondly our synergy plans were fully developed and also increased. I think those roughly -- I'm working from memory here, those roughly offset each other in terms of the numbers that allow us, last I checked, to be consistent with that statement that we made before. I think that's still believe that's true.

On the tax side, at Quantum, we have pretty significant NOL's. What you will see in the -- it really isn't appropriate to think about a rate, because the -- we're going to pay close to $0. So, what I would model is roughly $500,000 of tax expense each quarter. On this. particular quarter, we had some acquisition-related tax charges as we vacated some foreign operations. But typically it's going to be, $500,000, maybe $1 million. But I would use $500,000 as a quarterly tax provision, not a percentage.

Great. Thank you.

[OPERATOR INSTRUCTIONS] Our next question is comes from [Ethan Araback] with Marathon Asset Management.

Can you talk a little about your liquidity right now and what the availability is under your revolver? And also what your expectation is for operating that cash flow in the next quarter?

Sure. At the time of the acquisition, we drew down on all of the credit facilities or almost all. And we have roughly $150 million of cash and marketable securities at September 30. So, you could argue that that's all borrowed. But that's how much we have. That was actually higher than our forecast going into -- post-deals going into then of the quarter. From an operating perspective, we believe that there are lots of opportunities to generate cash within the combined balance sheet.

I'm just going to flip a couple of pages here. Give me a second to look that up and then on the next question, I will answer it. But it's a positive number. I just don't remember what it is. On a cash flow for next quarter.

Great. And along with that, how close are you to the $110 million EBITDA covenant for September of '06?

We are -- I will just say it this way, we are over our covenant. We will be over $120 million.

Okay. Great.

For the 12 months.

And then final question, just the fiscal periods from a year ago don't match up perfectly. But just back of the envelope, how do you think your revenues were this quarter, relative to the combined ADIC and Quantum a year ago?

Are you talking linearity or total?

If you were to look at how -- for the three months ended September 30, 2006, versus the three months ended September 30, 2005, if you were to do the pro forma calculation, what does the revenue picture look 2006 versus 2005?

I would just use the $300 million as the -- that we put out as the basis of that. It would have been higher on a pro forma basis in the past period because you just paste the two together. Here it's more complicated than that because you have a subperiod, you have a period that ADIC never reported, actually two periods that ADIC never reported and you've got the the combining of the business. So, I would say that think of it as a $300 million business. It's hard to do pro forma wise.

Okay, thank you.

[OPERATOR INSTRUCTIONS] You are our next question is a follow-up from Glenn Hanus. Please go ahead.

Back on the gross margin for a second. When -- at ADIC, you kind of maxed out in this maybe -- I don't have all the numbers in front of me, but 32ish were some of your best gross margin kind of quarters.

Yes.

And you were adding software and had you a branded business of 60%. Now, granted you didn't have the royalties stream. But -- so I'm just trying to think, all right, so now combined, why should I think that you really are going to be able to sustain gross margin above that sort of peak level that you had at ADIC?

Well, first of all, you hit one of them on the head. The royalties actually, Rick, it's a pretty nice business model. That's a big number. That's 10 percentage points right there on $300 million, when you have $30 million. So, that's number one. Number two, if you remember on ADIC, ADIC always suffered from investing early to continue to scale the business. And now we have more scale in this combined Company. So, the combined Company has more ability to leverage its assets.

One that I used to always talk about is service. We have more concentration around the world of more customers, so that we can leverage our service assets better. So, the next big one is leverage. And then the third one -- actually, there's four. The third one then is also sort of scale related. This was two companies that both had scale issues across multiple areas. You pull that together. That also is gross margin dollars. And then finally, and I think the one that Bill is referring to and it's really key in Rick's five points, is that both companies had different strengths of technology and go-to-market. And when you optimize those things, you don't spend money in places that you done need to.

I think the feet on the street that ADIC brings to the table helps in how you go to market. And I think the channel program that Quantum brought to the table helps. And you don't spend money trying to do something you can't do. So that will lead to better prices, the right solution, the right customer, and all of that stuff is what is what contributing to the gross margin. So I would say, as I speak for my COGS at ADIC, the opportunity to get to the 35% gross margin is a lot greater as this combined business than either company had stand alone. There's just no comparison.

And I would also add this issue that I -- we've referred to a couple of times in this call, is kind of a state of the industry in the OEM business, and the fact that a lot of the OEM business in the industry is at very, very low margins. And a lot of companies have been pursuing that business and it struggles to be financially viable, as they've gone all out to win a particular opportunity at very low margins. We will increasingly be selected. We're going to compete for that business. But we also now have the option to be able to have the alternative of walking from that business to build our own branded opportunities if that business becomes untenable. And versus companies who are totally dependent upon pursuing that very poor gross margin business.

So you will see that in our performance. You will see possibly revenue declines in a quarter because there's business that we said, it's just such a low margin business, we would rather take our investment and go after more enterprise business. Or pursue our software business or take our drives and put them in our automation and generate market excitement around that and then come back to the OEM. We have a lot more plays that we can run as a result of that, that we think are -- we're very focused on the gross margin number as the most important number. Because we're really trying to build a business model, not just a business but a business model. And we think we have a lot of the opportunities to make different calls to be able to improve our performance more than we have before.

Okay. Thank you.

Our next question is a follow-up from Brian Freed. Please go ahead.

One follow-up. With respect to your guidance for the December quarter, you talked about mitigating some of the revenue bleed in the September period. But as -- to sum up, it looks like this $300 million would be indicative of some revenue bleed there. Do you think there would be some lag to that or do you think that's more of a function of conservatism on your part?

Well, actually, we gave $300 million for both quarters. So I think you have to just take that as the guidance. I think Attributes that could positively impact the third quarter are those -- the year ends of one of our major OEM's, the year ends of one of our major channel partners, the fact that we have our own branded business, the fact that we've been together for a few months. But I don't think that we have enough history or enough knowledge to say that we can give guidance different than sort of a $300 million business model. I do think as we spend, have more time together, and the business runs as one, we will be able to give a little more specific revenue guidance. But right now, I think $300 million is the right way to think about it.

Okay. Thanks.

On the question on cash flow for next quarter, I would use $10 to $15 million from an operating perspective. We have a number of initiatives to continue to push on the balance sheet for that but I would start with that.

[OPERATOR INSTRUCTIONS] At this time, I am showing no additional questions. Please continue with your remarks.

Well, thank you for joining us for this first conference call as a combined Company. And for bearing with us through some of the complexities of the numbers. We really believe next quarter will be a lot more straightforward and we really look forward to that discussion. So, thank you very much and have a good evening.

Ladies and gentlemen, this does conclude the Quantum Corporation second quarter fiscal 2007 conference call. You may now disconnect and thank you for using AT&T teleconferencing.