Quantum Corp (QMCO) 2007 Q3 法說會逐字稿

Good afternoon, and welcome. I'm Shawn Hall.

Good afternoon, ladies and gentlemen, thank you for standing by, and welcome to the Quantum Corporation third quarter 2007 conference call. During today's presentation, all parties will be on listen-only mode. [OPERATOR INSTRUCTIONS] As a reminder, today's call is being recorded today. I would like to turn the conference over to Shawn Hall, General Council. Please go ahead, sir.

Thank you. Good afternoon, and welcome. Here with me today are Rick Belluzzo, Jon Gacek and Bill Britts Executive Vice President of sales and services. The webcast of this call, our earnings release and a quantitative reconciliation of any GAAP and non-GAAP financial measures discussed today can be accessed at the investor relations section of our web site at www.quantum.com, and will be archived for one year. During the course of today's discussion, we will make forward-looking statements within the meaning of the private litigation securities reform act of 1995. The forward-looking statements include our business prospects, priorities and opportunities including anticipated future revenue, gross margins, operating expenses and income, our cash position, trends in the market in which we compete, and the expected timing of new product launches and the expected synergies and benefits of our recent acquisition of ADIC.

We'd like to caution you that our statements are based on current expectations and involve risks and uncertainties that could cause actual results to differ materially. We refer to you the cautionary language contained in today's press release announced in our fiscal Q3 2007 results as well as to our reports filed with the securities and exchange commission from time to time including our most recent 10k filed on June 12, 2006, our 10Q and the final definitive proxy statement related 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 are identified in our filings with the SEC are incorporated by reference into today's discussion. We undertake no information to update these forward-looking statements in the future. With that, I turn the call over to Rick Belluzzo.

Thank you Shawn. Good afternoon, and thank you for joining us for the Quantum third quarter earnings call.. On May 2nd of last year, we announced our intention to combine Quantum and ADIC to create a new storage company. The end result of this strategic initiative was focused on building a company that would be positioned to deliver improved financial performance while having increased opportunity to grow and innovate in the storage industry. The acquisition of ADIC closed on August 22, and with only 5 1/2 weeks of ADIC's operations included in the September quarter, we reported initially promising results as a combined company. From the day we announced the combination, we have been aggressively planning and implementing the integration in order to both achieve our stated synergy goals and demonstrate the longer term promise of the combination of two key players in the backup, recovery and archive market. Clearly Q3, the quarter we are reporting today was viewed as very critical towards establishing momentum for the new Quantum. Measured in terms of revenue and operating income performance. Thus far, we are very pleased with our results. Ultimately, we believe the success of our efforts should be measured based on our achieving our business model goal of 8 to 10% non-GAAP operating income resulting from non-GAAP operating margins in the 35% range and non-GAAP operating expenses in the mid 20's. And by achieving a revenue base that is more robust in terms of the combination of both the level of revenue and the composition of the revenue. We feel that the Q3 results that we are announcing today demonstrates excellent progress on these fronts.

Q3 included a number of operational highlights. We achieved solid revenue performance of $302 million, which is a first full quarter as a combined company. We moved quickly, very quickly to fully integrate our sales marketing and service teams on a worldwide basis in order to ensure that we would maintain revenue and position the company for new opportunities. Today, these teams are integrated. Road maps are defined. As we announced yesterday, we have a new integrated reseller channel program. By moving quickly to have one integrated sales force selling products from both legacy companies, we were able to achieve our Q3 revenue goal while simultaneously delivering outstanding progress on our seal sales and marketing synergy goals. Jon will provide more detail on our revenue performance in a few moments. Also during last quarter's call, we presented five critical success factors that we would focus on in order to measure progress toward achieving our business model goal. Let me provide some details on each of those areas.

First, we stated that we wanted to grow the branded content of revenue to 60% including royalties. In Q3, we achieved branded revenue of 54% up from 52% last year despite weakness in branded media. We expect to continue to move toward the 60% level over next few quarters as we begin to ramp our new disk based products, leverage our leadership [inaudible] and grow our software business. Next, we stated that we would achieve $20 million in quarterly synergies over the next four quarters and that $10 million would be recognized in Q3. We are very confident in our ability to achieve or exceed this goal. We have taken all of the actions necessary to deliver on this goal and the resulting savings will continue to build over the next couple of quarters.

In Q3, we exceeded our $10 million goal with especially strong performance in operating expenses. As a result of this, we delivered a non-GAAP gross margin of 32.5% and non-GAAP operating expenses of 25% leading to non-GAAP operating income of 7.5%. Well on our way towards our 8 to 10% goal. I would also add that this is the strongest non-GAAP operating income quarter in at least four years. The third goal we noted was main taping our media licenses in the range of $27 to $30 million per quarter and eventually supplementing this with additional technology license revenue. In Q3, we achieved royalty income of $29 million which was a slight increase over last quarter. In addition, on the revenue front, we believe it is critical to build the solid revenue stream outside a traditional tape products while Q3 revenues from disc space products and software remained a small portion of our overall revenue stream. We are taking steps towards ramping software and disk-based product sales. This includes our recently introduced new family of disk-based systems that combine technology from both companies called the D.X.I. series

The D.X.I. series of disk space backup and replication appliances used Quantum's deduplication technology to increase the amount of data users can retain on fast recovery rate systems by 10 to 50 times. This new product line is very well positioned in a growing market segment and has already begun shipping to select customers and will be generally available in the next 30 days. We expect this product line along with our growing software business to allow us to achieve the goal of 30 to $40 million per quarter of combined revenue within the next year. And finally, we aim to take advantage of our improving operating model and focus on asset productivity in order to generate positive cash flow and enable us to de-lever the company.

In Q3, we generated $6.8 million in cash from operations. We expect to see improved performance in the coming quarters. In summary this is a very productive quarter. We've made excellent progress in achieving our integration synergy goals allowing us to take a significant step toward achieving our business model goal. In addition to this, we are becoming increasingly positive about opportunities to capitalize on our stronger more competitive position in the storage market and our ability to utilize these assets that we have to create greater value. Now, let me turn the call over to Jon who will discuss more of the business and financial details.

Thank you. As Rick mentioned, we are pleased with our December quarter results and we believe the first full quarter of combined company Demonstrates that our integration of new Quantum is ahead of plan and we are closing in fast on our business model goals. As I go through the income statement, I'm going to compare the quarter sequentially. Please remember that our results for Q3 are for a full quarter compared to Q2 which included only 5 1/2 weeks of ADIC, and this fact is the largest reason for the sequential changes in revenue expenses. However, I'm going to go through each outlined item and describe both the results on a GAAP and non-GAAP basis and provide related business points. So it's a full quarter versus 5 1/2 weeks.

Starting with revenue, total revenue for the quarter was $301.9 million. Royalty revenue amounted to $29 million for the period and product revenue was $272.9 or $272 million. Royalty revenue increased $1.2 million from Q2 as a result in the increase in the L.T.L. royalty. The D.L.T. royalty was flat from the prior period. As I mentioned last quarter, looking forward, we expect the L.T.L. royalty will continue to increase as its install base grows and the D.L.T. royalty will decrease over time. Overall, we expect revenue to be in the range of 27 to $30 million per quarter for the near term. Product revenue includes sales of hardware and software products and service through both our Quantum brand branded and O.E.M. channels As a reminder, our branded products generally have higher gross margins and higher related selling costs than similar O.E.M. products. Sales of our branded products also give us an opportunity to sell ongoing services and allows to us provide additional products, services and Solutions to our end user customers. Over time, we expect that Quantum branded revenue will grow in absolute dollars and as a percentage of our product sales and as a result will increase our gross margin percentage.

For the December quarter, revenue is the $272.9 million of which 54% was branded, 46% was O.E.M. For the prior quarter, prior revenue was $222.5 million of which 52% was branded and 48% was O.E.M.. So a 2% point increase on the brand inside. Consistent with last quarter, I'm 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. It is comprised of tape automation, disk-based systems and software. Q3 revenue was $154.4 million compared to $102.9 million for the prior quarter. The group that showed the strongest growth in traction was our mid range tape libraries through both the branded and O.E.M. channels with our flagship I 500 product leading the way. We also saw growth and sales of our store net software. In coming quarters with the launch of the DXI disk based product family in the March quarter, we expect our disc space product revenue will begin to make a more significant contribution to this grouping. The second group is devices in media.

Q2 revenue for this group was $80.6 million compared to $92.3 for the prior quarter. Explain that change in fact our device revenue was up due to the strength in our mid range and low end devices through our O.E.M. channel but it was offset by significant decline in non-royalty media revenue. Media is a commodified product category with margins that are relatively low compared to our corporate average, this quarter there were pricing dynamics in the marketplace that caused to us purposely de-emphasize sales of media. In the media space, our strategy is to support our branded and O.E.M. tape library customers with our Quantum branded media and sell media in the open market when it makes financial sense to do so. This quarter, we definitely pulled back in that area. Final group is services and other. This includes service contracts, repair, installation and professional services. Services revenue total $37.9 for the December quarter compared to $27.3 in Q2. Looking forward, we believe our service offering will continue to be a key driver of growth and profitability. Now, I will move to cost of revenue, gross margin dollars and gross margin percentage which for the third quarter were as follows.

Cost of revenue was $212.9 million. Gross margin dollars were $89 million and gross margin percentage was 29.5% all on a GAAP basis. Included in cost of revenue and negatively impacting gross margin dollars and gross margin percentage were three items which totaled $9.2 million. The first amortization of acquisition related intangibles of $8.4 million, an ADIC transition related expense of $500,000 and stock compensation expense of $300,000. Excluding these items, non-GAAP gross margin was 32.5% for the quarter. For Q2, which included 5 1/2 weeks of ADIC results, cost of revenue was $179.8, gross margin was $70.6 and 28.2%. Included in costs of revenue and negatively impacting gross margin dollars and the gross margin percentage in Q2 were three items which totaled $7.9 million. Amortization of acquisition-related intangibles are 5.6. A purchase accounting adjustment for inventory of $2 million and stock compensation expense of $300,000. Excluding these items, non-GAAP gross margin was 31.3 for the second quarter. So the comparative is 31.3 in the second quarter and 32.5 in Q3. The improvement in gross margin is primarily the result of increase in the branded versus the O.E.M. mix, realization of cost reductions related to synergies and a move towards higher margin products in both the O.E.M. and the branded channels. And as we've mentioned before, when our branded business grows and we introduce new products, we expect our margins will continue to improve. Now, I will move to operating expenses.

R&D expense for the quarter was $32.1 million compared to $27.9 for the prior quarter. Sales and marketing expenses were $37.4 million compared to $30.6 million for Q2. And general and administrative expenses for Q3 or $15.2 million compared to $12.5 for the prior quarter. The increase of each of these line items is the result of having the full quarter of expense compared to the partial Q2 and include amortization of intangibles, stock compensation and ADIC transaction related expense. Let me break those out. In total, amortization of intangibles included in the Q3 operating expenses totaled $5.7 million for Q3 compared to $4 million for Q2. Of that amount, $5.3 million was included in sales and marketing in Q3, and $3.6 for Q2. So the bulk of our amortization and intangibles is in sales and marketing. Stock based compensation included in OpEx for Q3 and Q2 respectively was $2.2 million and $2 million. $2.2 in Q3, $2 million in Q2, and ADIC transition related expenses included in OpEx for Q3 was $1.2 million and it's comprised of costs that could not be included in purchase accounting under GAAP but were a direct result of the acquisition.

For the quarter, Quantum generated operating income of $3.7 million compared with an operating loss of $21.7 for Q2 on a GAAP basis. Included in Q3 operating income is amortization of intangibles of $14 million, acquisition related restructuring charges of $500,000, stock compensation expense of $2.5 million and $1.8 million of ADIC transition related expenses. Most importantly when these items are excluded, the result is a non-GAAP operating income of 7.5% of revenue for our first full quarter as new Quantum compared with 5.4% for Q2. This is a significant achievement and is a great measure of the financial opportunity that can be realized by Quantum over time. One more measure of the potential for Quantum that Rick mentioned earlier is Synergies. Our estimate of the Synergies realized in Q3 is $15 million compared with $1.7 in Q2 when we were just starting to execute toward our integration goals. We expect to achieve at least $15 million for Q4 and really should be approaching $20 million. We are very pleased with the progress we have made here and are ahead of plan achieving our goal of $20 million per quarter in cost reductions that were established at the time of the merger. One final measure that we've been asked to provide is EBITDA. Adjusting for the same items above on a non-GAAP basis. Our EBITDA for the quarter was $37.9 million.

Moving to nonoperating items, interest income and other was $2.2 million and interest expense was $15.3 million for a net interest and other expense of $13.1 million. Our weighted average interest rate on our debt was $8.7 million for the quarter. Our quarterly tax provision was $200,000 compared to $2.5 million in Q2. I'm going to thank you again for enduring the explanation of the income statement. As we move forward it will become easier to explain the results and in particular, the sequential comparisons which I think are the most important will be for full quarters as the combined company moves on. I promise we'll have fewer unique items as we move forward. Moving on to the balance sheet, cash and cash and cash equivalents, short term investments totaled $151.4 million. We generated $6.8 million of cash from operations during the quarter and repaid $7.8 million dollars of debt. Accounts receivable at quarter end were $202 million, down $5.7 million from the prior quarter. Our D.S.O. for the quarter was 63 days. I plan on giving D.S.O. on a go-forward basis. This is the first time we've done that. Inventory was $99 million, representing the decrease of $18 million from the prior quarter. Almost the entire portion of the decrease was related to raw materials. This is due to a great job by our operations team and managing inventory. This will remain a focus as we look to optimize our balance sheet and generate cash. Fixed asset purchases amounted to $1.6 million for the quarter, and depreciation expense was $8.7 million for the quarter.

Moving to liabilities, accounts payable were $80.6 million, a decrease of $21 million. This is primarily the result of payment of some large acquisition-related items during the quarter. One liability item I like to bring up and we'll continue to do so is deferred revenue. Total deferred revenue increased $6 million in the quarter to $85 million at quarter end. As a reminder, the vast majority of our deferred revenue was generated from Quantum branded products and is the result of selling additional service contracts above and beyond the product standard warranty or selling ongoing software maintenance. We expect that our deferred revenue will grow as our branded business continues to grow. Looking at our Q3 results, we believe our target business model is well within our reach and that we have plans toward achieving it. However there's more to do and the people at Quantum are excited about the opportunities and challenges ahead of us in pursuing our business model objectives.

Looking forward to the march quarter, which is generally seasonally weaker than Q3, we expect total quarterly revenue of approximately $290 million, gross margins of 29 to 30% and OpEx spend of approximately $80 million. The gross margin percentage includes the impact of approximately $8.3 million in amortization of acquisition related intangibles, $400,000 in stock based compensation. While the OpEx amount of $80 million include the approximately $5 to $6 million in amortization of acquisition related intangibles and approximately 3 million in stock-based compensation charges. With that, I'll turn it back over to Rick.

Thank you, Jon. As we look to the next quarter, we'll be focused on continuing the momentum that we've established in terms of driving deeper integration and delivery on our synergy goals. Over the next few months, we will be delivering our integrated channel program beginning significant I.T. integration and fine tuning some of the actions we've already completed. All of this is intended to ensure that we achieve or exceed our synergy goals and meet our financial model. At the same time, we will continue to place strong emphasis on building our branded business. This will be critical, especially given the introduction of the D.X.I. series of disk-based offering. As a result of the merger, the combined company has nearly 1,000 people in sales, service and marketing. We view this as a tremendous asset that will be focused on growing our branded business along with our partners. Finally, we've recently focused on taking the next steps with our product and technology road maps. We believe there is increasing opportunity to define new more profitable business segments within the back-up recovery and recovery and archive portion of the storage industry. As we define these opportunities we will be ensuring that we inline our investments in order to capitalize on the growth potential. Thank you for joining us and now I'll just turn this over to the operator for questions.

Thank you, sir.

Ladies and gentlemen, at this time, we will begin the question and answer session. Our first question comes from Glenn Hanus with Needham and Company. Please go ahead.

Good afternoon. Could you provide a little color on, I guess, L.T.O. four drives or a little later in availability than expected and did that impact your branded media this quarter, and was that having to do also with the pricing dynamics there and when do you think that whole situation might correct itself.

Well, I would just start by saying, I don't think so. I don't think the L.T.O. four affected media in any way. Because people do have an install base that they buy, media four. And that install base is pretty robust and I don't think that was necessary the driving force. The media pricing environment is, you know, fluctuates from quarter to quarter and our intent is to be very nimble in watching that, but really ensure that the revenue base that we build is one that delivers sustainable margins. That's something that's important to us.

I got it all wrong. Could you explain what caused this one quarter aberration or is this a trend or --

So, Glenn, I guess I'll answer this way. We're -- we are very focused on good, sticky profitable revenue, and we are -- we play in a media market where we are not the largest player and from time to time, it is going to not be to our advantage to drive revenue at the expense of profitability. So we are looking closely at all our businesses. This particular quarter, we chose not to push hard on the revenue lever just because we didn't think there was enough profitability to be had for us. And we're going to continue to be opportunistic. I think Rick used that word in the right way. And it isn't really just media. Media has its own dynamics. But we are not going to have revenue for the sake of revenue.

I would also add that strategically, we're a major player in the market today and we really feel that we need to continue to work to get a, you know, better competitive position in media. And that's something we have to now as a combined company we feel we have a lot more presence to do that. We haven't been able to make that work thus for. So, as John says, we're going to be very cautious, very clear about building revenue that is sustainable, and we're very focused on margin, gross margin and operating expenses in terms of driving an operating margin that is positive, sustainable cash generating and helps us fit within our goals to delever the company over time.

You seem to be making great progress on the Synergy and cost reduction front. The $20 million goal it seems in reach. Do you feel like there might be, you know, a target beyond that, you may not want to give it today, but do you think that's pretty much it on the cost side there, or might there be, you know, more to be had?

I think the challenge will be, you know, when do you stop calling it synergies and when is it just operating the business? So I think from the information we shared with you today, I think we feel very good about achieving in the near term that $20 million goal. We believe that we have taken all the actions meaning people have been notified, facility decisions have been made. We can tally all of that up and see how we get no that number or exceed it quickly. So that is a given.

Going forward, I prefer to think about how we get more competitive and drive our model versus just calling them synergies. For example, we haven't really begun to integrate our systems. Our systems integration will start to occur here and that will increase productivity, allow to us take a lot of complexity that we currently have in the company. That will have benefits to the company in a wide range of areas. So there are a lot of things like that. But I think continuing to call those synergies is something that's not going to be as productive because we're working on so many other things.

That's why I think focusing on our business model goals is ultimately what's important. I think next quarter we'll talk about synergies again. I suspect it will become less important over time and will be more than important is are we hitting that 35% gross margin? Are we hitting our expense structure goal? Are we driving towards 10% operating income. That I think will be more important.

Maybe lastly you could comment on just the competitive aspects with, you know, Sun and on the library side? Do you feel that being a combined company you're starting to see some competitive benefits in the branded business and in the libraries and what are you seeing out there competitively?

Let me just start by saying I spent a lot of time in the field last quarter, talked to a lot of customers. Customers universally like the scale that we bring, like the fact that we can commit to better service infrastructure, like the fact we can improve account coverage. We have worked very hard to make the customer piece, the front end of this very clean and transparent to the extent that there's complexity, and there is, you know, we kind of have that behind the curtain. Quantum people are dealing with those complexities and we tried to make it very clean for our customers. The feedback around that and the message has only been positive in terms of the interactions that I have had with customers. So strategically, having this thousand person go to market capability globally we view as a big competitive advantage. Anecdotally, on the tech side we find a lot of opportunities that we're involved with and business and deals we have won. I can't tally up and tell you whether it's all working or not working. I'll have Bill Britts here maybe who's much closer to that say a few words on it. But I think that the go to market strategy for what we are doing here and the reasons for the combination I it into feel are very compelling.

Just to amplify on what Rick said. There is really two key elements to this. One is the product portfolio and with the combined companies, we have a very, very strong line up top to bottom. And John mentioned earlier that in our mid range space, we absolutely knocked the cover off the ball. So from a product standpoint and a product portfolio, breadth of product and ability to solve problems from the low end to the enterprise and service capability around it, we have a very strong lineup against any of the players in this space evidenced with our market share position in the open systems tape automation space.

Equally important, is the channel and the go to market that Rick talked about. We're at scale it is very important also that we differentiate ourselves from the competitor and that we're the independent storage company with an independent go to market independent channel that it's a very clear business model. So the channel understand very clearly, what our objectives are and how to use and leverage our expertise in this back-up, recovery and archive space. That's not true for the other players that have broader business portfolios trying to sell things other than archive.

Thanks.

Thank you. [OPERATOR INSTRUCTIONS] And our next question is a follow-up from Glenn Hanus. Please go ahead.

Do you want to maybe talk a little bit about, you know, you've come pretty far already on the gross margin side, the goals sort of 35%. What are sort of the key, you know, to-do's? Is it just a matter of mix? Is it, you know, you've got facility consolidations yet to do? What are the sort of key to-do's that, you know, kind of get to you the next level there?

Well, I would break discussion into two areas. First of all, relative to synergies and just executing the business, growing the branded business as we've said is really critical because of the margin differential there. We still have synergies that we need to flow through in terms of, you know, some of the efficiencies we can gain through the supply chain work and a variety of elements like that that we believe will continue to allow us between the two of those things, you know, we believe we can close the Gap on that 35% number. That's the first point. The second point is a more strategic point which is given the combined company, what are the areas we should emphasize? What are the business opportunities that we have today as a much larger player that can put us in areas where the margins are sustainable, where the differentiation is strong, where we bring competitive advantage.

I can tell you for example the DXI product that we just started to ship is fundamentally different. Don't think of it anything like the traditional D.T.L. products that are in the market today. Because the D.T.L. markets took commodity hardware and put this D.T.L interface on it and maybe some management capable and went out and competed with that product. It was not a significant margin enhancer for Quantum or for anyone in this business. You take the D.X.I. product which we built from combining our hardware platforms of, you know, one company [inaudible], our replication technology, de-duplication, management, all of those capabilities. And, you know, the margin structure for that business is substantially better than it is for the traditional D.T.L. market.

So that is the longer term opportunity is how do we redefine segments? How do we bring technology together that allows to us make more of a contribution and be able to have a sustainable, you know, long-term business that has margins associated with it? If you look at some of our competitors, those that are public and some of these segments have gross margins in the 20% range, overall, you know, we think that's not a sustainable business. We don't think you can invest in a robust R&D program and we feel today we have the ingredients to move into some of these segments to take some of our, you know, more commodity businesses and really extend them with some of the technology opportunities we have today. So we really just think about it short term and long term when we put this together we were very much focused on the first phase. We continue to work that over the last month. We were strategically focused on the second phase because we think that second phase is in some ways even more important because it really delivers a sustainable opportunity.

What state CapEx and depreciation outlook per quarter and how will that trend?

I think depreciation will be in a similar range $9 million-ish, $8 to $9 million per quarter and CapEx was pretty low. We're less than $2 million this quarter. I don't any it'll stay that low over time. Probably closer to $4 or $5 million a quarter. Having said that, you know, we're very focused on utilizing our cash well and really trying to not spend money where we don't need to. So that was one of the things I was pleasantly surprised about this quarter. We didn't spend a lot of money in that area.

All right. Thank you.

Thank you. And management, there are no further questions. I'll turn the conference back to you for closing comments.

Well, thank you for joining us. This is a quarter that, again, we're very pleased with and I'd just like to use this opportunity to thank all the team members at Quantum for their hard work and dedication to delivering very good progress this quarter. It definitely took a team effort. I believe there's more to come and so again, thanks for joining us and thank you for all that helped make this result a reality.

Thank you. Ladies and gentlemen, that will conclude today's teleconference. We do thank you for your participation, and at this time you may disconnect.