Quantum Corp (QMCO) 2008 Q1 法說會逐字稿

Thank you for standing by, and welcome to the first quarter fiscal 2008, conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). This conference is being recorded today, Wednesday, August 1, 2007. 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 today are Rick Belluzzo, our CEO, John Gacek, CFO, and Bill Britts, Executive Vice President for sales, marketing and service.

The web cast 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 website at www.quantum.com, and will be archived for one year.

During the course of today's discussion, we'll 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, our target business model, and anticipated future revenue, gross margin, OpEx, and income performance. Trends in our business, and the markets in which we compete, and trends impacting our media royalties, and the expected timing and features of new product launches.

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 refer you to the risk factors and cautionary language contained in today's press release announcing our fiscal Q1 2008 results, as well as to our reports filed with the Securities & Exchange Commission from time to time, including our most recent 10-K filed on June 13, 2007.

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 the forward-looking statements in the future.

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

Thank you, Shawn. Good afternoon, and thank you for joining us for the Quantum Q1 FY '08 earnings call. It has been almost one year since we completed the acquisition of ADIC. During this time period, we've been aggressively moving forward, with a series of actions, aimed at fully integrating the two companies, improving the operating model for tape products, and positioning the company for longer term success.

As we reported during our last call, we have moved quickly, towards capturing the synergies, that have let to an improved operating income model, as well as refocusing our strategic priorities, to capture more opportunity, than the specific growth segments of the storage industry.

With this progress behind us, we characterize Q1 of FY '08 as a critical quarter in terms of taking actions, that would position us to capitalize on opportunities available to the new Quantum. In short, as we entered this quarter, we knew that we would be facing, a very aggressive set of execution priorities, that would be critical toward achieving our business model goals, for the remainder of the year. Therefore, our objective was to complete the vast majority of the integration, and strategic actions, that would allow us to enter the next phase of our transformation. One that is more focused on growing the business, and transitioning the companies to take advantage of our expanded market opportunity.

With this as a background, we're very pleased with this quarter's operating income performance, and most importantly, with our execution of critical priorities. Q1 is always our most challenging revenue quarter in terms of seasonality. This year was no exception. Our total revenue was $245.8 million, which was below our internal plan, by around $15 million. With primary weakness in our AMEA brand business. As I mentioned, this is usually a seasonably weak quarter, but we're still clearly disappointed, with the results.

Now that we've completed virtually all of our major integration actions, we're placing more attention and focus, on growing revenue in the upcoming quarters. In spite of the revenue shortfall, we were able to deliver solid non-GAAP operating income results of $13.2 million, which was 5.4% of revenue, as compared to the 4% guidance that we provided during our last call. This was largely driven by strong 35.5% non-GAAP gross margins, and continued improvements, in operating expenses.

This gross margin result is the best non-GAAP performance in five years, and reflects improvements in business mix, and lower costs. These results further indicate that the go forward business model for Quantum, is progressing consistent with the plan, that we outlined, when we combined the companies.

Now that the business model and underlying structure of the company are solidifying, we're shifting our emphasis toward improving our global branded revenue performance, with a specific focus on extending our tape automation leadership, and growing our disk systems, and software business.

I would also like to summarize that the list of activities that we implemented over the last few months, have been significant. These actions have been important in driving improvements in our business model, but are even more relevant as we move forward, during the next phase.

As a reminder, our strategy is continue building our tape automation business, by focusing on the healthiest segment of the market. The branded midrange to enterprise open systems segment. And, growing a disk systems and software business, while utilizing our strong, go to market infrastructure including a large, global install base. In pursuing this strategy, we'll also optimize our investments. In other areas, through partnerships and reduced spending. All of the actions that we have taken over the last few months, have been focused on aligning around this direction.

During this time, we achieved the following. We improved our capital structure by refinancing our acquisition related debt. We finished integrating our global Oracle ERP system, enhancing our automation capabilities, and improving efficiency. We established a partnership with HP to generally develop LTO tape drives, allowing us to save over $15 million per year, in estimated development costs, while giving us improved product cost, on a go-forward basis.

We completed the sale of our Penang facility to benchmark electronics, allowing us to better align our operational capability with our system strategy, while improving our asset utilization model. We increased our focus on developing our disk systems and software business, through the DXI7500 announcement and the. STORNEX30 Launch. We increased our sales force by nearly 50 people, to facilitate more growth in our branded business. We feel these and other actions, will allow us to achieve an ongoing operating model, that will lead to improved financial performance, through both branded revenue growth, and an improved more flexible cost structure. As I said before, these actions are largely behind us, our priorities now focused squarely, on growing our branded business, and capitalizing on the improved business structure.

In summary, despite this being a very challenging quarter, we believe that we've done a very good job in executing on our priorities, allowing us to reach an important milestone, where we we can shift our focus from integration-related activities, to establishing a more valuable and sustainable position, in the storage industry.

Now, let me turn the call over to Jon, who will provide some of the financial and business details. Then I will come back and provide you with more color on our disk systems, and software progress, along with our business plans. Jon.

Thanks, Rick. I'm going to provide additional detail on income statement line items, as well as on significant balance sheet changes, that occurred during the quarter. But before I do, I want to emphasize, several key points from the first quarter.

First is revenue. Rick mentioned we were $15 million below our internal plan, and that weakness was primarily centered in Europe. Another way to look at that, is we were down sequentially $31.5 million from Q4. Our branded versus OEM product mix was 58% branded, and 42% OEM. These changes, however, are consistent with what we've been emphasizing as our strategy, which is, to focus on maintaining and growing our profitable revenue opportunities, and not pursuing low margin, or low growth businesses.

The next point is gross margin. On a sequential revenue decline of $31.5 million, our non-GAAP gross margin increased from 33% to 35.5%. This reinforces the changes we're making in our infrastructure and cost model, and shows the power of our business model. As we increase our branded business, and drive revenue and growing segments that are profitable, we'll generate significantly improved results.

The third point is non-GAAP operating profit of 5.4%, on non-GAAP OpEx of $74.1 million. Our guidance for this quarter was to achieve 4% operating profit. We exceeded that goal, and several of the changes that Rick summarized, and that we announced this past month, will allow us to continue to lower our OpEx going forward. We continue to drive to a business model that includes improving gross margins, and improving operating income.

Finally, we had approximately $11.7 million of acquisition related restructuring charges during the period. Included in G&A, we had accelerated depreciation of $2.2 million, related to the conversion of the new Oracle ERP system, as well as severance and retention costs of $9.5 million, of which $200,000 is included in costs of revenue, and $9.1 million is included on its own line item, in operating expenses. These costs and changes are primarily the result of changes in our LTO development strategy, as reflected in our recently announced development agreement with HP. We believe we have completed all of the significant restructurings related to the acquisition of ADIC, and expect only the follow on facility's restructuring cost of approximately $2 million, that will occur in the future, as we will accrue those, once the facility is fully vacated.

Looking at first quarter results in more detail, I'll go through the income statement line items, describe the non-GAAP amounts, and highlight the related business points.

Start with revenue. Total revenue for the quarter was $245.8 million. Royalty revenue was $24 million, and product revenue was $221.7 million, for the quarter. Royalty revenue declined approximately $5.5 million from Q4. This is a result of Q4 including the $3.3 million from the data to main cross life agreement for our D duplication technology. And the $2.2 million decline in DLT royalties from the prior period.

In addition, due to the timing of the LTO Ford drive introduction, we saw minimal contribution from LTO royalties in the period. As a reminder, when we look forward, we expect the LTO royalty will increase, as the installed base grows, and the DLT will decrease over time.

As a reminder, product revenue includes sales of our hardware and software products, and services through both our Quantum branded and OEM channels. Our branded products generally have higher gross margins, and selling costs, than similar OEM products. Sales of our branded products also give us an opportunity to sell ongoing services, and continue to provide additional products, services and solutions, to our end user customers. Over time, we expect the Quantum branded revenue will grow in absolute dollars, and as a percentage of our product sales, and results will continue to increase our gross margin percentage.

For the June quarter, product revenue was $221.7 million of which 58% was branded, 42% was OEM. For the prior quarter, product revenue was $247.8 million, of which 57% was branded, and 43% was OEM. We improved about 1%.

Beginning last quarter, we broke out into separate categories, and disclosed our disk products and our software products, of the combined category, to allow you to chart our progress. In addition to our tape automation systems, services and other categories, and devices in media, let me walk through each of those.

The disk and software category includes our new DXI products that began shipping in the prior quarter. Our older VTL products, PVX and DX and our StorNex software, and the related disk revenue.

Revenue in this category was $9.1 million for the quarter. This was a modest increase over the $8.6 million in Q4, reflecting growth, in our midrange disk products including the new DXI3500 and 5500, and a decline in our older enterprise VTL products, as we began the transition to DXI, and our software revenue, was essentially flat. We plan to expand our DXI product family in fiscal '08 and we expect this revenue category will grow quickly this year.

[Nextous] tape automation systems, revenue was $108.4 million in Q1 compared to $119.2 million for the prior quarter. We had two areas of sequential decline. First, our branded European automation sales were down. We believe this is a result of our own execution which we're addressing. Last quarter, Europe was very strong, and North America was weak. This quarter, it was the opposite. North America has rebounded, and Europe was very weak. Our North American nation revenues were basically on plan, for the quarter.

The other area that declined which was expected was low end automation systems with OEMs.

The third group is services and other, which includes hardware service contracts, repair, installation, and professional services. Service revenue totaled $40.1 million for the first quarter, compared to $38.5 million in Q4. In our quarterly report on form 10-Q, we'll break out for the first time, service revenue, and service cogs, as those items now exceed 10% of our revenue. So that will be new. We haven't broken it out yet in the press release, you'll see it in our Q.

As we look forward, we believe our service offerings will continue to be a key driver of our growth and profitability.

The final group is devices and media. Q1 for this group was $64.1 million compared to $81.6 million for the prior quarter. A decline of $17.5 million. Branded devices and media were down $10 million, and OEM devices and media, were down $7.5 million. We expect that we'll see additional declines in OEM devices revenue, as products roll off, and we focus on more profitable revenue segments. Also, we describe last quarter, media is a commoditized market, and we will be opportunistic in driving profitable revenue.

In the media space, our strategy is to support our branded and OEM tape library customers, with higher margin, quantum branded media, and sell media in the open market, when it makes financial sense. Our media team has been working to improve our immediate cost position, and we look to partner with one or two of the media suppliers, to improve our economics.

Now, I'll move to cost of revenue and gross margin, which, for the first quarter of fiscal '08 were as follows on a GAAP basis. Cost of revenue was $167.7 million. Gross margin dollars were $78.1 million, and the gross margin percentage was $31.8%.

The prior period amounts were as follows. Cost of revenue is $195.6 million. Gross margin dollars were $81.7 and gross margin percentage was 29.5%. That's a 2.3% improvement on a sequential basis.

On a non-GAAP basis, first quarter cost of revenue was $158.4 million. Q1 gross margin dollars were $87.3 million or 35.5%. compared to $91.5 million or 33% in the prior quarter. This is a sequential improvement of 250 basis points, on a $31.5 million, sequential decline in revenue. Another way to think about it, is our revenue went down $31.5 million, but our gross margin dollars decreased only $4.2 million.

Improvement in gross margin percentage is primarily the result of an increase in branded versus OEM mix, stronger execution on, and continued realization of cost reductions related to synergies, and a move to higher margin products within both channels. You can see the power of our model. As the Quantum branded business grows, our gross margin improves very quickly.

You'll note I didn't go through each of the non-GAAP reconciling items individually. They're fairly consistent with last quarter, and we included the data on our web site, and in the press release. Those items include stock compensation, amortization of acquisition intangibles, and ADIC acquisition related restructuring and transition costs.

Moving to operating expenses, one change for fiscal '08. We have stopped allocating IT costs to R&D and sales and marketing. As a result, you'll note an increase to G&A expenses, and corresponding declines in R&D, and sales and marketing, expense. For the prior period, those operating expenses have also been reclassified to reflect this change. This will allow comparability on a go-forward basis.

R&D expenses for the first quarter were $26.4 million compared to $29.1 million for the prior quarter. This decline is the result of decreasing our investment in the development of tape drives, and we expect R&D expense will decline further, during the year.

Sales and marketing expenses were $35.4 million compared to $36.9 million for Q4. This decline as a result of lower branded revenue, and the resulting commissions, and a decline in marketing spent. General and administrative expenses for Q1 were $21.5 million compared to $16.9 million for the prior quarter. This increase was primarily the result of $2.2 million in accelerated depreciation, related to our Oracle conversion, I mentioned earlier.

In addition, we had restructuring of approximately $9.1 million. Primarily related to the result -- related to the changes in our LTO development strategy, and the related joint development agreement with HP. Total GAAP operating expenses were $92.3 million in Q1, compared to $87.5 million in Q4.

Amortization of intangibles including operating expenses totaled $4.5 million for Q1 compared to $4.4 million for Q4. Stock-based compensation included in OpEx for Q1 and Q4 were $2.5 million, and $2.1 million, respectively.

Excluding the restructuring and transition expenses related to ADIC acquisition and the amortization of stock based compensation, non-GAAP, OpEx totaled $74.1 million in Q1, compared to $75.4 million in Q4. For the first quarter, we reported GAAP operating loss of 14.3 compared with an operating loss of 5.8 for Q4. Adjusting for the previously mentioned reconciled items, we generated non-GAAP operating income of $13.2 million or 5.4% of revenue for Q1. This compares to $16 million of operating income in Q4 or 5.8% of revenue. Again, our guidance for Q1 was 4% of operating income on declining sequential revenue.

We think we've now implemented the significant improvements we had planned for, in order to improve our cost structure going forward. We believe we're on track to achieve our 10% non-GAAP operating income goal for fiscal year ended March 31, 2008.

One final measure is EBITDA adjusted for the same items above, our EBITDA for Q1 was $28.1 million compared to $29.7 million in the prior quarter.

Moving on to nonoperating items, interest income and other, was $4.4 million and interest expense was $13.6 million. For net interest and other expense, of $9.2 million. Included in other income, is an approximate gain of $2.1 million from the sale of our data to main shares, and their IPO. Our weighted average interest rate this quarter, was 8.72%. And our quarterly tax provision was a benefit of $1 million, compared to $2.2 million expense in Q4.

Q1 benefit was primarily the result of the closure of a foreign tax audit and the release of related contingency of $2 million, offsetting our normal quarterly cost, of approximately $1 million for foreign and state taxes. Our tax rate will continue to fluctuate quarter over quarter, as we integrate legal and tax structures, but a $1 million expense is a good estimate.

Moving on to the balance sheet, cash and cash equivalents, and marketable securities, totaled $89.9 million. We used $21.2 million of cash to fund operations during the quarter, and had net borrowings of $24 million. Significant use of cash and operation -- use of cash and operations with accounts receivable. As a result of our system conversion, we were unable to invoice customers for about 30 days. In addition, we were also very focused on the Penang sale, and refinancing during the quarter. Going forward, we believe we have room for improvement in leveraging the balance sheet and we'll get a better handle on the cash flow requirements to operate the business, and reduce our debt, and decrease interest expense.

Accounts receivable was $175.2 million, an increase of approximately $25.8 million from the prior quarter. Our DSOs were 60 days, compared to 57 days in Q4. Inventory was $76.3 million, representing a decrease of $14.8 million from the prior quarter. This continues to be an area of focus. In Q1, we completed the consolidation of our North American manufacturing operations into Colorado Springs closing our Costa Mesa site, and subsequent to quarter end, we sold our Penang manufacturing facility, to Benchmark Electronics.

The net assets associated with the sale of the Penang facility of $8.2 million, are classified on our balance sheet as assets held for sale, at June 30th. This primarily includes inventory fixed assets, and net accounts payable. Fixed asset purchases amounted to $4.7 million for the quarter, and depreciation expense was $9.7 million.

Moving on to liabilities, accounts payable were $77.9 million at June 30th. A decrease of $15.1 million over the prior quarter, due to timing of payments. Total deferred revenue was essentially flat for the period. As a reminder, the vast majority of our deferred revenue is generated for Quantum branded products, and is the result of selling an additional service contract above and beyond, a product standard warranty, or selling ongoing software maintenance. We expect that our deferred revenue will grow, as our branded business continues to grow.

I will finish with a brief discussion about our new debt structure. We completed our refinancing of the ADIC acquisition debt, subsequent to June 30th. Our new facility consists of a $400 million term loan, and a $50 million revolver, with terms of seven and five years respectively. The interest rate is LIBOR plus 350 on both facilities. As a result of the refinancing, we'll write off the remaining ADIC acquisition debt issuance cost of approximately $8.1 million during Q2.

Let me say we're very pleased with this new facility. As it has improved structure, and interest rate, and an improved covenant package.

Q1 was a very busy quarter. We continue to see improvements in our operating model, and our ability to report improved financial results over time. Looking forward, we believe we're on track to achieve non-GAAP operating profit of 10% for fiscal 2008. We expect Q2 revenue to increase sequentially, and non-GAAP operating income, to improve to approximately 6% of revenue. With that, I'll turn it back over to Rick.

Thank you, Jon. As we have made clear in recent communications, our strategy is to be a leader in the back-up, recovery, and archive segments of the storage industry, by continuing our leadership in tape automation, where we hold the number one market position, and by growing a solid disk systems and software business, by building on our leadership in de-duplication technology, high performance file systems, and replication, along with our early position in VTL libraries.

In order to address some of the industry's highest growth segments, in many ways, this is our first quarter of pursuing this new direction. During the last call, we said that we wanted to make our disk systems and software business an increasingly stronger contributor, to our revenue stream. And we will continue to be dedicated to this direction. The changes we have made in our underlying model are all directed toward this new emphasis. We have barely scratched the surface in pursuing this opportunity. And giving that much of this opportunity, is an emerging market segment, we're paying close attention to customer feedback, and ensuring that we maintain the flexibility required to adapt appropriately.

There is no doubt this is the right direction for Quantum and we have the necessary ingredients for success. At the same time, there will be ups and downs as we move forward. The 7% sequential growth in disk software revenue, was not as high as we would have liked. As sales of some of the older products fell off more quickly than the expected -- than expected. And that the ramp of new products wasn't sufficient to compensate. However, we continue to feel very good about the opportunity to grow our disk and software business particularly our new DXI series solutions.

Since we started shipping the first DXI products in this family, about six months ago, we've seen increasing momentum. In the last two months alone, we've sold nearly twice as many systems, as we did in the first four months, and we've had wins spanning a broad range of customers around the world, from smaller organizations to well-known brand name companies, and to major governmental agencies.

These customers also represent a wide array of industries including telecommunications, financial services, healthcare, education, technology, and consumer products. While a number of these deals involve multiple units that we're just beginning to install. Others are single unit purchases, that we expect to generate additional business, as customers experience a tremendous benefits of the DXI series, and want to deploy it more widely across their organization.

This is one of the reasons we're excited about the next DXI system. The DXI7500 which we announced in June, and plan to ship later this year. With the addition of the DXI7500, our DXI series becomes the first disk-based back-up family, to extend the benefits of data de-duplication, remote replication, and disk to tape creation, across a product line that covers distributed sites, midrange environments, and primary data centers. In addition, the DXI7500 includes policy-based de-duplication, a unique approach to allow customers to choose the de-duplication process best suited for their requirements of a specific back-up job.

While customers who have already purchased the DXI3500 and 5500 have been impressed with these products, and the tremendous value they provide, we've also seen clear affirmation of competitive advantage, that we have in this market. For example, in the case of customers who still want to leverage the benefits that tapes provide for longer term archive and disaster recovery, we can bundle our leading tape automation offering, with our DXI systems. In fact, we're finding that roughly 20% to 25% of our customers purchasing DXI systems, also buy tape at the same time.

On a related note, our large installed base of tape automation customers, is also providing us with a competitive advantage. As customers are turning to us when they're ready to purchase disk-based back-up systems. This also gives us, and our customers more flexibility, in when and how, we might structure the disk-based back-up deal.

For example, with the tape automation service contract comes up for renewal, we're finding some customers see this as a good time to restructure our overall engagement, to include disk-based back-up. Finally, our global scale and strong service and support infrastructure, are proving to be an important differentiator.

On the StorNext side we also have made progress over the last few months. We launched the latest version 3.0, which features our data de-duplication technology for archiving, and we enhanced our market position with HP in the global resaler, and we continue to gain new enterprise customers, including Microsoft, Fox News and the U.S. Bureau of Land Management. We'll continue to provide further updates as we build our disk and software business.

In summary, Q1 was a very critical quarter for Quantum. We feel we delivered solid operating results, while we also implemented a very aggressive set of actions focused on accelerating our transition, toward building a more valuable storage business. I feel that we have completed the major actions associated with the merger of Quantum in ADIC and have taken major actions, aimed at aligning our infrastructure, and our investments around our new strategic focus.

Going forward, we're now placing our energy into growing our branded business, with a priority on tape automation, disk systems, and software, and making continued incremental improvements, in the operating structure of the company, through further systems and process integration. Thanks for joining us. I'll now turn the call over to the operator for questions. Operator.

Thank you. Ladies and gentlemen, we will now begin with the question-and-answer session. (OPERATOR INSTRUCTIONS). Our first question is from Brian Freed from Morgan Keegan. Please go ahead with your question.

Good afternoon, thanks for taking my call. A couple of quick questions. First related to the operating expenses, on the G&A line, when you take -- adjust for the accelerated depreciation, it doesn't seem to fully account for a pretty large sequential step. Can you go into a little more detail about what happened there, Jon?

Sure. We had a smattering of other things. We moved some facilities. We had some increased Telco costs. They were all $300,000, $400,000 items. We had legal fees related to all of these deals we were doing. So, there is a -- smattering of things. I think it will get back to a run rate, a more normalized run rate. I think we're also fortunate in Q4 -- I think it was 15.1 is what we had in Q4. That had some benefits in it as well. We just didn't have expenses we thought we might have. It was around 17.4, 17.5 is the run rate.

Ok. All right. Great controls on the gross margin line. As you look at your drive toward 10% operating margin, how do you see the blend of the leverage going forward as we go from that five and a half to 10% operating margin split between improvements and gross margin, and improvements in operating margins?

I think the bulk of it comes from improving gross margin, and that's really the branded business growing, and being a greater percentage of the overall revenue. There will be, absolutely benefit, on the OpEx line, you know, we gave some guidance that we're going to say, $15 million per year on the HP venture. You know, that should get worked into your model. That's roughly $4 million a quarter. But the big numbers, are in gross margin.

Ok. Then my last question before I cede the floor, last quarter, you talked a little about, full year targets both for overall revenue, and your disk-based segment. Can you comment on what you're thinking in those segments at this point?

Those haven't changed. We think we'll be $1.1 billion to $1.2 billion for the year, and our goal for the disk and software is $30 million we mentioned last quarter.

Ok. Great. Thanks.

Thank you. Our next question comes from the line of Mark Moskowitz with JPMorgan. Please go ahead with your question.

Thank you. Good afternoon. Jon, maybe I could piggyback on the last question as far as the revenue trajectory, at least as you started for the year, what gives you confidence you can still get to the $1.1 billion to $1.2 billion bogey for the full fiscal year at this point?

So, we're roughly -- as we mentioned, $15 million off our plan, which rolls up to that 1.1 , 1.2. We understand the reasons for that. I am not as hung up about getting to that number, as I am about growing the branded business and getting the OpEx under control. We have the ability to get more revenue. We can get more media revenue very easily. The problem is it just doesn't generate as much profit as we would like.

So, I think all of us here -- Bill can comment as well, we're very focused on growing the segments of the business that are generating profits. I think you can see as we look at the last two quarters, we're actually creating a more valuable, and healthier company, on less revenue. So, as soon as that revenue sort of turns the other direction, which we think it will, in Q2, the power of the model just gets that much bigger.

So, I guess I would say I'm less concerned about the 1.1 to 1.2. I am concerned about-- we have to grow the branded business, because that's really the driver to the higher gross margin, which is really the driver to the 10%

Ok. And then as far as Rick's comments earlier about the mixed signals in terms of U.S. being better, Europe being weaker, how should we think about the factors playing out in terms of the next three months that you said that you guys expect your revenues to be up sequentially. Is that more because of general improvements in some regions versus others, or is it more company specific, in terms of some of Quantum's newer products launch in the next couple of months.

I think it is a multidimensional challenge, but I would say in general, what we're anticipating for this quarter is that all GOs will be up sequentially from Q1. Q1 historically, is a difficult quarter seasonally, as we kind of go back and look at kind of historical Quantum and ADIC for that period. That is a difficult quarter seasonally.

In Europe, it was a combination of our own execution challenges, getting alignment of our sales force with the new strategy, hiring people in Europe is more difficult than hiring people in the U.S. There's just less mobility in the work force. We're significantly adding to our sales team in all GOs, and we're actually on track in the U.S. and we anticipate we'll have the impact from the additional sales resources hired in the U.S.

First, we think that North America is very well-positioned to continue on what was a very good Q1. In Europe, we also had some softness with some is major partners, that drive a lot of our midrange in enterprise business. We don't anticipate that that will be the case for this coming quarter.

And in Asia, we have a situation where we have markets specifically, China and India, where we're making disproportionately big investments up-front, to take advantage of the overall macro-growth, in those economies and those markets.

So, it is a combination of adding additional sales resources. The additional product portfolio with the disk based back-up, now playing a bigger part of our overall revenue mix. And it is also improved execution. As Rick mentioned, we've done a lot in the last year, to basically integrate the company, the system, getting everybody very, very clear on, how we're going to go to market, and I think we're largely -- that's behind us and it is really about focusing on getting alignment, and focus, with our sales marketing organization lined up with our product portfolio.

Ok. And then if I could, clearly this past quarter, it it was quite active in terms of your integration activities, and also your capital structure revamp. I'm just kind of curious going forward, Jon or Rick, if you could, weigh in on how both the management team and the sales force will be compensated, or incentivized. In term of incentive comp, is it going be driven on top line? Is it going to be driven on holding the margins in strict accordance to get to that 10% operating margin bogey, or is it going to be on new customer penetration just given the whole excitement about de-duplication?

You know, our sales force is clearly compensated on revenue and you know, with a look at profitable revenue. That's the branded team, is -- we have a fairly typical sales compensation system. That is about driving success, in revenue wins. The management team, our single focus in bonus focus, is on operating income. Which we need revenue to achieve.

But we want to build a healthy foundation for the company, and we've tried to keep things pretty straightforward, and believe it all comes together in operating income, to drive improvements in gross margin, to keep bringing expenses down, to drive top line revenue in the branded and new product segments. So, that is what we're focused on.

And I would just add that your observation is, you know, we had a very aggressive quarter in terms of change. I mean, if you were around a Quantum facility, I mean we were doing agreements, and really felt motivated to aggressively get all of the stuff done in Q1, so we could make sure, that we were focused going forward on the right activities, which is around gaining customers, growing revenue, and we clearly have incremental work to do, post the integration but those are -- many small incremental steps, versus big system transformations, or closing facilities, or reducing head count in areas.

We've done so much of that, that it is -- you know, it is significant. I always throw out a set of numbers here that we didn't talk about, that I think helps reinforce that. When we started this process, the companies had about 3300 employees. Today, after all of these changes, we're at about 1800, I believe. Half of that head count is in sales, service, and marketing. And we've transitioned our employee-based benchmarks through our factories. We've closed some things. We've made a lot of changes, but we now find ourselves at this billion plus, business, $1.1 billion, $1.2 billion business, with our head count around 1800 people. Half of those, driving revenue and customer opportunities. You know, we think we've really transformed and structured into a very competitive platform. To move into what we keep referring to, as a high value storage business.

I appreciate that. Maybe you could just talk about the de-duplication act, opportunity in terms of what that means for Quantum over the next year, and how you see yourself stacking up against the competition in terms of data domain, EMC, and some is other flavors out there.

Yeah, I'll start with a few comments and I'll have my friends here join in. When we brought the companies together, we put teams together to put our solutions, and our products, and our road maps together. And our disk systems and software team, you know, started to make real progress with the recent Rocksoft acquisition, and a variety of other things.

In December of last year, we all sat in a room and said we believe that we should make some big moves here. The big moves were about getting more focused, on the new segments. More focused on data de-duplication, disk based back-up, our file system software, all of the other elements. And that we should make trade-offs in other aspects of the business.

To do that, we would grow our sales force because we need more capacity to build this market. And we were really going to focus, and double down on the product side, to make sure we had a road map that was aggressive, and that we could really, you know, get ahead, and stay ahead in this business.

So, we began shipping the product early in the year, and you know, today is a company, where all -- mobilized around that opportunity where to sell, what the customer feedback is, how to enhance the product. I mean we're moving very aggressively in being able to establish this business.

I would just say that I've been here, as you know, for four plus years, and we've always been kind of struggling with market segments that aren't healthy or declining. This is an exception. This market segment is growing. It's expanding. It is what customers want to talk about. The sales funnels are full. And we have -- you know, the early phases of a solution we think is, really outstanding. We have good customer feedback. And we're just going to keep driving aggressively because we think it can really become, a fundamental part of the company going forward.

And the other thing I would say that's exciting about it is that our -- 900 person or so sales service and marketing team, are calling on the same accounts, the same customers, that are going to buy disk solutions added by tape solutions.

I said in a lot of these customer visits, you feel the synergy of opportunity that we have, by being -- having a large install base in tape systems, and being able to bring to bear a well-integrated solution with disk and de-duplication, and so that's the path we're on, and you know, we're making -- we're building that business. We're making progress. And there's just a lot more to go. In terms of opportunity.

I don't know if you guys want to add anything.

One thing I would emphasize is, it is still very early, in how this market is developing. De-duplication is a technology, certainly is getting a lot of attention. If you go out and talk to customers as Rick mentioned, the two top technology trends that everybody is either adopting or looking to adopt, or expand, or server virtualization and some type of de-duplication for optimized storage.

So, if you look at kind of where the different players are lining up, they're going to be players that will use de-duplication in primary storage, the normal companies that compete in that space. They're going to be people that will be trying to do that on the client side. And they're going to compete on the basis of coming up with just inherently better, back-up applications. And they'll be focused there such Abamar, Symantec, and then there's target-based solutions, and we have started there with, I think really, a different approach which is to build it off of our clustered file system. Our StorNext file system. We're using that embedded technology base, to be able to build our DXI products. That's why we quickly were able to announce an enterprise product, the 7500, so quickly after our midrange 3500 and 5500.

So, it is very early in how this market is going to, kind of line up from a competitive standpoint. We're very pleased with the position early adoption, we worked through a lot of the -- I will call it the consultative part of this, because the data types, and how the customer is actually doing their back-ups, and the retention policies, greatly impact data de-duplication rates. In some cases, it can be 2 to 1, 3 to 1. In other cases, it can be as high as 50, 100 to 1. Depending on the nature of the data, and the back-up schemes that people are using.

So, we're trying to, really be consultive, the fact that we have a very strong tape business, allows us to really start with what's the customer problem. Work back from that. Tape will continue to play a very important role. It will change to be more of an archive, and removable media disaster recovery, type of solution. We see it primarily in the core data center, continuing to persist. But there still will be this role for tape in a consultative approach, starting with the back-up program, we found to be very well received by our customers. The last thing I would add to this in terms of the nature of this segment is, you know, if you go through the list of all of our wins, you know, you'll find they're are one or two system wins. You find a big enterprise -- a big, global company will buy, you know, a fairly -- it looks like a fairly small purchase of -- an initial implementation, and all of our wins have been like that. And of course, the goal is going to be to recruit more customers, with early implementations, and then watch and work with these customers, to go from a trial or a test site, to 12 sites to 20 sites, to 30 sites, and be able to build a revenue momentum.

A lot of revenue momentum will come from that, because the sales process to sell the two units, is just as big as if they were to buy 20 units, but they're going to start with two, then move to 20. So, that's another piece of knowledge that we have gained that's different than tape, where you can go in and have a multi-million dollar deal with an enterprise customer, because it is a standard, well understood solution. So, that's part of the building process, and it is part of the experience that we see. In fact, we're more and more, talking about how many customers we won. It is almost more important than how many units we sold, because we think that's going to be a precursor to more sales.

I appreciate the help there. Just one last question before I cede the floor. Jon, did you provide commentary on the interest expense on a quarterly basis going forward?

No. I didn't. We have the convert and it its rate is around 4%. It is roughly a $1.5 million per quarter. Then we have the new debt which is LIBOR plus 3.5, which I think is right around 8.75. That's another 8. So, roughly 9 to 10. Per quarter.

Okay, thank you.

Thank you. Our next question comes from the line of Glen Hanus, with Needham and Company. Pleased please go ahead with your question.

Hi, guys. Maybe you could talk about cash flow from operations, you know, that was sharply down this quarter with the account receivable issue, and how that might look going forward, and then maybe, some commentary to get down to the free cash flow line. Thanks.

Sure. So, there is a cash flow statement in the release, and it is the only one during the year that's easy to use because it is just for the first quarter. So, you'll see there receivables were up about $26 million. That, by far and away is the largest -- the largest item. That's in there. So, we think that will get better. You know, we who had an extraordinary quarter last quarter. I can't remember what the cash from operations was but it was huge.

Should we start looking for positive cash from operations?

Yeah.

Going forward?

Yeah. I think you will. I mean clearly, it is nice to start with some higher income. That's one thing. But our balance sheet management this quarter was not as good as the prior. As I mentioned, we had a lot of things going on. and the system conversion. kind of hurt the receivables piece. We'll be generating cash from operations. I can't remember what the free cash flow numbers are for the year. But it is ten-ish million, per quarter.

Ok. And the CapEx and depreciation levels that you had this quarter, is that kind of a good run rate going forward?

Depreciation, yes. CapEx, we still are -- we're really clamped down on that. The bulk of that in there, was Oracle ERP related stuff. We'll have a little bit more in future periods. We also, as we're doing some development, we'll have, you know, some equipment for DXI and the galaxy product. But we're way under -- you know, CapEx for a company of our size.

Plus the some of the changes we made in manufacturing operations, and other, will continue to lower the demand for CapEx.

Would you say that you're done with these -- some of the lower end automation, and device -- you know, you've had some sort of step function declines in that area, maybe that had something to do with the automation number going from 119 to 108, and the device going from 82 to 64. Should that start to -- those trends start to flatten out now, and possibly even improve going forward, or will we have more sort of step functions down, as you exit on profitable things?

That's a good question. We try to address that in the call. Probably I'll just re-emphasize it. On the automation side, we're pretty much there. This quarter. We'll still have some device -- some OEM device business roll-off, going forward. But we really think revenue sort of grows from here, and the growth segments start to, be greater than the step that's declining.

In the royalty area, I understand you had a benefit last quarter. The 24 level. Should we continue to slowly go down from there, or what's the trend there quarterly?

So that this quarter, DOC was down, and we really -- we haven't gotten any pickup from LTO-4 which -- we had a reduction in the amount of the royalty that we get for the other cartridges. So, I think 24 to 25 is probably a good number. If you heard me speak, it is -- we look out over the long-term, it is probably between 20 and 30 and fluctuates in there.

The thing that we all have realized is, we don't really control the royalty. So, you know, we do our best to monitor it, and obviously report it. But it is not something we can influence.

And your operating income target using 10% total for the year. Is that a total for the year number, or you know, key quarter?

That's the total for the year. That means at some point, we've got to get over 10, right?

I would assume your peak quarter would be like in December.

Right. Generally speaking, that's our seasonably strongest. We would expect, we gave a 6% target for this coming quarter. Obviously, we would have to be over 10 in Q3, and probably over in Q4, too, to get to that 10%.

Where was your non-GAAP tax?

Our non-GAAP tax? Expense, you mean?

Yeah.

We had a benefit of about a million. There was --

on a GAAP basis.

On a non-GAAP basis. That's what's so funky about our tax rate. Because we have NOLs, it doesn't matter.

All right, thank you.

Yep.

Thank you. (OPERATOR INSTRUCTIONS). Our next question comes from the line of Dennis [Perry] with Crosslink Capital. Please go ahead with your question.

Hey, guys. Thanks for taking the question. I was hoping you guys could provide a little bit more color around the DXI opportunity. Maybe just a start. Could you possibly describe where you're finding incremental opportunities? Are they with existing customers, new customers, and any other characteristics that you typically find would be helpful.

I would just start with the fundamental value proposition around DXI, is centered around being able to provide the benefits of disk based back-up, which can improve the restore, capabilities. It means that you can basically do restores directly from disk, rather than having to access from tape. It also helps with the actual back-up process, in a lot of customer environments.

So, it is basically a way to enable a customer, to be able to retain multiple terabytes of data, for the cost of disk-based back-up, that starts to make a lot more sense, relative to the cost of tape. So, it is really around the economics of disk-based back-up being greatly improved by virtue of using this de-duplication technology, but the product in this category, is really taking off, and it is very, very attractive to customers primarily because you combine that de-duplication technology with republication, and its Wan optimized.

It is very, very efficient on a network because you're only transmitting over the network, the unique blocks of data, the unique chunks of data from that original back-up. So, what you end up with is a hub and spoke, type of model where you can replace tape, out at the edge, where it is most problematic. It is where the administration costs are high, it's where generally people aren't doing a very good job of protecting that data. So, it is going to improve the ability to provide some kind of back-up on a local basis, in a remote office or branch office. But then you can replicate it, get it off-site for your disaster recovery characteristics, back to a well-managed data center. So, it is really those two characteristics of the product. The de-duplication technology, and the optimized replication, that make this such a powerful value proposition for the customer.

So, in our view, tape will change in its roll. People certainly understand the advantages of disk-based back-up, but prior to de-duplication, it was really something that was used primarily for a short term cash, because of the economics. And now you have the ability of retaining three months, six months, depending on the date of duplication, on disk, before it migrates to tape.

Where we're winning, where we're being successful, is really around the fact that we have a very, very large installed base of customers, that have trusted their back-up systems to us, and so we have those relationships where we can go in, consult with the customer, help introduce how they can use this in their back-up schemes, and how they can architect, basically a better way to handle disk based back-up.

Rick mentioned the statistic earlier that about 25% of our DXI purchases to date, have included at the same time, a tape purchase as well. So, we're selling both disk and tape, at the same time to those customers, and that really understates the impact of, kind of the total solution because we have a number of customers, that we've been able to work with, that when it comes time for upgrade or renewing maintenance on their tape library systems, we can actually work with them to introduce DXI. That's really where we've seen the early adoption.

If I look at kind of specific areas, where we have some very unique characteristics to the product, we really have looked at this, as not a VTL. You kind of think about where the disk-based back-up market really started. It was taking a disk subsystem with serial ATA, and just being able to emulate a virtual-- tape library so you had a virtual tape library.

What our DXI products really do is it basically is a software stack that can present itself as a fiber channel VTL. That's how the interface is set up. It can be set up as an iSCUSI VTL or, just as NAS, a presentation to the back-up of application. That flexibility along with the road map that we've lined up, that's enabled us to win business against, not only the smaller focused players like Data Domain, but also to have a differentiation, relative to Network Appliance, EMC, and the other players in this space.

Ok, thank you.

Let me just add one -- the sweet spot, the perfect circumstance that we have, is we have an installed base customer who we've been talking -- we talk to all the time. Has a budget for $100,000 to buy a big tape library. For us to be able to go in and say, you can buy a smaller tape library and DXI system for $130,000, and because of the power of this concept, it is like we can see people say, go back and get more budget. We couldn't do that very well with tape, because people were always trying to be restrictive about it.

But when you go back with this concept, you know, that's the magic of what we're trying to do, is go into a normal relationship, a tape opportunity, continue to sell tape, and convince the customer to spend more money, by putting disk in front of it, and that's a real plus. Plus for the customer because they get a better solution, and it allows us to expand our footprint in that customer, and of course, expand revenue. There are cases like that. We want of course to do that a lot. Across the globe. In order to make this model work well.

Ok. And what sort of gross margin assumption should we make for the DXI series?

We don't -- we haven't really broken out gross margin. Let me tell you the things we say, and then you can pick your spots in between. Our software is pretty close to 100%. We talk about our automation business branded being 40% OEM, 20%. I can tell you that the DXI product line and disk product line is above 40, and less than 100. So, how about that for guidance?

Ok. Maybe just as an added point of clarification, should we think about it as software-like gross margin?

It is not as high as software, because there is this component of hardware, underneath it. You know, some of our competitors who have sort of pure plays, you can see with their gross margins are. Ours aren't going to be vastly different than that.

Ok. Fair enough. And one last question if I might. Can you provide anymore information on the de-duplication tractions, such as the value of the gross pipeline or the number of pending trials?

I would just say that it is ramping very rapidly. This is a very hot space and if you look at just kind of, that early indications that kind of in terms of interest, in terms of people that have actually started with some type of proof of concept, all of that is going very, very rapidly and that supports the earlier guidance that Jon gave that we're very confident that DXI will be a major revenue contributor to our financials or revenue for this fiscal year.

One thing we've done is we've looked at our revenue traction compared to other major product launches. And this one is about on that same trajectory. What I would say though, is is it is a newer category so the sales cycle, sometimes is a little longer. But I would also say our funnels are quite a bit fuller, and that goes to the point that Rick made earlier, that there's just lots of excitement about this. So, we have lots of opportunities. The goal is to get those closed, and then to get follow on deals, because the power of the product is really in a multiple unit sites, and we have a lot of those customers, but they want to prove the product out first.

Give you one specific example. (Inaudible) Telecom has been a long-time customer of ours for enterprise libraries midrange libraries. They just placed their first order for four units. They'll be quite a few others. They've basically added it to their standard, certified products list. That proof of concept and working through all of the implementation, that was about a nine-month sales cycle. So, it is very, very large customer. There's tremendous opportunity there. The initial order was only for five units.

Ok. Great. Thank you very much, guys. That's been helpful.

Thank you. Our next question comes from the line of Jamie DeYoung with Gruber & Mcbaine Capital Management. Please go ahead.

Thanks for taking my question. Rick, Jon. Just a couple quick questions here. How many new sales hires, did you have in the quarter, and what is the expectation for the year?

During Q1, we added 50 what we call territories, very specific sales organization modules so in other words, there's an outside salesperson, there is an inside salesperson, there is a net territory, the ratios will vary. We've added 50 of those territories in the last couple of quarters. And if you look at kind of where we're heading, we're going to be adding more in Europe, we'll be adding more in Asia, in the U.S., we have done a pretty good job of closing the open wrecks that we had put into the plan.

Ok. And then you talked about the mix, with the branded and the OEM, and I think the branded margin, 40% and the OEM, 20%. Currently at 58% branded. What is your expectation you know, to be at for branded, by the end of the year?

I think, as previously we've said, 60/40 and we haven't got ton 60 yet, so we're going to exceed that though this next quarter. If you look at our plan and that kind of revenue, we're closer to 75% branded. By the time we get to the end of the year.

Ok, great. And then just a follow-up on the DXI, in terms of customer wins, can you give anymore color just on the amount of customers that you seated with just the initial one or twosies types of sales in the quarter.

We're all looking at each other to see if anybody has that number, it is a little bit harder for us, because we're not -- it is not a pure play -- we're not a pure play company in that way. We have lots of orders where we got DXIs and we have tape as well. Probably what we should do is, work that into our -- I think that's something we should talk about next time. Yeah. None of us have the data in front of us. We know some of our competitors, that's one of the things they've been doing. It is a hot, new space. We don't have any data here today to do that though.

Ok. On the data domain call yesterday, they said that they were seeing you in a lot more deals, in the last two months, than they had seen previously as well as EMC on the VMware side. They said, they didn't talk about -- they hadn't seen any pricing pressure and the sales cycle had, I think, you know, had been in this six-month, to nine-month, cycle. Is that kind of the same as what you're seeing?

Yeah, I would just say something on the pricing, I think at this early phase, price isn't so much the issue. The value proposition is so strong, there is only a couple of players that have a product, and it is not price, as much as it is effectiveness, and de-dup ratios, and these other factors. I don't know how long that's going to continue that way. I think it will become more competitive over time. I would agree with that on the -- on the margin perspective. I don't know.

On the competitive side, we clear, as we said in the call, we are -- our ramp has definitely picked up in the last couple of months, as we've gotten through some of theses long sales cycle products. Or challenges, I guess.

But the sales cycle is long and it is -- it has impacted our -- our ramp and when I refer to our sequential growth being less than what we would like, I think a lot of it is sale cycle related. We know all of the things are out there, and we're constantly hounding our sales team, as to when we'll get the deal done. It is largely because the customer is working their way through their infrastructure, how does it fit. What's their policy going to be? Is it -- all of that work takes time. But we think of course it is very valuable, and the margin structure, the business does support, a longer sale -- longer heavier sale cycle.

Great. Thank you.

That will change over time. That's what it is today.

Thank you.

(OPERATOR INSTRUCTIONS). We do have a follow-up question from the line of Mark Moskowitz. Please go ahead with your question.

Thanks for taking the follow-up. I apologize if I missed it. I jumped off for a second. Can you, or have you, talked about server virtualization. Bill mentioned earlier in response to one of my questions. What can be the impact if any on your overall business? Will that be a positive or a negative driver longer term?

I was just mentioning that if you think about what are the hot topics out in the IT end user community, server virtualization, is one of those top of the list hot items. De-duplication, is right behind that, in terms of basically showing interest level, is kind of -- kind of is why they -- why they're interested in talking to us as opposed to talking to somebody who's only selling type libraries for example or other type of disk based back-up. I wasn't really trying to draw a connection between server virtualization, and our products. I was really merely mentioning the fact that these are just very, very hot topics, with respect to what's on the IT, V.P.s and directors infrastructure, types of purchases.

But do you see it having -- let's -- for example, let's just say that server virtualization frees up the purse strings with the IT budgets over time, as folks are able to consolidate some of their server assets, and maybe even increase their patch rate. Does that help in terms of Quantum and others providing, as you referenced de-duplication, does that free up more dollars to go after that type of application?

I think obviously EMC would say that they're trying to capture as many of those dollars as possible. With their VMware offering, for example. The server manufacturers are not just trying to, basically pass it through at no margin site. I think from that standpoint, it is not like it is creating a lot of IT budget dollars, to try to go steal.

I think from a back-up standpoint, which is a little bit different type of sales cycle, and a purchase decision historically, I think Rick gave a really great example of where people really can improve, the protection of their data, as well as the restored characteristics. Their SLAs that might be in place for being able to provide a restore, in the case of a customer that has deleted files, or they want to bring data back. Now you basically improve the operation. You eliminate some of the additional operating costs associated with tape, out at the edge, and people are basically finding additional money to be able to buy these types of DXI solutions. De-duplication replication combined, drives them to look at spending more from a CapEx standpoint, capital purchase stand point, as opposed to operating cost. So, that's probably the biggest driver of, how we're actually able to get more budget, for these types of solutions, and I would say that's less -- that's really not as dependent on server consolidation.

I would say that -- I have felt for the last five years that IT budgets have been driven about spending money to save money. I think virtualization is an example of that.

I think this trend, I think this totally aligns with what we're doing with de-duplication for people to develop a simpler, more manageable infrastructure, you know, to reduce complexity at remote sites, to centralize more data, and to bring the data into a data center, and be able to manage it effectively. There is more emphasis on reducing power consumption, and again that plays into the de-duplication. I really think this trend fits very nicely into, this technology, I should say, fits very nicely into trends that are more macro in nature that exist in storage. And I think that's one reason we've decided to drive the segment so hard.

Thank you.

Thank you. Gentlemen, at this time, we have no further question questions. Please continue.

Ok. Well, thank you for joining us. We look forward to our next call.

Ladies and gentlemen, that does conclude today's conference call. You may now disconnect.