Quantum Corp (QMCO) 2009 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, welcome to the third quarter fiscal 2009 teleconference conference call. (Operator Instructions). Following the presentation the conference will be open for questions. (Operator Instructions). This conference is being recorded today, Thursday January 29th, 2009. I would now like to turn the conference over to Shawn Hall, General Counsel. Please go ahead.

Thanks. Good afternoon, and welcome.

Here with me are Rick Belluzzo, CEO, Jon Gacek, CFO, and Bill Britts, Executive Vice President of Worldwide Sales, Marketing and Service. The webcast for 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 Securities Litigation Reform Act of 1995. The forward-looking statements include our business prospects, priorities, performance and opportunities including our anticipated fiscal fourth quarter financial results, trends in the markets in which we compete, the expected timing of new product launches and our expectations regarding future debt covenant compliance and estimated third quarter good will impairment charge. 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 you to risk factors and cautionary language contained in the reports filed with the SEC from time to time, including our most recent 10-K filed on June 13th, 2008 and our 10Q filed November 7th, 2008. Such reports contain and identify important factors that could cause actual results to differ materially from those contained in our forward-looking statements. All such risk factors identified in our press release and in our filings with the SEC are incorporated by reference into today's discussion. We undertake no obligation to update these forward-looking statements in the future.

With that I will turn the call over to Jon Gacek.

Thanks, Shawn.

Good afternoon and thank you for joining us. Today we are reporting our results for the third quarter of fiscal 2009. This quarter's financial results are the most important that Quantum has reported since the acquisition of ADIC. Results include the highest non-GAAP gross margin, operating profit, and earnings levels in 8 years, achieved in a very tough economic environment. These results demonstrate we are on the right strategic path. The company has unique market opportunity and we have the ability to create significant value for shareholders. At the same time our third quarter results included initial estimated non-cash impairment charge to Quantum's good will that was triggered by the significant decline in our stock price due to economic climate and our capital structure. The irony of it is, these events happened in the same quarterly period.

Here are the key financial results for the quarter. First, disk systems and software revenue, including related service revenue, was $31.3 million compared to $15.5 million a year ago, an increase of 100%. Second, our non-GAAP gross margin was 44.9%, compared to 37.7% for the same quarter last year. Third, our non-GAAP operating profit was 15.3%, including total non-GAAP operating expenses of approximately $60 million, compared to 9.9% and $70 million in the same quarter last year. Fourth, we generated cash from operations of $19.3 million, an EBITDA of $40.6 million, we made our regularly required quarterly payment of $1 million on our acquisition debt, and our ending cash balance increased to $51.2 million at December 31st.

We also reduced head count and expense during the quarter and as a result, incurred a restructuring charge of $4.1 million, and finally, we recorded a initial estimated good will impairment charge of $350 million against our approximately $390 million of good will. I would like to refer everyone to the financial states and supporting schedule included in the press release that will be helpful for you to refer to those documents as I make my comments.

I'm going to start with the good will impairment charge. As required by GAAP, during the quarter we performed analysis of fair value, and concluded its likely that the fair value of our good will is lower than its carrying value based on a combination of factors including the current economic environment, and its impact on our business and the continued stock market decline which has affected our trading price. Therefore, we are now conducting a detailed impairment analysis of our good will in accordance with FASB standard 142, and as of December 31, 2008, prior to the impact of this non-cash impairment charge our good will was approximately $390 million. Our initial estimated impairment which is included in a separate line in our operating expenses is $350 million.

It's important to note that while this charge is required by GAAP it does not impact our cash balances, our liquidity, our ability to generate cash flow from operations going forward, or our debt covenants. We expect the amount of the impairment charge to be finalized between now and the filing our form 10Q with the SEC which we expect to occur no later than February 9th, 2009. As a result the amount recorded in our form 10Q may differ from the estimate we have recorded to date. Please note that the $350 million impairment charge is excluded from the non-GAAP results which I describe through the rest of the earnings call.

With that, I'll move to revenue.

Revenue for the third quarter ended the December 31, was $203.7 million compared to $252.5 million a year ago. Royalty revenue was approximately $19 million for Q3, compared to $26.8 million, in the same quarter a year ago. The decline is primarily attributable to the decline in the DLT media royalty. Our Q3 royalty revenue did not include amounts related to our intellectual property from our disk and software patents, as it did in prior quarters' results.

For the quarter, non-royalty revenue totaled $184.6 million, of which 65% was branded and 35% was OEM. That compares to non-royalty revenue of $225.8 million a year ago, of which 62% was branded and 38% was OEM.

Looking further at various revenue classifications devices and media totaled $29.7 million compared to $58.2 million in Q3 a year ago. The decline primarily attributable to our anticipated decrease in OEM device revenue and a $11.4 million decline in branded media. We continue to manage our media business opportunistically to generate gross profit dollars. This quarter's media market pricing resulted in a pulling back on media revenue opportunities.

Tape automations systems revenue $85 million compared to $112.8 million in Q3 of fiscal 08. Two-thirds of the decline related to OEM products and one-third was related to branded automation. The decline in branded automation was primarily related to declines in volumes across entry, mid-range and enterprise automation in Amia, compared to the same quarter last year where we had a very strong quarter.

This systems and software product and related service revenue was $31.3 million, up from $15.5 million a year ago, a 100% increase. Our year-over-year growth was largely driven by license revenue from EMC, and the addition of the DXi7500 to our product portfolio.

Turning to gross margins, non-GAAP gross margin in Q3 was 44.9%. I'm actually going to repeat that because it sounds so good. 44.9% compared to 37.7% in the prior period. This improvement is driven by the increase in our disk system and software revenue, an increase in branded service revenue, declines in our lower margin tape drive and media products and reduction in manufacturing expenses and product costs. Our gross margin improvement occurred despite a year-over-year decline of $50 million in total revenue, including $7.7 million decline in media royalty revenue.

The message here is we have made significant progress in improving the mix of our revenue towards higher margin, higher value products and we have reduced our overall manufacturing costs as well.

Moving to expenses, non-GAAP operating expense totaled $60.2 million, compared to $70.2 million a year earlier. For the quarter, R&D was $15.4 million, sales and marketing was $29.2, and general and administrative expenses were $15.7 million. The significant changes here relate to head count reductions and associated employee costs, decreases in travel expenditure, and lower marketing and R&D project spend. In addition, we closed our North American facilities Thanksgiving week and the week between Christmas and New Years.

Moving beyond expenses, non-GAAP operating profit for the quarter was $31.3 million or 15.3% of revenue, compared to $25 million, or 9.9% of revenue in the same quarter a year ago. This is an exceptional result and shows both the power of our model and the opportunity the company has to create value. Net other expense of $600,000, was primarily comprised of a non-cash charge related to our interest rate caller, which we are required to mark to market each quarter and that is required by our debt agreement.

Interest expense for the quarter was $7.3 million compared to $11 million a year earlier, this included cash interest expense of $6.8 million amortization of debt issue cost of $500,000. The coupon interest rate for our remaining acquisition debt of $249 million at December 31, will be approximately 4.958%, approximately 4.958%, for the quarter ending March 31 under five percent.

For the quarter we recognized a net tax benefit of $2.3 million related to the release of a tax reserve involving the expiration of a statute of limitations of a tax position taken in a prior year. However we still believe, for those who do models, it's reasonable to model $1 million per quarter of tax expense.

Summing it up for Q3 we had non-GAAP income of $25.6 million, with non-GAAP EPS of $0.12, compared to non-GAAP income of $13.8 million, and non-GAAP EPS of $0.07 in Q3 of fiscal 08.

Focusing on cash flow for the quarter and the balance sheet at December 31, I want to highlight several key points. Cash flows from operations for the quarter $19.3 million. We paid down $1 million of our ADIC acquisition related debt during the quarter, which totaled $249 million at the end of the period. As we stated at the beginning of the year, we intended to aggressively pay down our debt in the first two fiscal quarters to ensure covenant compliance until our EBITDA improved. We now have paid down $91 million during the first nine months of fiscal 2009.

Non-GAAP EBITDA for the quarter was $40.6 million. We are in compliance with all debt covenants at December 31 and expect to be in compliance with the debt covenants during the next 12 months.

For the purpose of calculating our debt covenants for EBITDA for the last twelve months was $106.7 million. Sequentially, inventory decreased $10.9 million, and the accounts receivable decreased $2.8 million. We had an accelerated payment of $14.6 million from one customer. CapEx was $1.3 million, purchases of service parts for maintenance or approximately $1.2 million, and depreciation and amortization totaled $17.8 million for the quarter.

Looking forward, for the fourth quarter, we've taken in to account both seasonality, and the macroeconomic environment and our plan anticipates a sequential decline in branded and revenue and a slight increase in expenses. Specifically in Q4, we expect revenue of $175 to $195 million, non-GAAP gross margins of approximately 40% to 42%, non-GAAP OpEx between $60 million and $63 million, and non-GAAP operating income of $10 million to $20 million.

With that, let me turn the call over to Rick.

Well, thank you, John.

We were very pleased with our Q3 performance, especially in terms of our progress on our key strategic priority. That is transitioning Quantum and our business model from a device centric to a more system centric focus. This has included shifting our revenue content to a mix that favors higher gross margin businesses with a primary focus on our branded business and disk systems and software business.

In addition to shifting our revenue, we aggressively aligned investments around new opportunities in these areas, while reducing investments in some other more mature parts of our overall business. All of these actions are key to improving the value of Quantum in terms of profitability and our market position.

In Q3, several elements our results point to the effectiveness of our strategic focus. Our record non-GAAP gross margin of 44.9% represents an increase of more than 13% from the combined Quantum and ADIC level when we merged the companies 2.5 years ago. The 100% year-over-year growth in disk systems and software reflect the progress we are making in building this business through both our branded sales efforts and OEM partnerships. Next, the 14% year-over-year reduction in our non-GAAP operating expenses is a result of the aggressive work we have been doing over the last six months to reduce spending and to improve our operating performance while ensuring that we can continue to deliver on our strategic opportunity. All of this contributes to our non-GAAP operating profit of 15.3%, and the $41 million in EBITDA that we delivered, even in the face of a clearly challenging macroeconomic environment.

It's also worth noting that if we had not taken the good will impairment charge our GAAP net profit would have been the highest it's been in four years..

In summary, we are very pleased with our operating results. But at the same time we recognize there are still a few critical areas that require focus in order to improve our execution or capitalize ore affectively on our opportunities.

The first of those is the return on investment from branded sales and marketing effort. With EMC and Dell licensing our duplication and replication software we must do a better job aligning our efforts to drive our branded DXi sales, with the support that we will provide to these partners in selling products with our technology. Because we have not been sufficiently aligned in these areas, we have seen a somewhat weaker disk revenue and certainly higher costs than should be the case. Fixing this is a primary focus as we work to capitalize on our large installed base OEM partnerships and channel relationships. To improve here, we will need to more effectively align our product portfolio, our sales model, and our marketing programs.

Next, we have an exciting opportunity in the deduplication replication market. We are a leader in the early phases of this market and have strong OEM partners in Dell and EMC. However, the market is evolving at a very fast pace, and therefore we must also move quickly to take full advantage of this opportunity. This means continuing to enhance our technology and product offerings and accelerating time to market while still managing our overall investment levels. And then finally, we must continue to work on our overall OpEx reduction. The current environment is very challenging, and we need to make sure that we drive our competitiveness in all aspects of the business. And as I said in previous earnings calls, and what we demonstrated in Q3,is that we are confident that we can continue to reduce our expense levels while still delivering on our strategic priorities.

Now, let me say a few words about the market. The overall IT market is clearly tightened over the last six months. Storage has not been immune, although activity levels have not weakened as much as one would think. In particular, the market deduplication replication continues to show momentum and back up redesign remains a high priority according to many IT surveys. In general, however, deals do take longer to close, channel partners have been reducing inventory levels, and pricing is clearly more aggressive. We expect to market to remain challenging through calendar year 09.

Quantum's position in the deduplication replication market is clearly getting stronger. Our software platform is currently shipping in Quantum-branded products and in EMC disk libraries. In the first half of this year, Dell will also offer storage systems with this software enabling replication compatibility across products from all three suppliers. This will further enhance our market presence, continue higher margin license revenue, and begin to establish an ecosystem to deliver on our extended edge to core strategy of providing multi-site, multi-tier data protection. As a result of our partnerships with Dell and EMC, and continued momentum in our branded DXi business, we expect deployments of our deduplication replication software will surpass those of the market leader this calendar year.

For the recently completed quarter, we introduced a Quantum DXi7500 Express Deduplication Appliance, optimized for small and medium sized enterprise environments and QuickFit configuration program designed to make it easier for channel partners to size, order, and install Quantum deduplication solutions. Although it only shipped for less than half of the quarter, the DXi7500 Express showed strong sales over this period reinforcing the adoption of our deduplication and replication technology. Based on shipments through the December quarter, this technology is being used now to protect for than 400 petabytes of data.

We are continuing to build on this momentum as as illustrated by the hardware and software enhancements to the DXi7500 announced earlier this week. Besides increasing usable capacity by 22% we provided more granular replication capabilities, expanded the range of options for direct tape creation from disk, and added support for a number of ISV applications. Also this week the DXi7500 was named as a finalist in the backup hardware category for the Storage magazine SearchStorage.com 2008 Product of the Year awards that will announced in February.

While all this speaks to our progress and future opportunity, we clearly face a significant amount of pressure as a result of the tightening credit markets. We believe that this factor has put the most significant pressure on our stock price, and we obviously need to address this risk factor aggressively. We have worked on four approaches to the problem.

First, we have been focused on raising a level of EBITDA to avoid any debt covenant issues and improve the financing capacity of the company. Second, we have taken the cash generated and used it to reduce our debt significantly. But starting this quarter, Q3, we have transitioned to holding more cash, in order to give us further flexibility. Third we are monitoring the debt markets and will pursue viable options to refinance as they develop. There is some progress here but the overall market remains very constrained. Finally we are exploring a range of strategic options ranging from strategic investments, asset sales and other solutions.

It will take some combination of these efforts to transition into a more desirable capital structure. The key principle is that we must continue to make the business more valuable in terms of both profitability, and market position. And as I said, we believe we are making notable progress in both of these areas.

In summary Q3 was a good quarter in terms of driving stronger operational performance. In the coming quarters we will work to make significant progress on our three execution priorities, improving the return of our branded sales and marketing investments, continuing to enhance our technology and product offering while accelerating time to market, and finally continuing to drive further OpEx reduction. At the same time we have a very strong sense of urgency to make fundamental improvement in our capital structure.

Again, thank you for joining us, and let me turn the call over to the operator for questions. Operator?

Thank you, we will now begin the question and answer session. (Operator Instructions). Our first question is from the line of Brian Freed with Morgan Keegan. Please go ahead.

Hey, guys, great quarter, congratulations. Been a long time coming. Anyway, real quick on your, the deduplication side of things, can you give us anymore color into the mix between the branded DXi product and the EMC royalty contribution in the quarter?

No. But both were up.

Okay.

Again, our position there, Brian knows this well, we don't want to talk about our partners' products so we are not going to break those out separately, both are up and we both are having success in the marketplace.

Okay, and as you guys talk about your go forward strategy and leveraging more from your branded sales force, does that to some extent imply a more singular focus on the midrange to avoid channel conflict, with, say, EMC, and then with Dell forthcoming, being into the low end fulfilling solution for deduplication?

Yes, Brian, it actually, if you look at the results with our 7500 Express we've got a pre-configured, very purpose targeted product implementation that's really built around our channel partner relationships and being able to leverage those. So it really takes advantage of our historical success in the open systems kind of mid range and up to the low end of the enterprise.

Okay, great. And than lastly, I might have missed it in the details, but did you give the percentage of the DXi that had the right to tape function enabled?

We didn't actually. I'm looking over to see if we have it. I don't have it handy, if we get it, we'll answer it after another question.

Do you have the sense it's changes materially?

I'm looking at Brad. I don't think we know right now.

I would just add to this whole process, as we have been pursuing this market there is no doubt this deduplication replication trend is probably one of the most significant if not the most significant storage trend that's underway. And we entered the market with our platform, with our product, and as opportunity developed we added EMC recently, Dell, that's evolved into this perspective that we have an opportunity to partner and to build the ecosystem where we have multiple suppliers with replication compatibility, and that leads us to getting more focused in places where we can deliver more value, which is more what we call the low-enterprise, mid-range part of the market.

Today we are not fully aligned there. We have more work to do to get our sales force channelled, marketing program and product I would say as well, all aligned around that opportunity. And we're pretty aggressively focused on that and we believe we need to do that in order to optimize our results. And today we are not exactly where we need to be.

I often tell our team it's like a kid's soccer team where there's great opportunity. Everyone's after the ball, and we're kind of bunched up on the field. We've got to spread it out, play our position, and I think we'll get a lot better results in the marketplace with a lot lower costs.

Great, thanks.

(Operator Instructions). Our next question is from the line of James Basch, with Dialectic. Please go ahead.

Hey, guys. That was really good execution in the December quarter. As far as March goes, revenues projected to be sequentially down, which is more than understandable in this environment. The question more is on operating expenses, I think you mentioned, Jon, that the expenses will be slightly up this quarter. Why is that the case? And then I have a follow up question.

Sure, so there is a couple of one time events like the two plant shut downs in Q4 that won't replicate or repeat excuse me. And then this quarter is also has two sort of high end expense items where you start having FICA again, and then sales guy in their accelerator mode. So, we have those factored in. We're going to continue to look at reductions but from a guidance perspective, we're looking at from run rate to the things that were one time in nature on both sides.

Okay. And then the follow up is, you guys have stated before, I think in previous conferences and publicly, that in terms of looking at convenance that March would be the toughest covenant quarter to get through and then things should get easier after that, so it's nice to see the large EBITDA number in the December quarter. Can you talk a little bit more about why you feel that's the case? As March should be the hardest hurdle to jump over and then it should get easier.

Yes, so, I guess I'm going to revise that today with that comment. March doesn't look as hard as it looked going in to Q3. And not that we're only going to clear the bar but the number is we roughly need to do $6 million of EBITDA in Q4 to meet the March covenant and our plan is to do a lot more than that.

So now it's sort of because this quarter was so strong, we're not really that worried about March. I don't want to say we are not worried , because we're going to operate right, I don't want to give the wrong impression, but it's gotten a lot easier in Q4.

Then in beginning in Q1, last year that quarter was just a very weak quarter I think number was around $18 million, we had a poor quarter, and we've got these ramping good things going on inside our business, our DXi, EMC's DL3D products and then Dell comes on line as well. Within all of that, all the rest of the changes that we're doing in the business. So we really feel like our execution is improving and our opportunities are more clear the farther out

Right. Alright, thanks again, and good luck.

Thank you.

Thank you, our next question is from Jason Bernstein, with Quattro. Please go ahead.

Hi guys, great quarter. Just two things.

Operator?

(Operator Instructions). Our next question is from the line of Steven Baughman with Divisor Capital, please go ahead.

Afternoon guys, congratulations on getting to the turn around here, it's nice to see. Just on, you may have mentioned it but if you did I missed it, when you were talking about the March quarter, do you think disk and software can grow off of the strong performance that you put up in December?

It's hard, seasonally, the quarter is generally down, so we've tried to model it that way. But as I look around the table we feel a lot of momentum. So we've tried to model it conservatively for the obvious reason, but it's hard to predict how the macroeconomic environment is going to impact us. But, having said that, we are getting a lot of traction, we think our partner is getting traction, and we feel good about it. So the answer is maybe, but we're not modeling it that way.

Got it. And, Jon, just to stick on that line, is it possible for you to characterize the gross margin in disk and software compared to the other segments of the business or the corporate average?

Sure. I would say, I would give you the pieces. Our pure software business, the store and that stuff, it's close to 95%, the disk products, are in the 60% to 70%, and then the license we get from EMC and from when we get it from Dell that's 100% because we don't ship any hardware. So, really, it pushes it up pretty high.

Yes, probably 70% to 80% on a blended basis.

Or higher.

And, then, Jon, just talking about the EBITDA convenance, do you have handy the March number that now you're going to anniversary from last year? What you guys did in March EBITDA for covenant purposes?

Oh, yes, you mean for the period?

Correct.

The March period last year was -- I'm sorry, I actually don't have it. I thought it had it in front of me. I'm going to get it from somebody else, hold on a sec. It was 19.5%.

19.5%, okay. So you're going in to this quarter with almost 87% of EBITDA that whatever you do in March is going to add to.

I probably made the number too high, I think we have to get to 91% based upon the current debt amount. That's why I said, a quarter ago, this looked really hard with the step-down but given such a strong period, it really makes it look out farther off my skis, to run with a sports analogy,.

Okay, got it. And then, just a final question, Rick, when you were talking about what you guys were focused on to deal with the crisis in the credit markets, I think your last initiative was talking about looking at strategic options. Have you guys, or has the Board formally hired an investment bank to help you with that evaluation?

That was a bit of a broad phrase that included a lot of thinking about how we work with our partners in terms of potential investments, it includes other pieces of the business that we can monetize on our business moving forward. I wouldn't interpret that to say the company is for sale. That wasn't the intent of that statement. There are many options, we feel that finding the right solution to the capital structure is very very important and we think doing that of course ultimately the most important thing we are doing in this environment, but we also recognize underlying that is improving EBITDA, improving the value of the business. And that those options then become available, our IP portfolio, we have many things to work with that we're looking at everything possible in order to make sure that we have the best set of option available to us.

Great I understand more clearly now. Thank you very much and congratulations again.

Thank you.

Our next question is from Jason Bernstein with Quattro. Please go ahead.

Okay, let's see if we can make this work. Congratulations on a great quarter. I just had a question, was the River Bed settlement included in the cash number this quarter?

The cash was included, yes.

It was, okay.

Yes, we collected that this quarter.

And what was the D and A number again?

17, 17 something, hold on. 17.8%

17.8%. Okay, great, thank you.

(Operator Instructions). Our next question is from the line of Chris Cook with Zazove. Please go ahead.

Hi, thank you for taking my question. I may have missed this, what are your expectations for CapEx, for Q4 and going on in to fiscal 2010?

We have been, if you look at the last three or four quarters, we're below $4 million, normal, I'd say, it's about $4 million, but we're really into the business is fairly mature and we really have that clamped pretty far down. So you could put $3 million or $4 million in and you'd be conservative.

And your expectations are that that would continue in to fiscal 10.

It means, like this quarter was $2.5 million. Last quarter it was $1.5 million. It's kind of a. I'll call it a burn rate if you will. We include in that our service parts that we use for maintaining our products. That's half of it. So that's a little bit different than some people.

Thanks.

(Operator Instructions). I'm showing no further questions at this time, please continue.

Thank you for your questions, and thank you for joining us today. I just want to close by reiterating what I said before we started the q-and-a, that we feel very good about the results that we delivered this last quarter, and we really believe in the opportunity we have to extend this progress. At the same time, we know there are a number of very critical areas that we have to take action on, while we're in a tough economic environment we still do believe that we have many opportunities to improve execution in order to capitalize on the opportunities that we have before us. I think we laid those out during this call. And you can be sure that our primary focus over the next few quarters are addressing those areas so that we can continue the momentum that we delivered in our third quarter. Again, thanks for joining us, and we look forward to talking to you on the next call.

Ladies and gentlemen, this concludes the third quarter fiscal 2009 teleconference you may now disconnect,