Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Quantum Corporation fourth quarter fiscal 2009 conference call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator instructions) This conference is being recorded today, Wednesday, April 29th of 2009. I would now like to turn the conference over to Shawn Hall, General Counsel. Please go ahead, sir.
Thank you. And good afternoon and welcome to our call. Here with me today are Rick Belluzzo, our CEO; Jon Gacek, our CFO; and Bill Britts, our Executive Vice President for Sales, Marketing and Service. The webcast of this call, our earnings release, and a quantitative reconciliation of any GAAP and non-GAAP financial measures discussed today can be accessed at the Investor Relations section of our website at www.quantum.com and will be archived for one year.
During the course of today’s discussion, we will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements include statements regarding our business prospects, priorities, and opportunities; our future financial performance, including anticipated revenue, gross margin, expenses and income performance and debt covenant compliance; and trends in our business and in the markets in which we compete.
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 the risk factors and cautionary language contained in today’s press release announcing our fiscal Q4 2009 results as well as to our reports filed with the Securities and Exchange Commission from time to time, including our most recent 10-K filed on June 13, 2008 and our most recent 10-Q filed on February 9, 2009.
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’ll turn the call over to Jon Gacek.
Thanks, Shawn. Good afternoon and thank you for joining us. Today, we are reporting our fourth quarter results. As we close out our fiscal year and look forward to fiscal 2010, it is clear that we are in the midst of a tough economic environment that creates uncertainty for all types of businesses. However, we believe we have improved our position in storage market during fiscal 2009.
Our fourth quarter revenue was clearly impacted by the overall macro environment, including sales of our core enterprise and mid-range tape products. However, our disk and software revenue increased significantly year-over-year, and we did a very good job of managing our operating expenses by reducing costs that support our mature tape business and investing wisely in our growing disk and software business.
Here are the key results for the quarter. First, disk systems and software revenue, including related service revenue, was $24.2 million compared to $12.5 million a year ago, an increase of nearly 100%. Second, our non-GAAP gross margin was 40.9% compared to 36.2% for the same quarter last year. Next, our non-GAAP operating profit was 5.8%, including total non-GAAP operating expenses of $59 million, compared to 3.9% and $74 million in the same quarter of last year.
Fourth, non-GAAP net income was $4.2 million or $0.02 per share compared to breakeven for the fourth quarter of last year. Fifth, we generated cash from operations of $38.2 million and EBITDA of $17.5 million. We made our required quarterly principal payment of $1 million on our acquisition debt and our ending cash balance increased to $87.3 million at March 31.
And finally, we obtained a loan commitment of $100 million from EMC and commenced a tender offer to refinance the $135 million of our $160 million convertible debt. In our related note, since quarter-end we obtained an amendment to our senior debt agreement to allow us to complete the refinance of our convertible debt, using equity or by making open market repurchases.
I’d like to refer everyone to the financial statements and supporting schedule, including the press release. If you follow on with those, it will be helpful as I make my comments. With that, I will move to revenue. Revenue for our fourth quarter ended March 31 was $168.1 million compared to $228.9 million a year ago. This is a $61 million decline year-over-year. However, as I walk through the revenue detail numbers, remember that our non-GAAP gross margin is up 470 basis points over the same period a year ago.
Royalty revenue was approximately $16.2 million for Q4 compared to $24.6 million in the same quarter a year ago. The decline was in both DLT and LTO media royalty. The year-over-year DLT royalty decline is consistent with the previous two quarters. However, the reduction in LTO royalty was the result of a decline in unit volume and a decrease in LTO-3 royalty rate that took effect this quarter. We believe the volume decline is due to a combination of macro economic factors as well as a reduction in channel inventory held by distributors.
For the quarter, non-royalty revenue totaled $151.9 million, of which 70% was branded and 30% was OEM. That compares to non-royalty revenue of $204.3 million a year ago, of which 66% was branded and 34% was OEM. Looking further at various revenue classifications, devices in media totaled $28.8 million compared to $58 million in Q4 a year ago. The decline is primarily attributable to our anticipated decrease in OEM device revenue and a $12 million reduction in branded media sales. We continue to manage our media business opportunistically to generate gross profit dollars, not revenue dollars.
Tape automation systems revenue was $61.3 million compared to $93.9 million in Q4 of fiscal ‘08. Just over half of this decline was related to branded products and the remaining portion was related to OEM automation products. The decline in branded automation was primarily related to volume declines across entry, mid-range, and enterprise automation, with international territories accounting for two-thirds of the overall decline.
Disk systems and software product and related service revenue was $24.2 million, up from $12.5 million a year ago. As I mentioned, nearly a 100% increase. Our year-over-year growth was driven by license revenue from EMC, the addition of DXi7500 revenue, and an increase in our StorNext software revenue this quarter. Service revenue declined $1.1 million in Q4 compared to prior fiscal year as a result of a decline in OEM out-of-warranty repair, offset by an increase in service revenue related to our branded products.
Turning to gross margins, non-GAAP gross margin in Q4 was 40.9% compared to 36.2% in the prior period – the prior year, sorry. This improvement was driven by the increase in our disk systems and software revenue and declines in sales of our lower margin tape drive and media products. Our gross margin improvement occurred despite a year-over-year decline of more than $60 million in total revenue, including an $8.4 million decline in the media royalty revenue. The method 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 $59 million compared to $74 million a year earlier. For the quarter, R&D was $16.1 million; sales and marketing was $26.1 million; and G&A expenses were $16.8 million. You can see we’ve made significant progress this quarter in getting our sales and marketing expense more in line with our revenue, particularly our branded revenue.
Moving beyond expenses, non-GAAP operating profit for the quarter was $9.8 million or 5.8% of revenue compared to $8.9 million or 3.9% of revenue in the same quarter a year ago. Net other expense of $500,000 was primarily comprised of foreign exchange losses due to the stronger US dollar during the quarter. Interest expense for the quarter, $5.7 million compared to $9.8 million a year earlier. This included cash interest expense of $5.2 million and amortization of debt issue cost of $500,000.
The coupon interest rate for our remaining acquisition debt of $248 million at March 31 will be approximately 4.91% for the quarter ended June 30. For the fourth quarter, we recognized a net tax benefit of $600,000 related to the release of a tax reserve upon completion of international audit. As you look forward in model, we still believe it’s reasonable to model tax expense of approximately $1 million per quarter of tax expense – $1 million a quarter.
Summing it up for Q4, we had non-GAAP net income of $4 million with non-GAAP EPS of $0.02 compared to non-GAAP EPS that was breakeven in the same quarter last year. Focusing on cash flow for the quarter in the balance sheet at March 31, I wanted to highlight several key points. Cash flow from operation for the quarter was $38.2 million. We paid down $1 million of our ADIC acquisition debt during the quarter, which now totals $248 million.
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. From New Year, we paid down $92 million in total. Non-GAAP EBITDA for the quarter was $17.5 million. We are in compliance with all debt covenants at March 31, and we expect to be in compliance with our debt covenants during the next 12 months. For purposes of calculating our debt covenant, our EBITDA for the last 12 months was $104.6 million – our LTM EBITDA was $104.6 million.
Sequentially, inventory decreased by $5.1 million and accounts receivable decreased $37.4 million during the quarter. We had an accelerated payment of $14 million from one customer. CapEx was $1.1 million. Purchases of service parts for maintenance were approximately $700,000. And depreciation and amortization totaled $17.5 million for the quarter.
As we enter the new fiscal year, we expect Q1 to look a lot like the just completed Q4 in terms of revenue, operating income, net income, and EBITDA. And for the full fiscal year, we expect revenue in the range of $700 million to $750 million; and on a non-GAAP basis, gross margin of 41% to 43%; total operating expenses on a non-GAAP basis from $230 million to $240 million; operating income of 9% to 11%; and EBITDA of $100 million to $120 million.
Now let me turn the call over to Rick.
Thank you, Jon. Our fourth quarter results clearly reflect both the significant challenges in the current economic environment as well as the opportunities that we have to transition the company to a systems model. To start with, as our results reflect, the overall economic environment was very constrained, as we experience weakness across nearly every segment of our business and associated pricing pressure. This included branded product sales to all OEMs and media royalties.
In spite of this, we were able to deliver in line earnings as a result of continued focus on expenses and a solid gross margin, driven by our continued shift to higher gross margin products. In short, given the challenges we faced during the quarter, we are satisfied with our overall performance, especially the $17.5 million in non-GAAP EBITDA and strong cash flow from operations.
Having said that, despite the significant year-over-year growth in disk systems and software revenue, we are still disappointed with our results in this area, where there is clearly opportunity for even greater growth. We were impacted by weakness in the enterprise market and we also lost some momentum due to a product transition.
More specifically, we made both hardware and software enhancements to our DXi7500 platform, which improved our competitive position but negatively impacted DXi7500 sales. The weak enterprise environment also slowed the momentum in building EMC royalties. However, as I said, the deduplication and replication market is clearly still a very fast growing market even in this challenging economic environment.
We believe that in this constrained environment, customers will be more aggressively implementing tiered storage solutions as part of their efforts to lower overall storage costs. As such, this continues to represent a key opportunity for our branded DXi business, our deduplication software sell-through OEMs, and our StorNext products. It is also the reason growing our disk systems and software business is a dominant theme of our priorities for fiscal year ’10.
Looking more broadly at the overall storage purchasing end market, the environment is still not clear. However, we expect some improvement as the year progresses with increasing opportunity and a lessening pressure to push out deals. While FY ’09 was a challenging year, we made significant progress in terms of shifting our business model and taking actions that will allow us to focus on our growth opportunities.
Improvements in our overall business model over the past year can be seen in the following. Our non-GAAP gross margin for fiscal ’09 grew 500 basis points year-over-year to more than 41% as we continued to shift our revenue to higher margin opportunities. Disk systems and software revenue grew from 5.5% of revenue in fiscal ’08 to just under 12% in ’09. Despite this, we clearly still have a lot of work to do in order to grow the segment of the business.
We generated cash from operations of $88 million in fiscal ’09, allowing us to reduce debt and improve our liquidity. We’ve reduced non-GAAP operating expenses throughout the year, as demonstrated by the fact that our Q4 expenses were $59 million compared to $74 million in Q1, a 21% reduction. And finally, all of this allow us to increase our non-GAAP operating income to 8.5% of revenue for FY ’09 compared to 6.9% in ’08. We expect this to further increase as we grow our disk systems and software revenue.
Our tape performance was clearly under pressure in fiscal ’09. However, just to be clear, we intentionally shifted away for pursuing lower margin tape revenues such as tape drive and low-end automation sales through OEMs. In fact, many of the low end tape segments have been under the most market pressure. So we have disinvested in these areas and instead focused on those segments where we are well positioned and can still generate good margins, such as the mid-range where we continue to see opportunity with our Scalar tape library platform.
As we’ve said before, we see a continued but different role for tape as disk increasingly becomes the main target for backup (inaudible) centered around disaster recovery, launch from archive and compliance, and integrated closely with disk. In fact, the recent third-party survey of Quantum DXi customers showed that 80% of the respondents were integrating DXi and tape for a comprehensive data protection strategy.
Regarding our disk systems and software performance in FY ’09, although we were somewhat disappointed in our Q4 results coming of our record third quarter, we continue to take steps to further strengthen our market position. For example, we increased the usable space of our DXi7500 platform by 22% and made a set of software enhancements that provide new functionality for multi-site multi-tier operations. These enhancements offer more replication options for improving data protection and additional choices for direct tape creation from disk, as well as enabling more effective, centralized deduplication.
We also continue to see strong validation from DXi customers. The third-party survey I mentioned earlier showed that 70% of the respondents had reduced their disk backup requirements by at least 85% with the DXi7500. In addition, 45% of the DXi users responded had reduced their backup when they buy at least half. And particularly important in these times of tight budgets, nearly 60% had cut their backup cost by more than 10%, with 25% experiencing cost savings of more than 40%.
On the StorNext side, we finished FY ’09 with continued momentum in its core markets, most notably media and entertainment, the largest and fast growing for us because of the pervasiveness of complex workflows and large archives. Leveraging new partnerships, we have increased StorNext footprint in studios, broadcasters, and post production houses, as well as in the high-performance computing, life sciences, and genomics environment, where we’ve had some recently large wins.
We see increasing opportunity for StorNext’s customers create and retain more and more digital content for purposes of remerchandising it in new and future applications. To capitalizing the opportunities ahead, we have also made a series of significant adjustments in fiscal ’09. These include investing more R&D in disk systems and software versus our tape offering and further refining our product roadmaps.
In addition, we changed our go-to-market model to focus more on gaining greater leverage through our partners and doing a better job of expanding our opportunities with lower cost. As a result of these actions, we are now completely focused on product execution and gaining market momentum. These are the critical items that will allow us to extend the business model transition and further improve our operating results.
For fiscal year ’10, we have four key objectives. First, we will put greater emphasis on articulating and communicating our edge-to-core vision of protecting and managing data from the edge of the network to the core of the data center, embracing backup recovery and archive solutions.
This vision includes our ability to deliver a single scalable disk-based architecture with deduplication and replication that can scale for protecting and managing a terabyte of data and remote office to more than 200 terabyte at a data center, and is also compatible with solutions from multiple vendors such as EMC. This vision also includes tight integration with tape for disaster recovery, long-term archive and compliance, as well as centralized management and secure data transfers across the environment.
A second objective is to build our edge-to-core offerings over the next year through product enhancements and new products and solutions. As I mentioned earlier, we feel that our product roadmaps are very well defined. So the focus now is on executing on these roadmaps.
In the coming year, we will have two major DXi software releases and a new hardware platform that will further improve our competitive position. We will also have a significant new StorNext release and expand our management and security offerings. Finally, we will expand the competitiveness of our tape product line through both enhancements and new products. All of these actions are central to capitalizing on our opportunities and expanding our revenue.
Third, as I said, we have made a series of changes in our go-to-market model. These have been implemented, and now the focus will be on executing to improve our alignment and leverage with our channel partners, generate more lease and cover more opportunity, and become more aggressive in driving our overall market message. Although we have reduced our sales and marketing expenses over the last two quarters, we feel confident that the model will allow us to meet our revenue goals with the reduced level of spending.
Our final major priority for fiscal year ’10 is to execute on our capital structure work to address our convertible debt maturing next year and lower our overall debt level. These actions are underway and Jon will provide an update on our progress here in just a minute.
In summary, fiscal ’09 was a mixed year. The environment became increasingly sour as the year progressed. This had a significant impact on our performance that we were aggressive in reducing our cost to deliver improved operating income and EBITDA results. Also during the year we implemented a number of actions that position us well for fiscal ’10, even in the continued challenging macroeconomic environment. Our focus is to be aggressive in executing on our very limited set of priorities to make major progress on our company transition.
With that, let me turn the call back to Jon to provide an update on our financing activities. Jon?
Thanks. As I previously mentioned, during the quarter we obtained a $100 million loan commitment from EMC and launched a tender offer to refinance $135 million of our $160 million convertible debt. And subsequent to quarter-end, we amended our senior debt agreement. I want to take a minute to update everyone on the status of the bank amendment and the tender offer.
Last week we finalized the bank amendment, which received greater than 90% approval from our senior lenders. The key points of the amendment were as follows. We agreed to pay down $40 million of our senior debt immediately, which we did last week. $20 million of the paydown was funded with our cash and the remaining $20 million was funded with a prepayment of future license fees from an OEM partner.
In addition, we agreed to pay down an additional $20 million of senior debt upon completing the refinancing of at least $135 million of our convertible notes. This payment will also be funded by a prepayment of future license fees from the same OEM partner. Once the $135 million of our convert is refinanced, we now have the ability to retire the remaining $25 million with either open market repurchase with our operating cash or by issuing equity, neither of which were possible before the amendment. We believe this increased flexibility provided by the amendment is important to us completing the refinancing of our subordinated debt.
Yesterday, we amended our tender offer to increase the price to $0.74. At this amount, we would use all $100 million borrowed from EMC to refinance $135 million of the convertible debt. Tender offer is scheduled to close on May 12. And if you are interested in more detail, the Schedule TO filed with the SEC lays out the significant terms and conditions of both the tender offer and the EMC commitment.
With that, we will open it up for questions. Operator, we are ready for questions.
Thank you, sir. (Operator instructions) The first question comes from the line of Brian Freed with Morgan Keegan. Please go ahead.
Brian Freed – Morgan Keegan
Good afternoon. Thanks for taking my call. With respect to the prepayment from the OEM, how does this get recognized this revenue in terms of your timing? And also how do you account for this in the balance sheet? Is it going to be a short-term or a long-term liability? And then secondly, as you kind of look at that in terms of your OEM opportunities, can you give any color on the Dell relationship?
Let’s start with the prepayment. The prepayment accounting is not any different than, say, a service contract. So we recorded an increase in cash and then we defer the revenue. And then when that revenue is earned, we will reduce the deferred revenue and recognize the license fee revenue. So the $20 million that has been funded to date will be recorded as deferred revenue and it will be a current liability, if you will – or current liability section of the balance sheet. And then when and if the $135 million gets refinanced and the next $20 million is paid, we will do the same thing. It will be a current liability.
As far as Dell goes, Brian, you’ve known us for a long time, we don’t talk about our OEMs and their launch plans. Dell made the announcement on what they intended to do. I can say two things. We are working with Dell on our deduplication technology. When they are going to launch a Dell branded product? I can’t say. They do sell Quantum-branded and EMC-branded through their S&P group. And then as I mentioned on the last call, we haven’t built any Dell revenue into our 2010 plans, similar to what we did last year with EMC where we built no EMC revenue into our 2009 plan. So we are going to walk away for Dell, and that will be their announcement when they make one.
And I would just add to it, Brian, that, as you know, our strategy is what we talk about edge-to-core. We believe that this open replication environment is really important. So, having the ability to share information from multiple vendor products, different hardware with the same software, we think, is significant in the industry. And so we will continue to strive to make our software work in different ways in different environments in order to continue to expand the notion that having some level of openness and compatibility is very much what customers are looking for in this environment.
Brian Freed – Morgan Keegan
Okay. And then one other question with respect to OpEx. You guys had some pretty big expense reduction initiatives over the last couple quarters. In terms of G&A, it was up sequentially, actually that may be down a little bit. Was that more – was that (inaudible) related or can you talk a little bit about what drove that?
We are kind of at the point where we will have some one-offs from time to time. I think last quarter we had a couple of benefits and this quarter we had a couple of things go the other way, nothing of help here [ph]. Major crisis certainly is a piece of it. We had sales tax type of credit the quarter before. So I think what you will see is – I’m going to expand your question a little bit. We had a fairly straight decline or a decline in our OpEx generally. I think if you take the guidance that we gave, you can see that band of OpEx. We expect to be quite a bit tighter as we move throughout fiscal 2010.
Brian Freed – Morgan Keegan
Okay. And one final one before I exit the floor, you guys announced some enhancements to the DXi platform in the quarter. What’s been the uptick on those? Are you pretty much through getting that pushed out to your installed base?
Very positive response. I mean, I think you’ve heard earlier Rick describe of the advantages of the new software that was released, the 1.1.1 release with improved replication performance, the ability to basically provide that edge-to-core solution that we talked about earlier. But that is obviously an important part of our strategy. It’s to be able to get that out to our installed base as well as to the new customer accounts.
And EMC installed base and EMC customer accounts, they also are putting that technology up.
Brian Freed – Morgan Keegan
Thank you. (Operator instructions) And there are no further questions in the queue. I would like to turn the call back to management for any closing remarks.
Well, again I’d like to thank you for joining us today. I think that the emphasis that you heard in the call is that it’s very much about getting through ’09 making a lot of changes in the company, pursuing our strategy, shifting our revenue stream, improving gross margin, bringing expenses down, product roadmaps. There is a variety of things we really felt that ’09 was a very, very active year. And as we entered ’10, we are pretty clear that the priorities that I presented here today are very much around a common set of things to grow revenue.
We think our business model was demonstrated last quarter that this can be a very solidly profitable business. There is a lot of cash generation potential. But we really need to focus on building revenue with our new model, with new products focused on tape of course, but as well aggressively on our disk systems and software business. And doing that along with continuing to improve our capital structure, we think it’s really what positions the company well that allows us to get through this transition that we’ve been pursuing after several years. So, thank you for joining us. And we look forward updating you again on the next quarter.
Thank you. Ladies and gentlemen, this concludes the Quantum Corporation fourth quarter fiscal 2009 conference call. If you would like to listen to a replay of today’s conference, please dial 303-590-3000 or you can dial 1-800-405-2236 and enter access code 11130098 followed by the pound sign. AT&T would like to thank you for your participation. You may now disconnect.
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