Quantum's CEO Discusses Q2 2012 Results - Earnings Call Transcript

| About: Quantum Corporation (QTM)

Quantum (NYSE:QTM)

Q2 2012 Earnings Call

October 27, 2011 5:00 pm ET


Shawn D. Hall - Senior Vice President, General Counsel and Secretary

Linda M. Breard - Chief Financial Officer, Chief Accounting Officer, Senior Vice President of Finance, IT and Facilities

Jon W. Gacek - Chief Executive Officer, President, Chief Operating Officer and Director


Brian Freed - Wunderlich Securities Inc., Research Division

Eric Martinuzzi - Craig-Hallum Capital Group LLC, Research Division

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

Shebly Seyrafi - FBN Securities, Inc., Research Division


Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Quantum Corporation's Second Quarter 2012 Conference Call. [Operator Instructions] This conference is being recorded today, Thursday, October 27 of 2011. And I'd now like to turn the conference over to General Counsel, Mr. Shawn Hall. Please go ahead.

Shawn D. Hall

Thank you. Here with me today are Jon Gacek, our CEO; and Linda Breard, our CFO. 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 strategy, opportunities and priorities, anticipated product launches and plans, and future financial performance. 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, 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 14, 2011 and 10-Q filed on August 9, 2011. These risk factors are incorporated by reference into today's discussion, and we undertake no obligation to update them in the future.

With that, I'll turn the call over to Jon Gacek.

Jon W. Gacek

Thanks, Shawn. Thank you for joining us today as we report our second quarter results. For today's call, I'm going to start with a summary of this quarter's business highlights including revenue results and product launches. Linda will provide more financial color and detailed results for the quarter, and then I will come back to discuss our view on the macro environment and provide Q3 guidance.

One of the key results this quarter is branded revenue growth. Our branded revenue was up 4% year-over-year and 11% sequentially. This was the eighth consecutive quarter of year-over-year branded revenue growth.

Branded revenue represented 82% of our overall product and service revenue for the quarter, which is the highest since the merger of Quantum and ADIC. Overall, we have strength in our data protection products, which include our Scalar tape products, devices and media, DXi, deduplication solutions, vmPRO, appliances for virtual environments and virtual data protection software, which we acquired through our acquisition of Pancetera and have rebranded as vmPRO software.

We also had strong quarter with our big data management and archive products, which includes StorNext software and our recently released StorNext appliances. At a macro level, we were very strong in Asia and the federal government space, and we saw a sequential revenue improvement in Europe and in the rest of North America.

We also had significant improvement in 2 metrics related to the channel, which is important because the -- growing the independent channel is one of our key initiatives for driving branded revenue growth.

First, total revenue from our top-tier partners increased 110% sequentially, driven by DXi revenue, which was up nearly 165% sequentially and Tape revenue, which increased 60% from the prior quarter. Second, we had a sequential increase of nearly 40% in the number of channel partners who sold DXi this quarter. In both cases, the July launch of the DXi6701 clearly had a positive impact.

Now, I will drill down a little deeper on our revenue performance by major product category. Disk systems and software and related maintenance, which includes our DXi, vmPRO appliance and Pancetera Software from our data protection group, as well as our StorNext software and our StorNext appliances from our big data management and archive group, was $300 -- I'm sorry, $36 million, I'm thinking head, $36 million for the quarter. This product category grew 17% year-over-year and 30% sequentially driven by DXi and the rebound in our StorNext software sales from the prior quarter and the launch of our StorNext appliances.

DXi6701/02 is based on our DXi 2.0 software, scales from 8 to 80 terabytes, is multi-protocol, includes our Accent distributed deduplication software and provides twice the performance for half the list price of the comparable product from the market share leader. The 6701/02 launched at the end of July and was very strong right from the start. In fact, the 6701/02 had the most successful launch quarter of any branded system product that Quantum has introduced in terms of revenue. The message of twice the performance at half the price resonated well with end users. And as I previously mentioned, we had improved traction with the independent channel partners as a result of 6701/02 scalability, simplicity to position, performance, price and overall value.

Finally, the win rate for DXi6701/02 was 57% in Q2. In summary, we had a great first quarter with 6701/02. It is a very good product, and it was key to our revenue performance in the quarter and will be key to our performance going forward as well.

Moving on to StorNext software and appliances, earlier in the call, I mentioned that StorNext revenue improved this quarter. To be more specific, it increased 15% year-over-year and 55% sequentially. We had another strong quarter of new customer acquisition, but we also had a more typical quarter of sales into our installed base for both the StorNext file system and the storage manager.

In addition, we had initial success with our StorNext appliances including the StorNext Archive Enabled Library, SAEL, StorNext M330 and attached storage. As a reminder, our strategy is to launch a set of StorNext-based appliances targeted at specific customer use cases, broadening our overall addressable market and increasing the deal size. We launched our first appliance, the M330 in June and we have announced that we will launch additional models during this quarter.

This quarter's results do not include -- and I'm talking about Q2, this quarter's results do not include any measurable revenue from our StorNext reseller arrangements with NetApp or Active Storage.

Moving to tape, our tape automation product revenue, including both branded and OEM products, was relatively flat year-over-year and up 8% sequentially. Our branded tape automation revenue grew 5% year-over-year and 15% sequentially. This branded growth was the result of adding new enterprise and midrange tape customers, which totaled 135 for the quarter.

We continue to increase our share as a result of the disruption in the channel from industry M&A activity, our strong tightly integrated product portfolio and the tape attached we get as we sell new DXi solutions. Tape is still used in 75% to 80% of customers data protection architectures, and we expect we will perform better than the overall tape market moving forward.

On the product development front, we are continuing to aggressively launch new products enhancements that are in the growth areas of data protection and big data management. We recently added 2 terabyte drives to our DXi8500 and 6701/02 appliances. And in Q3, we plan to launch our DXi 2.1 software on the DXi8500.

Our new vmPRO 4601 appliance for protecting virtual machine data in the SMB and remote office environments will be available in the coming weeks.

As I mentioned earlier, in Q3, we will begin shipping several recently announced StorNext appliances namely the StorNext QD6000, the QS1200 the QM1200. On the tape automation side, we will begin offering dual robots in our Scalar i6K enterprise tape library. And finally, this week, we announced our new NDX-8NAS appliance and RDX removable disk library, which provide cost-effective, complete deduplication solutions for small business data protection. We expect revenue from all of these products during our third quarter ended December 31.

Overall, we are pleased with Q2's sequential revenue growth to $165 million and our overall sales performance. We definitely have improvement across the board in our revenue execution. The key to growth for Quantum is continuing to leverage our proven expertise and intelligent and unique solutions to provide customers with unmatched value in meeting their data protection and big data management and archive needs.

Now, I'll turn the call over to Linda for more detail.

Linda M. Breard

Thanks, Jon. Now I will walk through our detailed financial results for Q2. I would like to refer everyone to the financial statements and supporting schedules included in the press release and on our website. It will be helpful to refer to those documents, as I comment.

Revenue for our second quarter ended September 30 was $165 million compared to $167.7 million a year ago. As Jon said, year-over-year, our branded revenue was up 4%. We grew branded DXi revenue, inclusive of maintenance, 21%; branded software solutions, including our recently released StorNext appliances, were up 15%; and we had an increase of 5% in branded tape automation revenue.

Expected declines in our OEM business and royalties contributed equally on an absolute dollar basis to the offset -- to offset the increases in our branded business.

Royalty revenue was $14 million for Q2 compared to $17.7 million in the same quarter a year ago. The primary driver of the decline was expected reductions in DLT royalties. For the quarter, nonroyalty revenue totaled $151 million, of which 82% was branded and 18% was OEM. That compares to nonroyalty revenue of $150.1 million a year ago, of which 80% was branded and 20% was OEM.

The largest contributor to the revenue increase was growth in our branded DXi revenue including related maintenance, which was partially offset by planned declines in our OEM business.

Looking further at various revenue classifications, devices and media totaled $21.3 million compared to $22.5 million in Q2 of the prior year. The primary driver of the decline was OEM devices and media revenue, which declined $800,000.

As a point of reference, OEM devices and media revenue combined was less than $500,000 in the quarter. Due to the events in Japan earlier this year and concern over supply disruption, we continue to report higher than usual sales of branded media, which offset declines in our branded devices business.

Tape automation systems revenue was $62.4 million compared to $62.9 million in Q2 of fiscal 2011. Branded automation grew $1.7 million year-over-year, offset by a planned decline in OEM automation of $2.2 million.

Our branded enterprise and midrange platforms experienced moderate growth in revenue, while entry-level automation revenue was down slightly during the second quarter compared to the same quarter in fiscal 2011.

We continue to benefit from our strong tape automation product offerings, and as we have said before, are focused on gaining market share and making money in branded tape automation.

The addition of 135 new enterprise and midrange customers during the quarter that Jon mentioned demonstrates our continued success in executing against our objective. Disk systems and software solutions, including related maintenance revenue, was $35.9 million in Q2, up from $30.6 million in the prior year and $27.6 million last quarter.

As I mentioned earlier, we had a year-over-year increase of 21% in our Quantum-branded DXi revenue including related maintenance. On a sequential basis, branded DXi revenue was up 22%. This was our highest branded DXi revenue quarter-to-date.

Midrange revenue nearly tripled over the same quarter in the prior year and grew 66% sequentially. As Jon mentioned, the launch of our DXi6701 and 6702 appliances was our most successful launch to date of a new branded system product from a revenue perspective.

We have received a very positive feedback on these products from customers, the channel and the industry analysts. Offering twice the performance at half the price of the leading competitor and tremendous overall value, our new DXi6700 products have proven to be quite disruptive [ph] in the market.

Branded enterprise DXi revenue was down 35% from the same quarter last year, primarily due to the fact that last year's results included a large direct sale to one customer. On a sequential basis, branded enterprise revenue was relatively flat. However, we saw improved channel traction in both unit sales and overall revenue both year-over-year and sequentially.

Our overall win rate in our branded DXi business was 57%. Entry, midrange and enterprise win rates were all in the mid-to high-50th percentile. Our overall, win rate is up both year-over-year and sequentially. I would also note, as we have said before, that we believe the sale of DXi systems will pull in tape automation sales with them.

To this point, the number of customers buying both the tape system and DXi appliance nearly tripled from the same quarter last year and doubled sequentially.

StorNext software and appliance revenue was up 15% year-over-year and 55% sequentially, marking our highest level of StorNext and related revenue to date. We had more large deals in the quarter compared to the prior quarter, where our shortfall was mostly related storage manager and larger opportunities.

Additionally, new customer acquisition increased significantly, both year-over-year and sequentially. We view this as a positive and although, first time customer purchases tend to be smaller deal sizes, it provides us the opportunity to showcase one of our more unique offerings and provide our expertise to an expanded customer base.

Our recently released StorNext Archive Enabled Library, along with our M330 appliance and attached storage begin contributing to revenue in the quarter. We anticipate that these products will continue to ramp and look forward to the launch of StorNext QD6000, QS1200 and QM1200 appliances during Q3 that will further expand our StorNext portfolio to solve a broader range of customer issues.

Moving to service revenue. It was $35.9 million in Q2 compared to $37.7 million in the prior year. Branded contract revenue was the primary cause of the decline as revenue from legacy enterprise automation service contracts declined year-over-year. While we have continued to post increases in enterprise tape automation revenue over the past few quarters, the service contracts related to newer technology are lower cost than service contracts on some of the legacy products.

Now turning to gross margins. Non-GAAP gross margin in Q2 was 45% compared to 45.2% in the prior year period. On a year-over-year basis, non-GAAP gross margin was negatively impacted by the decline in royalties, which contribute a 100% gross margin.

Removing the additional margin contribution of royalties from the prior year period, would have resulted in a 100 basis point improvement in gross margin in Q2 of fiscal '12 compared to the same period last year, primarily driven by the growth in our branded business which typically contributes higher gross margin in OEM business.

Looking at expenses. Non-GAAP operating expense totaled $58.7 million in Q2 compared to $56.7 million in the prior year. Year-over-year, the primary driver of the increase was sales and marketing spend related to incremental salaries and benefits from additional investments we have made in headcount throughout the past year.

Research and development spend also increased, albeit, to a lesser degree over the same period in the prior year due to investments in headcount in our disk and software team. General and administrative expenses were relatively flat compared to the same quarter in fiscal 2011.

During the quarter, permitted the sale of certain patents that we were not actively using and recognized a $1.5 million gain. Although, ownership of the patents was transferred, we retained a license back to the patents.

Non-GAAP operating profit for the quarter was $17.1 million or 10.3% of revenue compared to $19.1 million or 11.4% of revenue in the same quarter a year earlier. The $3.7 million reduction in royalty revenue was the primary driver of the decline in operating profit compared to the same period last year, partially offset by the $1.5 million gain on sale of patents during the quarter.

Interest expense for the quarter was $2.9 million compared to $6 million a year earlier. This included cash interest expense of $2.2 million and amortization of debt issue cost of $700,000. The current coupon interest rate for our remaining senior debt, $59 million at September 30, is 3.74%. And the average interest rate for our total debt will be approximately 3.76% for the quarter ending December 31.

For the second quarter, we had other expense of $200,000 due to losses we recorded related to our deferred compensation plan, and we recognized tax expense of $300,000 primarily related to foreign and state taxes.

Summing it up for Q2, we had non-GAAP net income of $13.7 million with non-GAAP fully diluted EPS of $0.06 compared to non-GAAP net income of $13 million and non-GAAP EPS of $0.06 in the same quarter a year earlier.

Now focusing on cash flow for the quarter and the balance sheet at September 30, I would like to highlight several key points. Cash flows from operations for the quarter were $5.6 million. We paid down $30.3 million of our senior debt in Q2. At quarter end, the composition of our debt was $68.8 million of senior debt and $135 million of convertible debt. We ended the quarter with $49.5 million in cash.

Bank EBITDA for the quarter was $21 million. We are in compliance with all debt covenants at September 30, and we expect to be in compliance with our debt covenants during the next 12 months. EBITDA for the last 12 months was $71.9 million. For purposes of computing EBITDA for the last 12 months, the net loss of Pancetera Software for the 8.5 months prior to the acquisition has been included in the computation.

On a sequential basis, manufacturing inventory increased $1.4 million, accounts receivable increased $11.8 million and we had an accelerated payment of $7.7 million from 1 customer. CapEx was $2.6 million and purchases of service parts inventories were approximately $400,000. depreciation, amortization and service parts lower of cost or market expense totaled $11.1 million for the quarter.

To summarize the quarter, our revenue increased 7% sequentially and drove an increase of 13% in non-GAAP gross margin dollars and 142% in non-GAAP operating income compared to Q1.

As we have said, our business model is leveraged and as we grow our revenue, our results are positively impacted. In addition, we continue to focus on improving our capital structure, repaying over $30 million of debt in Q2. The term debt is now at $69 million.

Due to the progress in delevering the company in late July, S&P upgraded its outlook on Quantum from stable to positive. We have paid down over 85% of the ADIC acquisition debt in just over 5 years and will continue to utilize cash from operations to further pay down the debt this year.

Finally, I just want to provide an update on the impact to our business related to the flooding in Thailand. Currently, we see minimal impact to our third quarter of fiscal 2012, as we have visibility into our supply chain pipeline and are continuing to use existing stock on hand. We will continue to actively monitor and manage this in the upcoming weeks and months with the goal of supporting our customer requirements without any interruptions in supply.

Now, let me turn the call back over to Jon.

Jon W. Gacek

Thanks, Linda. I want to repeat one of the points that Linda made. We have a very good business model. We generate cash. And as our revenue grows, we have significant earnings power. And I think this quarter demonstrated all of those attributes. The other point I want to emphasize is this quarter, we have begun to position Quantum's proven expertise in providing intelligent solutions that have unmatched value for customers into 2 distinct market opportunities and related-product offerings. Those groupings are data protection and big data management, and archive.

And as I mentioned earlier, our data protection solutions include our Scalar tape automation products, Quantum devices and media including our new NAS appliance and RDX removable library, our DXi disk-based deduplication appliances and our virtual environments offerings, vmPRO appliances and vmPRO software.

Our intelligent solutions that address the big data opportunity are our StorNext software and our StorNext appliances. We think these are distinct markets, and we have aligned our research accordingly to address them. As a result, you will hear us talk about Quantum's vision and strategic direction more and more in terms of these groupings.

Now I'll move to our guidance for Q3 and the rest of fiscal 2012.

As we entered December -- or the December quarter, we have a lot of optimism about our market opportunity, our product portfolio and our internal sales and channel initiatives. Like the other storage companies that have reported earnings, we believe this upcoming quarter will be seasonally strong, but our customers are watching budgets closely and are being selective about where they spend money. We are mindful of both this and the overall macro environment, as we provide our guidance for the December quarter.

So for those of you that have models, here's our guidance: Revenue of $170 million; non-GAAP gross margin of 45% and total non-GAAP operating expenses of $61 million; interest expense will be approximately $3 million, and we still believe it's reasonable to model tax expense of $1 million for the quarter; assumed weighted average shares outstanding will be 270 million.

For fiscal '12, we still believe that both branded revenue and total disk systems and software revenue will grow over fiscal 2011. For total revenue, we think it is a reasonable range of $655 million to $675 million given our momentum and product launches tempered by the macro uncertainty.

Now, I'll turn the call over to the operator for questions. Operator?

Question-and-Answer Session


[Operator Instructions] Our first question comes from the line of Shebly Seyrafi with FBN securities.

Shebly Seyrafi - FBN Securities, Inc., Research Division

I guess my question is on the guidance. You're guiding I think below the street, that you're going to have the 2.0 software on the 8500 in Q4. I would think that could drive upside along with seasonality. We had a good GDP reports today. So perhaps talk about the timing of 2.0 software on the 8500 and why -- whether you're conservative in your guidance.

Jon W. Gacek

Well, let me hit the guidance first and then I'll come back to the specific product question. I hope that you get the feeling that we feel good about the quarter and the direction that we're headed. Having said that, it is difficult to think about all the macro things going on around us. I agree with you, today was a good announcement. Candidly, we didn't take that into account as we're putting this together. But I think we're trying to be cautious about things that we don't control. The things that we do control, we feel really good about. And we also feel good about some of the things like the 8500 and the 2.1 software, like the StorNext appliances. And candidly, we still have some new partnerships that haven't taken hold yet. So I would say, we are being cautious about the economy, but we are very positive. On 2.1 specifically, we're looking forward to having the whole DXi family on one software stack. We think that that's an easier set of solutions to position. I think our results on the 6701/02 this quarter demonstrate that with the product positioned correctly, with the right set of features, with the right performance, with the right positioning, we've got -- we have a very good story. And I think the 2.1 software onto the 8500 will just enhance that much more.

Shebly Seyrafi - FBN Securities, Inc., Research Division

Right, but do you expect it to occur early in the quarter or later on the quarter?

Jon W. Gacek

I'm looking around the room. I think it's shortly. It will be in the middle of the quarter. I think it's middle of the quarter, yes.

Shebly Seyrafi - FBN Securities, Inc., Research Division

Also, your gross margin improved nicely. I think you guided a sequential decline and grew 2 percentage points sequentially and you didn't have any help from royalty. So maybe you can talk about the drivers of that. My segmented gross margin model spits out a 10 percentage point increase in your DXi gross margin but that's just using assumptions. Maybe you can talk about the drivers of that gross margin improvement.

Jon W. Gacek

Sure. It's mostly mix and then just having more revenue to absorb the fixed costs. But moving to the $36 million of disk and software and having StorNext rebound, those are all higher than corporate margin products generally. We also grew the branded business. I think as we said, it's a record quarter for branded. The branded business have better margins. And we get a lot of earnings power as revenue grows. So it's a combination of mix and just growth.


And our next question comes from the line of Brian Freed with Wunderlich Securities.

Brian Freed - Wunderlich Securities Inc., Research Division

A couple of quick questions for you, Jon. First and foremost, as you look at the tape market, what particular industries or applications are you really seeing the most uptick for tape, one. And also, can you talk a little bit about the adoption rates for LTO-5 and are there particular features in LTO-5 or related to LTO-5 that might drive a resurgence in tape? Or do you think it's much more a function of share shift?

Jon W. Gacek

Well, let's start with LTO-5. Everybody has LTO-5, so it's not like it's unique to us. And so I think the fact that we're growing faster than the market is more about our overall solution set. Candidly, we're the only tape company that both has products that go from small to large that has a, I'll call it, competitive and integrated deduplication front end. Our DXi and path to tape capability is unique. And I think Linda mentioned in hers, our attached rate I think doubled or tripled this quarter with the sales of DXi. So we're definitely driving more tape automation sales as we sell DXi. As far as the industries go, it's -- I can't think of anything specifically. And as far as I can tell, we sold tape everywhere. I would say from a use case perspective, you don't sell as much in small environments. Those tend to be disk based, but we sold a lot of midrange enterprise tape. We sold some big libraries. And we're also really excited about our new dual-robot feature that will come online this quarter. That's been a deficiency in our product line for some of the deals that we can compete in, and now I think we'll be able to be in some of these bigger opportunities. So I think we've done a good job executing on tape. I think our iLayer story resonates with customers. Our price positioning is good. Our roadmaps are strong, and we've made a lot of continued software improvements in the products.

Brian Freed - Wunderlich Securities Inc., Research Division

Okay. My second question, kind of an industry question, as well but Overland Storages is in the process of suing BDT and they've been hinting around in the industry that you're next. Have you guys had a chance to review Overland's patents and are you concerned about that?

Jon W. Gacek

I prefer not to comment on their comments. I would say that just this though. We -- everybody has seen that litigation, and I believe that with BDT and IBM and Dell as well. And we'll just have to watch and see where that is. We really haven't spent too much time worrying about it.

Brian Freed - Wunderlich Securities Inc., Research Division

Okay. And then my final question. What line item did your patents -- where did you put your patents sale in?

Jon W. Gacek

It's actually in its own line item in the operating profit. Linda, do you want to?

Linda M. Breard

Yes. It's right below operating expenses and above operating profit.

Jon W. Gacek

So it's not in revenue.

Linda M. Breard

It's called out separate.


[Operator Instructions] Our next question comes from the line of Alex Kurtz with Sterne Agee.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

Jon, can you just talk about the run rate of the DXi, the services and the software? Last quarter you had $36 million. Obviously, that's a good step-up from June, but I think where we all sort of expected this product to be at some point anyway. So is that a good base level for our model moving forward? It's something with the 30 handle on it or mid- to high-30 handle on it moving forward at growing at some clip?

Jon W. Gacek

I know what you're trying to drive. I'm going to do a little marketing before I answer your question since you through me the ball. Products matter, and the 6701/02 is a really, really good product. And I think when we get 2.1 on our software, we're going to further improve the 8500, which also is a really good product, and it just makes it that much better. So this is a sequentially stronger quarter for us. I would expect that we will continue to grow that revenue into this quarter. And then when we see where we ended up for Q3, we can talk about Q4. But I really like where we're positioned. I think the sales team likes the products, the channel likes the products. They're very, very good and their positioned very well. So I think -- I'd like to think that the takeoff spot was last quarter and now we're moving up and we'll continue to drive to do so -- continue to drive to continue to do that.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

I mean, do you think you can hit the $40 million -- not to put you in the box here, Jon, but do you think you could -- in the next couple of quarters, you could hit the $40 million, the $40 million level? Or is that a safe assumption may be exiting the year?

Jon W. Gacek

Yes, obviously, well, I'm going to say it this way, I think if you just ask me to -- you did pin me down, I'd say, next quarter should be a strong quarter for disk and software. And we've got a lot going on around in it. And a 10% uptick doesn't seem that scary, but we still have to go execute on it.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

Okay. And just back on the patent gain here. Obviously, I'm just trying to understand why this is included in the non-GAAP operating margin because it's a onetime in nature. Should we be thinking about the non-GAAP operating margin excluding that, obviously, moving forward?

Jon W. Gacek

I'd say 2 things. There's -- the accounting for these types of things is not clear. You can have it in revenue. You can have it in other. You can have it where we put it. Most people put it where we did. No question, it's a unique line item for us. The industry has had a lot of this activity of late. I will say we have a very robust patent portfolio and felt like these 2 patents, in particular, others could do more with it than we could. But we're a formidable -- we have a formidable set of patents, and if there's opportunities to either monetize them, we'll continue to look at that and we'll also use them, if we need to in other situations. So we tried to put it in the most appropriate, most commonplace. But I have no problem with you thinking of it as being onetime, at least, for anything you've seen us in the past.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

And last question for Linda here. Obviously, there's going to be some, I think, fluctuation in the share count, potentially related to the convert. Can you just remind us how that sort of flows through for the next couple of quarters? Just so for modeling perspective like, are we at the 270 million level throughout fiscal '13 and the remainder of fiscal '12, or are there changes in the first half of fiscal '13?

Linda M. Breard

So for Q3, like Jon said in his guidance, we would -- given the $170 million number for revenue, we would be using that 270 million share count and then we'll come back at the end of Q3 when we report and forecast out for Q4 where we would be. But in general, Alex, if you're between or about $8 million to $10 million in operating profit, that would be the time where you start triggering into having those 270 million shares come in versus 240 million.


And our next question comes from the line of Eric Martinuzzi with Craig-Hallum.

Eric Martinuzzi - Craig-Hallum Capital Group LLC, Research Division

The royalty is something that obviously has a big impact on the profitability overall. We just posted the $14 million of revenue in royalty. Is that -- as I look, it trended down from Q2 to Q4 last year. Are we basing here or is there another leg down on royalty?

Jon W. Gacek

Well, I think, Eric, we've talked about the composition of it in the past. The part that's declining is the DLT piece, which is our proprietary technology. It's -- we're 2% or 3% of market share now of that. So at some point, that's going to flatten out. The other thing that happens to the royalty is that there are reductions in the royalty rates at different times based upon the contractual arrangements with the media manufacturers, and those hit at different times. So it's down a little bit. I guess it's down $3 million year-over-year. Traditionally, generally, the December quarter, it comes back up. But I think we're on a run rate of right around $60 million, I think is the way to think about it. Maybe even you could probably think about that way in the next year or 2.

Eric Martinuzzi - Craig-Hallum Capital Group LLC, Research Division

Okay. And then you had some organizational -- or you made some organizational moves over the last quarter. Just wondering, have there been -- what other changes have taken place beyond maybe the addition of the head of Worldwide Sales, new VP channel? What other changes are taking place?

Jon W. Gacek

Yes, we've started the year with a drive to get our sales teams integrated selling all of our products, both the data protection as well as the big data and archive products. So we continued to move that direction around resources and where people are reporting. Another thing that we've done, which hopefully, will start seeing benefit from is we have dedicated a very seasoned VP level person to work with Network Appliance in driving their revenue with our StorNext product. This individual is very strong, very good with customers and really understands the technology. I would think his focus with the Net App team is going to yield results. Then we've made some others, I would call them, important but more down the organization changes within sales.

Eric Martinuzzi - Craig-Hallum Capital Group LLC, Research Division

But there hasn't been any kind of mass retooling of sales managers, sales rep?

Jon W. Gacek

No. No. I think the other thing that we've done is we've really looked at -- I think we made a nice change during the year about how the teams were compensated around some of the newer products. And I think that's been well received by the team and also helped drive, I think, some of the growth that you saw this quarter.


[Operator Instructions] And I'm showing no further questions at this time. Management, please continue.

Jon W. Gacek

Thank you. I want to thank everybody for joining, and we appreciate the support and the comments. And we are very enthusiastic about where we are. We know we have more work to do and we know we're in a tough competitive environment and uncertain economic times. But make no mistake, we like where we're positioned and we think we're going to grow. We'll report our third quarter, the December quarter towards the end of January, and we look forward to talking to everybody then. Thanks very much.


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