Quantum Corp (QMCO) 2020 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Quantum Fiscal Third Quarter 2020 Earnings Conference Call. (Operator Instructions)

At this time, it is my pleasure to turn the floor over to your host for today, Rob Fink of FNK IR. Sir, the floor is yours.

Thank you, operator. I'd like to welcome everyone to the call. Hosting the call today are Quantum's Chairman and CEO, Jamie Lerner; and CFO, Mike Dodson.

Please be aware that some of the comments made during our call may include forward-looking statements. All statements, other than statements of historical fact, are statements that could be deemed forward looking. Quantum advises caution and reliance on forward-looking statements. Forward-looking statements include, without limitation, and (sic) [any] projections of revenue, margins, expenses, adjusted EBITDA, adjusted net income, cash flows or other financial items, any statements concerning the expected development, performance, market share or competitive performance relating to products or services and the expected timing of our relisting of securities on a national exchange. All forward-looking statements are based on information available to Quantum on the date hereof. These statements involve known and unknown risks, uncertainties and other factors that may cause Quantum's actual results to differ materially from those implied by forward-looking statements, including unexpected changes in the company's business.

More detailed information about these risk factors and additional risk factors are set forth in Quantum's periodic filings with the SEC, including, but not limited to, those risks and uncertainties listed in the section entitled Risk Factors in Quantum's quarterly report on Form 10-Q and annual report on Form 10-K as filed with the Securities and Exchange Commission. Quantum expressly disclaims any obligation to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Also note on this call, the company will be discussing non-GAAP financial information. Jamie and Mike are providing this information as a supplement to information prepared in accordance with accounting principles generally accepted in the United States or GAAP. You can find a reconciliation of these metrics to the reported GAAP results in the reconciliation table provided in the company's earning (sic) [earnings] release.

I would like to remind everyone that this call will be available for replay on Quantum's website for at least 90 days. A link to the website replay of this call was also provided in the earnings release, which was issued today and which is available on the company's website at investors.quantum.com.

With all that said, I would now like to turn the call over to Jamie Lerner. Jamie, the call is yours.

Thank you, Rob. Included with our earnings release today was the announcement that we've been approved to list our shares on the NASDAQ starting on Monday, February 3. I could not be more proud of this company and our new leadership team. Our relisting marks the end of Phase 1 of our turnaround and transformation, where we settled our legacy issues with the SEC, settled our shareholder lawsuits, removed $70 million in cost on an annual basis, became cash flow positive and profitable on a GAAP basis, returned to innovation and launched 6 new products in the last year, added key new leadership and technology talent, relisted on a national exchange.

With our relisting, we now enter a second phase of transformation, where we will be moving from making the organization sustainable and stable on a long-term basis to growing on a long-term basis. The second phase of transformation brings a new set of challenges, which I believe we are well positioned to tackle.

The core action items for this next set of growth transformations include: winning additional hyperscaler and cloud business; increasing margins by selling our technology's unique value versus winning by discounting; scaling revenue from our new product introduction's specialty software; entering new market verticals, such as surveillance and autonomous; and expanding into new international media and entertainment geographies; executing key inorganic growth initiatives.

We could not be more relieved and elated as Phase 1 of our transformation concludes with our relisting on the NASDAQ. When we completed our restatement and conducted our first earnings call, I laid out a vision and road map for a leaner, more product- and technology-focused Quantum, a company poised not only for growth but profitable growth. We will not repeat the mistakes of the past. We're focused on high-quality revenue. This starts with creating tangible value for our customers, which then leads to high margins and a stronger customer partnership. In fact, in a relatively short period of time, the new Quantum team has worked very hard to create differentiated solutions for all of our customers, enabling us to sell based on quantifiable value, not just based solely on price. We pledged to be disciplined, both in the management of our expenses and in the process in which we transact with our partners and customers. Last quarter's results and the progress over the first 9 months of this fiscal year demonstrates this discipline, and I couldn't be prouder of our team.

We continue to advance efforts to transform our business, focusing on margin expansion and profitability, as we reposition Quantum as an innovator poised to solve the biggest challenge around the storage and management of video and video-like data. As a reminder, video and video-like data is projected to be 80% of all the world's data by 2025, and Quantum is a clear leader in this space.

Quantum achieved its profitability guidance for the third quarter despite generating revenues lower than expectations primarily as a result of the volatility inherent to our hyperscaler business, where timing of large orders can fluctuate based on a variety of external factors. However, due to the discipline and the tangible value I described earlier, our earnings were within our guidance range, even with lower revenue.

We reported record gross margin, demonstrating our focus on high-quality revenue and value-based selling. And we returned to GAAP profitability for the first time in 3 years. This is a significant achievement, and that has occurred during a quarter when revenues were less than expected speaks to the operational and strategic progress we've made. Year-to-date, excluding nonrecurring charges, stock compensation and restructuring charges, we have generated nearly $18 million in adjusted net income, a positive swing of nearly $16 million. On a GAAP basis, we narrowed our year-to-date net loss to just $1.4 million, a positive swing of $32 million compared to the prior year. Our adjusted EBITDA year-to-date of $40.5 million increased $19.8 million or 96% over the prior year. Our strong performance in our Phase 1 transformation has created great momentum and confidence for our team as we enter Phase 2 and turn our focus to growth.

Our offerings in the video and video-like data portion of our business remain strong, and we continue to see growing demand for our differentiated solutions. Our focus is to increase the contribution from these products which maintain a better margin profile, which should mitigate the timing of hyperscaler revenue over time. Our software-defined F-Series NVMe servers had their strongest quarter yet. We have a large pipeline, and we just introduced a new lower-priced NVMe storage server, the F1000, which will drive even more velocity.

We are extending this software-defined architecture to the rest of our StorNext product line in the coming months, and we are getting some strong early demand signals from our customers in this area. We are building out our portfolio of products for surveillance, recording and analytics, and we are still in the early stages of adoption there. I'm encouraged with the momentum for these products, and this reinforces my confidence in sustainable, profitable growth through technology innovation.

It is clear that we have reestablished Quantum as a leader in the industry with differentiated solutions that meet a large and growing need: the management of video and video-like data. And it is clear that we have rebuilt the earnings power of Quantum and that we are now poised for sustainable profitability. As we move to the NASDAQ in the coming days, this profitability gives us tremendous momentum as we enter Phase 2 of our transformation and shift our focus to growth.

I'd now like to turn the call over to Mike Dodson, our CFO, to discuss the financials. Mike?

Thank you, Jamie. Welcome to everyone that has joined our call today.

Now turning to our financial results for the third quarter of fiscal 2020. Revenue was $103.3 million in the third quarter compared to $102 million in the year ago quarter and represents an increase of $1.3 million or 1%. This increase was driven by a 5% increase in product revenue, which was partially offset by a 4% decrease in service revenue. More specifically, product revenue increased primarily as a result of $9.8 million increase in primary storage systems, driven by a higher level of government sales, and a $4.2 million increase in media sales. These increases were partially offset by a $10.6 million decrease in secondary storage systems, which was primarily driven by fluctuating purchasing cycles within our hyperscale business.

Royalty revenue of $4 million for the third quarter continued to be relatively light. The LTO-8 adoption was lagging from expectations primarily due to attractive pricing for the LTO-7 and the next-generation LTO-9 that is 12 to 18 months away from delivery.

Gross profit in the third quarter was $47.1 million or 45.6% gross margin compared to $43 million in gross profit and a 42.2% gross margin in the year ago quarter. The increase in gross margin was primarily driven by higher product gross margin of 700 basis points, which was due primarily to a sales mix weighted towards more profitable product lines and cost reductions across a wide range of product offerings.

Total operating expenses were $35.4 million or 34% of revenue for the third quarter compared to $39.6 million or 39% of revenue in the year ago quarter. The decrease in dollars was driven by decreases in general and administrative expenses of $2.8 million, restructuring expense of $1.3 million and sales and marketing of $1.6 million, which was partially offset by higher research and development expense of $1.4 million.

The increase in research and development expense was primarily due to an increase in head count. The decrease in general and administrative expense was driven primarily by decreased costs related to the financial restatement, which was partially offset by an increase in stock compensation. The decrease in sales and marketing expense was driven by an overall decrease in head count and marketing programs. Our head count at the end of the third quarter was 821.

GAAP net income was $4.7 million or $0.10 per share for the third quarter of fiscal 2020 compared to a net loss of $4.3 million or $0.12 per share in the year ago quarter. The prior year quarter included $5 million of after-tax expense for the extinguishment of debt related to the August 2018 term loan amendment, which was partially offset by $3.8 million and other income resulting from a $2.8 million gain on the disposal of an investment and $1.1 million resulting from the change in mark-to-market valuation of warrants related to the term loan.

Adjusted net income was $7.3 million or $0.16 per share for the third quarter compared to $3.4 million or $0.08 per share in the year ago quarter. Excluded from the adjusted net income and net loss calculations are nonrecurring and other items, including restructuring charges, debt extinguishment costs, stock-based compensation and financial restatement costs. Adjusted EBITDA increased $3.6 million to $14.7 million in the third quarter compared to $11.1 million in the year ago quarter. There is a full reconciliation of our non-GAAP results to the most directly comparable GAAP measure in both the press release and the Form 10-Q released today.

Now turning to our year-to-date results. Revenue for the first 9 months of fiscal 2020 was $314.7 million compared to $299.4 million in the year ago period, an increase of $15.3 million or 5%. This increase was primarily due to an increase in primary storage systems, driven by a higher level of government sales and an increase in device and media sales.

Gross profit in the first 9 months of the current fiscal year was $136.4 million or 43.3% gross margin compared to $124.9 million in gross profit and a 41.7% gross margin in the year ago period. The increases in gross margin were primarily due to cost reductions in our cost of service and across a wide range of product offerings and a mix weighted towards more profitable products.

Total operating expenses for the 9 months of the current fiscal year decreased by $11.4 million or 9% compared to a year ago period. Total operating expenses were $117.8 million or 30% of -- 37% of revenue compared to $129.2 million or 43% of revenue in the year ago period. Research and development expenses increased 13% to $27.1 million for the first 9 months of fiscal 2020 compared to $24 million in the year ago period. Sales and marketing expenses declined $6.7 million or about 13% to $46.1 million for the first 9 months of the current fiscal year compared to $52.8 million in the fiscal 2019 period. This decline was driven by a lower head count to improve sales and marketing efficiencies.

General and administrative expenses decreased by $3.3 million or 7% to $43.6 million for the first 9 months of fiscal 2020 compared to $46.9 million for the same period in fiscal 2019. This decrease was primarily driven by lower costs related to the financial restatement, lower software expenses as we streamlined our processes and tools and decreased facility expenses as we consolidated our physical footprint. These decreases were partially offset by increases in stock-based compensation.

The net loss for the 9 months of fiscal 2020 was $1.4 million or $0.04 per share compared to a net loss of $33.4 million or $0.94 per share in the year ago period. Adjusted net income was $17.8 million or $0.40 per share for the first 9 months of the current fiscal year compared to $1.9 million or $0.05 per share in the year ago period. Adjusted EBITDA increased $19.8 million to $40.5 million for the first 9 months of the current fiscal year compared to $20.7 million in the year ago period.

I wanted to provide some information regarding our income tax provision as well as our outstanding share count. Over the years, the company has accumulated federal NOLs and expects to end the 2020 fiscal year with approximately $300 million in NOLs. So the company does not expect to pay cash for federal taxes for the foreseeable future. However, we do have typical statutory taxes in certain foreign jurisdictions, and we would expect the net tax provision at a quarterly run rate basis to be approximately $400,000.

Related to the outstanding share count. During the quarter, we had a former lender complete a cashless exercise for 3.8 million warrants that resulted in issuing 2.8 million shares. This exercise brings the outstanding share count to approximately 39 million shares. With the return to GAAP profitability during the quarter, we use the treasury stock method to calculate the fully diluted share count that takes into consideration dilutive equity instruments and represented 46.6 million shares for the quarter EPS calculation.

Now looking at the balance sheet and cash flows. Cash and cash equivalents increased $1.5 million to $7.5 million at the end of the third quarter compared to $6 million at the end of the prior quarter. These amounts exclude $5.9 million in restricted cash.

Outstanding long-term debt at the end of the third quarter was $1.2 million lower than the prior quarter and was $152.4 million, net of $14.6 million in unamortized debt issuance costs and $1.7 million in current portion of long-term debt. This balance was $153.6 million at the end of the prior quarter, net of $15.5 million in unamortized debt issuance costs and $1.7 million in current portion of long-term debt.

Borrowing on a $45 million revolving credit line decreased by $1.7 million at the end of the quarter to $5.3 million compared to $7 million at the end of the prior quarter.

Net cash used in operating activities was $5 million for the first 9 months of fiscal 2020, an improvement of $2.4 million from the same period in fiscal 2019 primarily reflecting improved operating results, net of changes in working capital accounts.

For the third quarter of fiscal year 2020, our operating activities were a positive source of cash of $4.7 million as we expected and indicated on our last quarterly earnings conference call.

Taking a look at significant balance sheet variances. I wanted to address the $17.2 million decrease in the total deferred revenue balance to $110 million at the end of the quarter compared to $127.1 million at the end of the last fiscal year. Approximately $9.8 million of the decrease represents the historical timing of the contract renewal process that peaks in the last quarter of the fiscal year following the end of the calendar year. The contract renewals and related bookings are always the highest in the fourth fiscal quarter, which results in a seasonally high deferred revenue balance at the end of that quarter. The remaining decrease of $7.4 million in the deferred revenue balance is primarily inventory that was held at distributors that was sold through the channel over the last 9 months. As of the end of the quarter, this legacy inventory that is held at distributors is down to approximately $300,000.

Related to other matters. First, as Jamie mentioned earlier, we have received approval to list the company's common stock on the NASDAQ Global Market. We expect trading to begin on Monday, February 3, under the ticker QMCO. Second, during the quarter, the company settled with the SEC related to all matters arising out of the SEC's investigation into the company's historical accounting practices that resulted in a restatement related to revenue recognition for transactions between fiscal 2015 and fiscal 2018. The settlement, which we disclosed in late December, included a payment of $1 million as a civil penalty.

Now turning to our financial guidance. The fourth fiscal quarter, excluding the impact of hyperscaler business, has historically been our softest revenue period for the year. For the fourth fiscal quarter of 2020, the company expects revenues of $95 million, plus or minus $5 million; the company expects adjusted net income to be $2 million, plus or minus $2 million, and related adjusted net income per share of $0.04, plus or minus $0.04. Adjusted EBITDA is expected to be $10 million, plus or minus $2 million. This fourth quarter outlook results in an update for our full year outlook. Management now expects total revenues for fiscal 2020 to be $410 million, plus or minus $5 million; and adjusted EBITDA guidance of $50 million, plus or minus $2 million.

With that, let me turn the call back to Jamie for closing comments.

Thanks, Mike. We're excited to relist on the NASDAQ and conclude the stabilization phase of our transformation and begin Phase 2, where we focus on long-term sustainable growth.

I would now like to open the line for questions. Operator?

(Operator Instructions) We will go first to Eric Martinuzzi at Lake Street Capital Markets.

Jamie and Mike, I'm curious on the revenue reset. If I look -- take a look at the full year, just so we don't get into the puts and takes of individual quarters, the revenue midpoint previously was $427 million, and now the revenue midpoint is $410 million. I'm curious to know, what are the variances -- of that $17 million variance, how much of that is due to hyperscaler not being what you thought it would be this fiscal year? How much of that is due to maybe royalty being below what you thought it would be this year? If you could parse that out, I'd appreciate it.

Sure. When we look at our full year, we would attribute that decrease almost entirely to the hyperscaler, the volatility in the hyperscaler revenue. We saw a part of that decrease in the current quarter. And when we look forward to the fourth quarter, obviously, it's our softest quarter of the year. But the difference in our annual guidance would be almost entirely attributed to the hyperscaler, just the timing of hyperscaler revenue. We don't see the demand going down, we don't see any competitive issues, but it's just simply the timing of when the revenue will come in.

Okay. And that's to say that it is volatile, and I know, obviously, near term, it's volatile to the bad, it can also be volatile to the good. But are you just proactively stripping it out and being overly conservative potentially here? Or is it truly, hey, this isn't going to be until FY '21?

Well, I would say that we're not in a position to be overly conservative, but we are being conservative in our guidance. But we do have relatively good guidance from our customers, and that would be the basis of what we're providing.

Okay. Okay. And then I wanted to shift over. Obviously, you're having good success with VS-Series there. You talked about software-defined architecture of the F-Series, and I want to make sure I understand that because I get the idea of a slick technology in a box. But I want to make sure I understand the value add of the software defined on top of that.

Yes. The part of the transformation we're making is to sell the software independent of the hardware, not have them bolted together or technically combined, allowing us to transform into more of a software company, allow us to get the full value of our software, allow that software to run on commodity hardware or even let that software run directly on the cloud. So the F-Series is architected that way. And where we're moving with StorNext over the next couple of months is StorNext will actually just be sold as software, and you'll have to buy a software license for it, and then you have a variety of different choices of hardware to run it on, but it will be actually completely unbundled and uncoupled going forward.

Okay. The gross margin on the product side, terrific job there that I've got it at 34% on the product. I look back as far as my current model shows, and I don't see it ever better than that. What should we be thinking about for product gross margin? Was that a onetime anomaly here? Or is that kind of a current run rate from which we can improve?

Yes. I would say we were very pleased with the gross margin this quarter. We had a good mix. I wouldn't say that that is now the new norm, per se. When you look at our products, at the low end of our gross margin with media, we're in the mid- to high single digits. And then you look at our royalty, which is 100%. So we have a wide range of margin contribution and when we look at the mix of what goes into our revenue. So we do everything we can from managing our business. We really are driven by gross margin dollars and providing earnings to the bottom line. We are not going to do discounting at the end of the quarter to get revenue. We're not going to sell for the sake of empty calories. So everything we do is to maximize the gross margin, and we'll continue to take those actions to ensure that we have very strong gross margins, very strong earnings. Where that settles out, it's difficult to predict within a gross margin percentage just because of the variability we have in our different products.

I understand. Those hyperscalers can really swing things, too, I'm sure. Okay. Well, that covers it for me. Congrats on the NASDAQ uplist, and I'll see the floor.

Thanks, Eric.

We'll go next to Craig Ellis at FBR Riley.

Yes. It's B. Riley FBR. And Jamie, my congratulations on all the things that you accomplished in Phase 1 and now embarking on Phase 2.

I wanted to go back and clarify the first question. So just with regard to hyperscalers, is it the company's sense that what's at play is that it's something that's really more seasonal and an artifact of what often happens between the calendar fourth and first quarter? Or is it something that may be similar to what a large server MPU maker said last week when they said that they just saw that hyperscalers were starting to move from a capacity absorption phase to more of a capacity digestion phase?

I think it feels more like what you -- the second item, which is -- you got to understand, a single unit that we sell to a hyperscaler can be over 90-feet long and take a team of people to install and integrate. And when they receive scores of these or over 100 of these, it's safe to assume they need thousands of square feet or tens of thousands, and even hundreds of thousands of square feet of building to put them in, with the power to support that, with the cooling to support that, with the system administrative and monitoring software to put that in place. So the digestion of these systems, as you put it, is nontrivial. And there's a lot of logistics. And I think in this case, I would think of it as they need these units. They need them as much as they've ever needed them. They want to install them as quick as they can. But just -- we had to kind of harmonize our manufacturing line to their ability to digest the systems and install them and cool them and power them.

That's really helpful color, Jamie. And then the follow-up question is related to that customer set. The company has been pursuing diversity with its hyperscale customers. Can you provide some color on how you're progressing and when there might be an opportunity to diversify beyond the current customer set?

Right. We have test equipment, so physical equipment, in most cases, bought by hyperscalers, delivered now to 3 additional hyperscalers who are testing the equipment. The feedback from the tests continue to be positive, and we feel that we are viable and meet all requirements, all stated requirements, both technical and economic. And I believe those -- it would be safe to think about those trials to continue for another several months, followed by more detailed financial negotiation where orders -- I would not expect volume orders for another 6 months. I think it will happen within the fiscal year, so within the next 12 months, but I think there's another solid 6 months or more of testing, tuning and negotiation before there's a second volume customer.

And then I'll ask one more before I jump back in the queue. You mentioned, in response to an earlier question, the movement of StorNext out into something that's sold individually. I'm wondering if you or maybe even Mike could provide some color on how we should think about that. Just mechanically, would we expect to see a fourth segment come into the model and have something that's reported along with products and services and royalty? And more importantly, how should we think about the revenue potential over the first year or 2 as the company moves to that direction?

Yes. I mean I think we're going to stay with kind of our 3 large pillars, which are primary storage, which I would think of as our high-speed products; secondary storage, which are backup archive and think of them as cheap and deep storage products; and then our services business. I think those are the right measurements. As we start to build up our software business, I think what you'll see is margin shaping differently in those businesses, and that's really what we're attempting to do. As well as I think the software separation and some of the other work we're doing with our products to make them easier to use, easier to install, applicable to more cases than just moviemaking and television, we're trying to drive growth in those products as well by appealing to other segments.

So I think that's really -- as we go into Phase 2, our focus is really value engineering. I mean a lot of the software separation allows us to combine more things on a single box, which is a form of value engineering. So a big part of Phase 2 is building the same product, but building it less expensively for margin expansion; making it less expensively so we can enter different markets in different market segments; making it more flexible so it can be combined with other pieces of software like video surveillance software, MAM software, all with an effort to enter additional markets, appeal to different segments and expand margin. Those are all things we're doing to drive the growth side of the business. And you can only imagine what a massive distraction all the stabilization work has been over the last 18 months. I mean I think we've done an unbelievable body of work to stabilize the company. And now with that behind us and the company is now stable, operating efficiently, every man, woman and child in this company is now focused on our value engineering and growth initiatives.

Congratulations on the uplisting.

Thanks, Craig.

We'll move next to Chad Bennett at Craig-Hallum Capital.

Great. So just following up on the hyperscaler volatility comment. Mike, did you have any hyperscaler revenue last December quarter?

Yes.

Is -- are you able to quantify it?

I mean we never break that out separately. But it'd be fair that when we look year-over-year, the level of revenue will be pretty much in the same ballpark between fiscal year '19 and fiscal year '20, but the distribution between quarters can swing quite a bit.

Okay. I guess, is it fair to say the decline, the $10.6 million decline year-over-year in secondary storage, that will be representative of...

Yes.

Okay. Got it. Okay. Perfect. That's enough. And so as we look -- as much as I can push into early next year, first half of next year, do we believe the company returns back to overall revenue growth and specifically product revenue growth in the first half of '21?

Yes. We'll come out with that -- those thoughts on the next quarter, Chad. Really, we're just looking at -- this 1 quarter, working to get this year done, and we'll provide that view next quarter.

Okay. And then Mike, how should we think about, maybe you have a little more visibility here, just into the royalty revenue run rate for the March quarter and if you can say at least into the early part of next year?

Yes. The visibility that we have, at least one quarter out, we would expect in the same range or maybe a little better. But I would say that range would be 4 to 5, to give you a range.

Okay. And that's looking out a couple of quarters or...

Just for the next quarter.

Okay. Got it. And then maybe last one for me, for Jamie. Jamie, is there any way to think about how significant the new products could be, maybe as we look into the second half of next year, whether it's F-Series, VS or, I believe, R-Series on the autonomous side? I mean are we at a point where those products, in aggregate, could contribute 10% of product revenue? Or any type of color there as we look out a few quarters, 3 or 4 quarters?

I mean our goal as a leadership team is to be able to grow organically 10% next year. So that will be a combination of new products that will be a combination of entering new markets, greater sales of the products we have today. So I would think of it in that way as we want to be able to take what we accomplish this year and grow 10% organically, and organically, meaning growing the products we currently have and our engineers building new products and selling new products. And I think 10% is about the right place for us to be.

For overall revenue?

Overall revenue.

Product. On product revenue.

Product revenue growth.

Product. Okay. Got it. All right, guys. Nice job on managing the business. Love seeing the gross margins and the EBITDA performance.

We'll move to George Iwanyc at Oppenheimer.

Congrats on finishing Phase 1 of the transformation. So maybe just digging into the visibility a little bit more. So if you exclude cloud and you look at your other markets, that's -- it's meeting at your expectations for the fourth quarter. And maybe can you give us a reminder of what the normal seasonality is, ex the cloud business?

Yes. The normal seasonality, I would put a range of 5% to 10% on the product revenue. It's just a softness just that we have experienced, and I would exclude the hyperscaler from that because that can just be lumpy, and we've discussed those revenue trends. As far as the demand that we've seen outside of the hyperscalers, it is as we have expected. There was -- we haven't experienced any surprises outside of the guidance that we would have given or understood in the industry.

Okay. And Jamie, could you maybe give us a little bit more color on how the value-based selling is going and where you're seeing the sales productivity gains?

Yes. I mean our customers want more from us. They don't want us just to sell them a product. Increasingly, they want us to help them solve a problem and, more importantly, solve a business problem, right? We have customers that want us to help them map genomes and create new drugs. We have customers who want us to help them produce more television shows more rapidly and efficiently. And we've always historically said, look, our answer to everything is to sell you a box. And if you call our support line with a problem, if something's broken, we'll fix it. But now we're transforming to say, we're more focused on our customers' success. So they're buying multiple products, multiple products that are integrated together to help them solve a problem.

And ultimately, a customer is going to pay a lot more money, a lot more attention and a lot more margin to someone who helps them solve a critical business problem than you just dropped a box off at the loading dock. And that's the transformation we're making with our sales team, and that's why we're seeing less of the old behaviors here where, hey, it's the end of the year, hit the revenue target no matter how much you have to discount or sell whatever you have to sell to go hit the revenue target. And Mike and I just don't look at things that way. And so we come in and say, look, we're going to hold to our prices. If you want some incredible discount, it's not going to happen. And if you're going to buy the product a couple of months from now, buy it a couple of months from now. We're not going to give you discounts to buy it abnormally early, because that's not where our focus is on selling you a box.

It's more about, let's talk to you about solving a critical business problem. How can we sell you a combination of products to do that? How can we sell you more services to install them in such a way to solve the business problem? And when you integrate the technology into the customer's network to solve a problem, it's a much stickier installation and a much stickier relationship than, again, hey, I need this much capacity, and we just dropped the capacity off the loading dock. And that's a transformation of our services organization, a transformation of our technical selling organization and a transformation of how we build our products so they can be integrated in a much more flexible way to solve problems. And that is going to take us a few more years to become really good at that, but we're becoming better and better every quarter.

And it's really changing how we talk to our customers, how we engage with the customers and how we sell to them, right? In this model, you're not just giving them a quote, you're actually giving them a proposal about, hey, we're going to build something unique and special for you that's going to help you solve this problem, and we're going to explain that in a multipage document instead of, hey, here's a quote. And it's a different way of engagement. I think it is a lot of work to make that transformation, but I think it just dynamically changes the kind of company we are and how our customers perceive us.

All right. And one more question for me. Just with that evolution, can you give us a sense of -- on the software side, how you see that progressing over the next year or so?

Yes. I mean we're building a series of layers, think of it as a layered cake. At the most basic layer, there is storage hardware. And our goal is to increasingly commoditize that, use commodity equipment, use basic equipment, use the lowest priced equipment that we can find for our customers. And that commodity equipment is given differentiation and flavor and given a personality by the software that we place on it. So we can take a generic server and turn it into a file server, turn it into a moviemaking piece of technology, turn it into a genomic sequencing piece of technology, turn it into a video surveillance platform, a cheap and deep archive platform. And so what the first step is separate the software from the hardware and sell that software separately and increasingly sell that software on a subscription, so our sales are less episodic and they're more reliable. Now that's a big transformation for us.

Now those 2 layers, software-defined storage and hardware, allow us to store video and video-like data. But our customers want more from us. They're saying, okay, you stored my video data, but now help me manage it. Where is that data? Is it on the cloud? Is it on hardware? What hardware is it on? Is it on the right priced hardware at any given time? Help us move data, help us back up that data, help us protect that data and help us administrate access to that data. So we're moving to a layer if you think of the lowest layers hardware, software-defined storage above that, and then data management software above that.

And also the other software we're getting into is manage these enormous quantities of video, photographs and build catalogs of it. How do I catalog -- I mean our average customer has 300 million files with us on average. They need tools to catalog those 300 million files, understand where they are, are they protected, who's accessed them, how do you search them. Very often, a video, you want to search for a face, you want to search for an image, you may want to listen to what they're talking about and search for a dialogue, and that requires a different set of analytics, cataloging and search technology. So I think you're going to see those layers come out from us this year and, again, an effort to move much more of our sales to software. Increasingly, that software will be sold on a subscription. And increasingly, it will reside in the cloud and be delivered from the cloud. We're moving our whole StorNext platform to the cloud. It will run on Google, Amazon and Azure. So we're seeing a lot of these kind of movements. Our DXi platform, which is a backup product, now backs up not only to on-premise hardware but backs up to the cloud as well.

So these are all transformations we're making this year as we, again, move to more of a software-defined and general software-based posture and a set of software all around the infrastructure for managing, moving, accessing and creating video.

We'll move next to David Duley at Steelhead Securities.

Just kind of a recap on the sequential gross margin improvement. I think another gentleman mentioned it all came from -- or a vast majority of it came from the product gross margin improvement. Could you help us understand which exact products you had this vast improvement in gross margins in? And how far you are along, I guess, on the total product set on this series of layers that you just went through with the previous questioner? Are we on this layer cake with all of the products now? Or is it just 1 or 2? Or just kind of, from a macro perspective, how far along are we?

Yes. I mean from a macro perspective, the product gross margin improvement was in the primary products. As Jamie has been describing, the positions we're taking, the direction we're moving there is to offer solutions and to move north, right? And as well as the customer base that we're selling to. As I mentioned in the prepared remarks, the increase there was predominantly government business, which is good margin business, and what we're providing them, the solutions we're providing them. So that's here today, right?

And Mike, what I'd add to that is we have a company that has gotten really good at doing many, many $120,000 to $200,000 transactions. And what we are able to do with the DoD is we are able to do a north of a $5 million sales. So we're selling, as I described, a more complex solution. We are working on solving a large complicated problem with them, and that drives higher value than, again, these kind of quick hit sales. And I think we want to keep our baseline of quick hit $120,000 to $200,000 highly transactional sales. But now we're layering over the strategic $5 million sales, $7 million sales, where they have higher margin because a sale of that size is not really a box sale, it's a series of things that we're selling someone to solve a more complex business problem or a strategic problem.

Okay. And then as far as how far are you along? So that would leave the hyper -- which products have you not, I guess, transitioned to selling more software-oriented mix?

Yes. I mean we're just in the beginning of that, right? We are doing the engineering work. But I mean StorNext today is not sold as software. It's not there yet. DXi is not there yet. We are just making that transformation. So those products, even the F-Series, is -- it is -- has software and hardware separated, but you still buy them together. So this -- we're at the very early days of this. So I think we're in the early days of solution selling. And architecturally, it will take a few more product revisions to actually sell all of our products as separated software. But all of that is on our -- the road maps that we're sharing with our customers today.

Okay. And I guess, on the hyperscale business, you guys have mentioned that it's lumpy. How long would you expect this to last? Because it sounds, frankly, from your explanation that it's a facility readiness.

Yes. Yes. I mean it's...

So it's something that usually lasts very long, but I just wanted to know what you guys think.

Yes. I mean I think it usually takes them about 6 months to deal with these digestion issues, 6 to 9 months. And really, it's safe to think about some of these are about digesting, but some of these things are actually -- for all of us who sell large amounts of equipment, some of it is tied to construction, right? You have to construct the building. You have to construct a cogen electric facility to provide the electrical power. So depending on if you're tied to basic logistics or, in some cases, the equipment is waiting on a building to be built or waiting on power to be -- additional power to be brought to the facility so that just gives you a sense of what the hyperscalers are dealing with as they build out their infrastructure. It's not just installing the equipment. Sometimes you actually need to build additional buildings or additional square footage or additional cooling capability to receive them.

So if the customer has a facility ready, then we wouldn't be having this issue?

I mean I wouldn't draw direct conclusions, but, I mean there's a whole set of these issues from -- it can be power, it can be cooling, it can be getting access to personnel, it can be the ability to support the equipment. I mean this is a big, complex infrastructure to receive and install the equipment. And it isn't just directly linear, and isn't something that we necessarily are always given a lot of insight into, right? They operate fairly privately, and they're quite quiet about how they run their building. And they give us -- like, in this case, we got notification as late as December about what their demand would be, and it was received late in the quarter that they had to slow down significantly for their own reasons.

With no other questions, that will conclude today's conference. We thank you for your participation. You may disconnect at this time, and have a great day.