Quantum Corp (QMCO) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Quantum's third-quarter earnings conference call. Today's call is being recorded.

At this time I'd like to turn the conference over to Mr. Shawn Hall, General Counsel. Please go ahead, sir.

Thank you and good afternoon and welcome. Here with me today is Jon Gacek, our CEO. 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 estimates and 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 12, 2015 and 10-Q filed on November 6, 2015. 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 will turn the call over to Jon Gacek.

Thanks, Shawn. Thanks for joining our third-quarter conference call. First, let me start off by addressing the 8-K we filed today regarding Linda's departure to pursue another opportunity. Linda has been a valuable Quantum team member for the past 17 years and over that time has made significant contributions and provided leadership to the organization. We wish her well in her new endeavor.

Moving forward, Chris Willis, VP of Financial Planning and Analysis, an 18-year veteran of Quantum, will take the role of interim CFO as we conduct our search for a permanent CFO.

Moving to our third-quarter results, I want to note first that given the overall market conditions and the magnitude of the business changes we implemented during the quarter to lower our cost structure, I'm pleased with the overall outcome. As we describe each quarter, our objective is to increase shareholder value by growing our scale-out revenue and investing to drive future scale-out growth while also delivering on our operating profit goals. This approach requires us to make balanced investment choices, evaluate our best opportunities for growth and consider our capital structure.

For the third quarter, our Scale-out Storage and related service grew to an all-time high of $35.7 million, up 31% year-over-year and 19% sequentially. For the nine months ended December 31, Scale-out Storage and related service has grown 32%. That growth was achieved without the benefit of any megadeals which we described as deals over $1 million, but we did see significant growth in big deals, which we classify as transactions between $200,000 and $1 million.

For the third quarter, excluding megadeals, Scale-out Storage and related service grew 48%. And for the first nine months of fiscal 2016 and again excluding megadeal revenue, Scale-out Storage and related service revenue has grown 49%. We introduced this metric last quarter to provide additional detail about where we are growing and the underlying health of the core scale-out product line. We have multiple megadeals in our pipeline and in the future we expect to close some of those megadeals and add additional megadeals to our funnel over time.

Turning to operating profit, due to the overall market environment, we took several series of actions this quarter to reduce our capital structure without impacting our scale-out revenue growth. The changes implemented improved gross margin and also lowered operating expenses. Although these changes had some revenue impact, they did not materially affect it.

To summarize, the impact of the changes that we took during the quarter on an $11 million sequential revenue increase that included a better revenue mix, our non-GAAP operating profit increased $13 million.

The point I want to emphasize is that these changes were made in response to a storage market that deteriorated in Q1 and even more in Q2. We have taken what we think are appropriate changes to increase overall profitability while protecting the opportunity to have substantial growth from our scale-out revenue in the future. I'll spend additional time describing the opportunity later in the call.

The last item I want to address is the continued momentum and recognition we're receiving in the marketplace for our new products and solutions, specifically Artico, our NAS archive appliance, Xcellis, our next generation storage systems powered by StorNext, and our new Q-Cloud offerings including Q-Cloud Vault and Q-Cloud Protect for Amazon Web services.

Artico provides customers including scale-out NAS users a flexible, low-cost entry point for archiving data both on premise and in the cloud. Powered by StorNext, Artico offers substantial savings but provides an ability to move large unstructured data files off primary storage to low-cost tiers of storage as Lattus object storage, tape or to the cloud while maintaining full access to all the files.

With its NAS interface and multi-tier storage support, Artico simplifies data management for customers and expands our addressable market in Scale-out Storage. As a side note, Artico was recently named a finalist in Storage Magazine and searchstorage.com's product of the year awards.

Xcellis is our next-generation high-performance storage system also powered by StorNext. Xcellis overcomes the limitations of scale-out NAS by automating and simplifying data management through a unique combination of converged architecture, continuous scalability and unified access in a single system. Xcellis consolidates multiple workflow components, simplifying the overall storage architecture operations and management as well as access to third-party applications in a StorNext environment. Xcellis users can also start with a small system and smoothly scale to the largest possible system without having to replace original hardware or take the system down thereby protecting past investments.

Lastly, by providing direct NAS support in StorNext environments, it allows all users regardless of whether they connect via SAN or NAS to access the same data within a multi-tier storage architecture that encompasses object storage, tape and the cloud. All this helps drive increased productivity and collaboration for customers and it expands Quantum's addressable market within existing scale-out verticals and to adjacent markets.

Xcellis recently won the Visionary Award at Storage Vision 2016, which recognizes companies that are advancing the state of the art in storage technologies and showcases visionary digital storage products.

In addition to adding Xcellis to our scale-out portfolio this quarter, we also released our Q-Cloud Vault series. Announced earlier this year and enabled by the release of StorNext 5.3, the new service provides cold storage in a public cloud for long-term data retention and disaster recovery. Key features and benefits beyond general cloud advantages include first, full integration as a tier in the StorNext managed workflow as automated policies and data movement. Second, no additional hardware separate of applications or programming needed. And third, straightforward pricing and billing directly from Quantum.

Customers can now use Q-Cloud Vault in conjunction with Artico or Xcellis creating a hybrid cloud solution that combines on-premise storage with the cloud. All of this reinforces the fact that we are fully embracing the cloud as part of a hybrid architecture helping customers to migrate data and maximize its value in the most cost-effective way possible.

Finally, this quarter we began offering a third cloud solution in the form of Q-Cloud Protect for Amazon Web Services. It enables customers to replicate data from either a physical or virtual DXi appliance on premise to a virtual DXi instance in the Amazon Web Services cloud. Requiring no additional applications or processes, it allows customers to sort copies of their data in the Amazon public cloud for off-site access and disaster recovery.

And because Q-Cloud Protect uses Quantum's patented de-duplication, customers can minimize the cost associated with transferring the data over the WAN and storing it at the Amazon cloud.

I will now walk through our financial results in detail. Before I do so, I would like everyone to refer to the financial statements and supporting schedules included in the press release and on our website. It will be helpful to reference those documents as I comment.

Total revenue for the quarter ended December 31 was $128 million compared to $142.1 million a year ago. Non-royalty revenue totaled $116.8 million of which 89% was branded and 11% was OEM compared to 88% branded and 12% OEM a year ago.

As I mentioned above, product and related service revenue for our Scale-out Storage solutions was $35.7 million, an all-time record and a 31% increase year-over-year. We have grown quarterly revenue from our scale-out solutions on a year-over-year basis for 18 consecutive quarters.

Revenue from large deals, those in excess of $200,000, was up nearly 50% compared to the same quarter in the prior year. Our Scale-out Storage momentum was particularly strong in surveillance which grew nearly 300% during the first nine months of fiscal 2016 and technical applications which grew 165% during the same period. I would also note that our growth was driven by North America and EMEA and that the number of worldwide partners selling our scale-out solutions increased 32% over the same period last year.

Overall win rates for the quarter remained strong at 77% and we added over 120 new scale-out customers in Q3.

Turning to our data protection products, our revenue in this area were impacted by the overall market weakness in both general storage and data protection and backup. In total, tape automation systems and related service was $51.2 million for the quarter compared to $66.7 million in Q3 of fiscal 2015.

OEM tape automation and related service revenue was down $1.2 million or 9% year-over-year. This reflected lower sales and entry in midrange libraries partially offset by an increase in enterprise revenue.

Branded tape automation and related service decreased $14.3 million or 27% year-over-year due to lower revenue in all product categories. Revenue from large deals, those over $200,000, was down 40% from the same period in the prior year. However, our win rate remained strong at 76% and we acquired approximately 80 new branded midrange and enterprise customers.

Disk systems, backup and related service revenue was $19.6 million, down $4.4 million from the prior year. Revenue from large deals increased slightly by 4%. Overall, DXi win rates remain strong in the upper 60th percentile and we added over 50 new customers in Q3.

Finally, as it relates to data protection, devices in media revenue totaled $10.2 million in Q3 down from $13.5 million in the prior year due primarily to lower media revenue. However, there continues to be significant pricing pressure on tape media products and we continue to make conscious decisions to not pursue unprofitable revenue opportunities.

Moving to service, it was $37.1 million in Q3, down 5% from $39.2 million in the same quarter last year. The decrease was primarily driven by the decline in service contracts for tape automation systems partially offset by growth in contracts for Scale-out Storage solutions.

Royalty revenue was $11.3 million, up 5% from $10.7 million a year ago. LTO-6 royalties grew 133% offset by a decrease in royalties for LTO generations 1 through 5. LTO-7 launched during the quarter and is expected to grow in future quarters.

Turning to gross margins, non-GAAP gross margin was 44.6% in Q3 compared to 46.2% in the third quarter of fiscal 2015. This decline is attributable to year-over-year decrease in total revenue and a decrease in material margin related to changes in our overall mix for the quarter.

Higher-margin service revenue decreased $2.1 million and lower margin products comprised a larger portion of the product revenue. In addition, the pricing environment is tougher than it was a year ago. These impacts were partially offset by a $600,000 increase in royalty revenue and the cost management actions we took during the quarter.

Comparing sequentially, non-GAAP gross margin increased from 39.9% in Q2 to 44.6% in Q3 due to revenue growth, revenue mix and the implementation of the cost management actions we took during the quarter.

Looking at expenses, non-GAAP operating expenses decreased $2.1 million totaling $49.9 million in Q3 compared to $52 million in the prior year. Year-over-year, our research and development expenses declined $2.6 million primarily as a result of lower salaries and benefits due to lower headcount, benefit savings and no bonus expense in Q3 of fiscal 2016.

Sales and marketing costs increased $1 million primarily due to higher marketing spend in markets with significant growth opportunities partially offset by lower commissions due to lower revenue. Sequentially despite the increase in revenue, total non-GAAP operating expenses decreased from $52.5 million in Q2 to $49.9 million in Q3 due to the cost management actions we took during the quarter.

Q3 non-GAAP operating income was $7.2 million compared to $13.6 million in the same quarter a year earlier. This represents a non-GAAP operating margin of 5.6% for Q3. As I mentioned earlier, but I want to repeat the point given its significance, non-GAAP operating income increased $13 million sequentially on an $11 million increase in revenue.

Interest for the quarter was $1.4 million which included cash interest expense of $1.2 million and amortization of debt issuance costs of $200,000. Interest expense decreased $1.1 million from a year ago as we repaid our convertible debt due November 15, 2015, during the first and third quarters of calendar 2015.

The average interest rate for our $138.9 million of remaining debt was 3.88%. In Q3, other income was less than $100,000. We recognized tax expense of $400,000 primarily related to foreign and state taxes.

We had non-GAAP net income of $5.3 million or $0.02 per share compared to non-GAAP net income of $10 million and $0.04 a share in the same quarter last year.

Let me now turn to cash flow for the quarter and the balance sheet. Cash flows used in operations for the quarter were $13.6 million. On a sequential basis, accounts receivable increased $9 million and manufacturing inventories declined $4.4 million. EBITDA for the last 12 months was $15.8 million. CapEx was $1.2 million. Fixed-charge coverage ratio was 1.73.

At December 31, our debt consists of $70 million of convertible debt due November 2017 and $68.9 million of outstanding borrowings on our Wells Fargo revolver. At December 31, we are in compliance with our debt agreements and expect to be in compliance with them over the next 12 months.

During Q3, we repaid $83.7 million of convertible debt due November 15, 2015. On October 5, we repaid $81 million of these notes for $82.4 million, which included $1.1 million of accrued interest and resulted in a $400,000 loss on extinguishment of debt.

On November 13, we repaid the remaining $2.7 million of notes plus accrued interest. To fund these transactions, we used a combination of cash on hand and $68.9 million from our $75 million revolver. Including our January 2015 repayment of $50 million of these notes, we repaid the original $135 million balance of the convertible debt due November 15 with roughly equal repayments from cash generated from operations and our revolver.

In summary, despite an overall difficult environment, we improved our balance sheet, adjusted our spending levels, delivered solid profitability that significantly improved sequentially, delivered record scale-out revenue and related service of $35.7 million despite no megadeals and still positioned Quantum to have a significant opportunity to grow in the future.

I will spend the next few minutes describing that opportunity and strategy and then provide guidance for the fourth quarter.

We believe we are well-positioned to grow scale-out revenue and increase overall Company profitability. To do so we will build on the momentum in three main overarching categories. First, video, which includes media and entertainment generally and specific use cases such as corporate video and sports video, animation and visual effects.

Second, intelligence and surveillance, which encompasses government, video surveillance and network forensic use cases. And third, technical applications, a broad category that includes oil and gas, geospatial applications, genomics and other scientific research.

What all of these have in common is demanding workflows involving large, valuable data files that must quickly be captured, cost effectively retained for analysis or reuse and made easily available for sharing and collaboration. In other words, these markets and use cases require storage that provides high-performance, low-cost capacity and easy access, and our ability to provide all three attributes in a single integrated tiered storage solution encompassing flash, spinning disk, object storage, tape and cloud is very differentiated.

In fiscal -- to date in fiscal 2016, all of these market categories have grown and contributed to our scale-out revenue growth despite the lack of megadeals this year and we have built a foundation for growth into the future.

I want to spend a few more minutes on the storage opportunity for video surveillance which is growing rapidly. There is a move to higher resolution cameras, more and more cameras and much longer retention times for captured video. All of this drives requirements for more storage and the numbers are staggering. Storage Newsletter published an article yesterday that indicated that 566 petabytes of video surveillance data is produced daily by the cameras that were installed in 2015.

To add some further context to the magnitude of that, a typical large discount retail store would have 500 to 600 cameras per store. Our video surveillance initiative began at the start of this fiscal year. Since that time we have certified storage solutions with a broad range of industry leading companies including video management system companies from 3VR, [PoE Netis], Genetec, Milestone and IP-video solutions from Arecont Vision, Access Communication, and Hotspot Networks.

In addition, we signed up the leading global distributor for video surveillance along with dozens of new reseller and integration partners who specialize in surveillance and security solutions.

So why are we so excited about this opportunity, and why are those entities excited about using scale-out solutions from Quantum?

First, it's our performance. We can handle more cameras per server than our competition. This lowers the overall cost of the solution.

Second is our ability to tier the stored video to lower-cost storage on tape or to the cloud. This also lowers the overall cost of the solution. To put numbers behind this, a video surveillance project of 500 cameras or more would result in storage making up 50% to 60% of the total cost of the project with cameras, servers and software making up the bulk of the balance.

With the Quantum scale-out solution, we lower the cost of storage to 27% to 33% of the total cost of the project, or roughly half the storage cost. As a result, integrators can add more cameras for better coverage or provide a longer retention period for better analytics or just save the customer money by using Quantum Scale-out Storage versus the competition. This business alignment with the ecosystem partners in video surveillance is why we have been able to make so much progress so quickly during the nine months since we kicked this initiative off. We're very excited about this opportunity and we're just getting started.

To date these partnerships have led to customer wins at a large government agency, a major metropolitan shopping mall, a large public transport organization and a state-of-the-art data center.

Moving on to data protection, our strategy is to continue to leverage our technological leadership, our extensive customer base and our channel and technology partnerships to generate profit and cash from our offerings. While the enterprise storage market is clearly challenging, our best-of-class technology in both disk and tape and the tight integration of the two are our key strengths in data protection. We also believe that customers are looking for new ways to manage and preserve their data seeking alternatives to traditional backup. We've seen this transition in demanding markets like M&E, oil and gas and the federal government applications where tiered storage and archiving is deployed instead of batch backup.

We expect this to happen in the data center and will aggressively position our archiving solutions like Artico, Lattus and Q-Cloud Vault as superior approaches to unstructured data management.

In December, we began offering LTO-7 technology in our Scalar tape libraries, with our StorNext AEL archive libraries to follow in subsequent months. This latest generation of LTO tape offers a low-cost, highly energy efficient long-term storage solution for organizations struggling to manage the massive growth of unstructured data and maximize the value of their digital content.

We are well positioned to capitalize on LTO-7 as the long-standing market share leader in LTO-tape automation and the fact that our Scalar and StorNext AEL systems deliver best-in-class management, monitoring and data protection.

We also continue to engage with other ecosystem players in data protection around opportunities for collaboration as in the case with our new Veeam partnership. By bringing together Veeam backup and replication software and our QXS storage and DXi de-duplication appliances, we are enabling customers to restore files in just seconds and virtual machines in minutes while reducing both on-premise and disaster recovery site storage costs compared to traditional backup applications. This combination also shortens backup windows and dramatically simplifies VM backups.

As we look towards the remainder of the fiscal year and into fiscal 2017, we believe we are well positioned to deliver significant value to customers with long-standing expertise and a powerful product portfolio. We also believe that our focus on growing Scale-out Storage revenue, unleveraging our data center installed base and infrastructure and increasing overall profitability is how we best can deliver shareholder value.

Now let me close with guidance for the fourth quarter. As you may recall, we didn't provide any guidance for Q4 on the last conference call just given the market conditions, so this will be our first guidance for the quarter.

Based on the current market conditions, we expect revenue of $118 million to $122 million. But I would like to highlight two additional factors that are important to understand when we're considering the guidance.

First, that revenue range does not include any of the megadeals that we're working on. One of more of them could close in the quarter but the timing of them is too uncertain to include them in our forecast.

Second, the pricing of commodity products in the market, specifically tape media, remains quite challenging and as was the case in Q3, we'll manage our tape media revenue to maximize profitability versus trying to maximize revenue.

We expect non-GAAP gross margin of 43% to 44%; non-GAAP OpEx of $48 million to $49 million. One note that this quarter we expect typical seasonal increases in OpEx in spending due to payroll taxes, which reset January 1 and sales commissions that increase for people who hit their annual compensation accelerators. We expect $1.5 million in interest, $400,000 in taxes which results in non-GAAP EPS of zero to $0.01.

With that, I would like to turn it over to the operator for questions.

(Operator Instructions). Eric Martinuzzi, Lake Street Capital Markets.

Thank you. Regarding Linda's departure, is she staying in the same industry? In other words, is she moving to another storage or data protection company, or is she pursuing an opportunity outside of the industry?

I'm going to ultimately let her disclose where she's going, but it is not in storage or IT.

Okay. And then as far as where the numbers came in for the current quarter -- I know you guys don't give guidance by product line or expectations by product line, but I think on the product side I was actually surprised -- usually I'm wrong on tape and devices and media, and this time I was wrong on backup and the scale-out. Understanding that the scale-out did in fact grow, which is great but didn't grow as much as I thought. Let's start there. That's a product that you've been able to grow pretty well in excess of 50% and then down to 40% and if I look for the year now we're averaging about a 30% to 35% growth. What's the expectation for scale-out growth going forward?

That's a great question. As you know, Eric, we broke out the concept of megadeals this year that we just haven't had anywhere near the magnitude and we had none this quarter and a megadeal is a deal over $1 million. That obviously contributed a lot last year.

When we exclude the megadeals, your 30% to 35% is correct. When we exclude the megadeals and just look at the underlying health of the business, we're growing at just under 50%. We're at 49%, I believe, for the first nine months.

I would say -- people have asked me, what is the characteristics of a megadeal? I could tell you a story about each one of them. They all have a different cadence to them. Generally where they are common or consistent is that they are large re-architectural type designs which are very cross functional in nature and take time to plan and implement. And they are also high value type deals.

In my prepared remarks, the 30% to 35% is right. Even in our midrange the $200,000 to $1 million, we grew 50% year-over-year. So we do have good momentum underneath the core of the business, which is kind of the overall health. We've just lacked any of these real large deals that we've been -- pursuing is not the right word because we know where they are, they just need to decide to close them.

So that rolled into our guidance as well. We felt like rather than handicapping whether or not those will close in the quarter we would just exclude them and give the guidance without them and then continue to drive to close them.

Okay. And then the DXi business, we're in decline there. It's obviously not where you guys want to be. You talked about your win rates being pretty strong, so when you are seeing deals you are winning them but obviously there is price competition out there, there's a macro issue.

Address the macro demand; what's going on now, where do you think that heads? And nobody is happy with a minus 18% comp when I look at the disk backup in service versus a year ago disk backup in service. Is that sustained or is there some relief?

We took out roughly $5 million of costs during the quarter and as we said at the last quarter and I repeat it again here, our goal there is to not reduce the opportunity in scale-out and so those costs are very much centered around the data protection side of the Company.

What happens when you do that is you just don't spend incremental dollars trying to drive revenue there and so there's a trade-off. You get some profitability but you'll have some revenue impact.

What's going on there is the data protection products sit behind storage, which sit behind servers and if you've seen -- I think one of the big storage companies reported today -- one of the big OEMs reported last week, those businesses are under pressure. We don't sell backup unless there's something to back up. We don't sell primary storage there. So we are really focused our investment and incremental growth opportunity with scale-out. We think we're very differentiated there. We think that the data protection products are important and a key part of our cash flow and our profit and that's why I don't take a lot more costs out because if I did we're going to be less profitable.

We are still investing in scale-out and we went to continue to do that. We think the market got better this quarter. It was more predictable for sure even though the results from last quarter or year-ago quarter are down. Sequentially it was much better. I said on the last call tape and DXi would grow sequentially. They both did. We thought scale-out would grow and, as you pointed out, it did.

So we're trying to manage both things. We are trying to manage profitability and the cash flow from the data protection and make wise choices there and not take away from the opportunity that just keeps materializing for us on scale-out. I just don't know of any other major storage type vendor who is growing at the 30% plus range this year, or has -- we grew that same product line 70% last year.

And just a layer deeper on the two new offerings. Xcellis, is there a TAM expansion here, or is this kind of just the evolution, the next-gen scale-out -- sorry, the workflow solution? And then the Q-Cloud, is there a potential -- always looking for you to be playing in new markets here (multiple speakers) top line growing again?

Yes, Xcellis, actually what is great about that product is it's both things. It's the next generation but it also enables an expansion by adding the cloud capability, by adding the NAS connectivity and the thing that's real nice about it, it simplifies the implementation for customers so you don't have to have as many specialty pieces, which allows us to kind of get into more run rate type opportunities, which as I mentioned earlier, we've been growing at a quite high clip, 50% plus year to date. So we're excited about that.

It's been really well received. It actually -- we had to buy more of them during the quarter. We brought it out pretty late in the quarter right around Thanksgiving and then we had to go find more, so we're excited about that.

We think that the ability to use Amazon as a tier for cold storage is important. We are big supporters of the hybrid type model. When you use the Amazon cloud with StorNext it just looks like one big name space, or for non-technical people like me, one big C drive. It virtualizes over the top of all the storage including Amazon. And we've had a lot of positive feedback about its applicability. So we like it a lot. And we do think it expands our market opportunity.

Okay. Thanks for taking my questions.

Chad Bennett, Craig-Hallum.

Good afternoon. Thanks for taking my questions. Jon, in the guidance you gave for the March quarter, backing out the big deals which I think is the right way to think about it, I guess that would imply relative to estimates the guidance range is kind of everything's equally lower relative to expectation kind of across product groups and that includes scale-out?

To be fair, Chad, I didn't actually compare your guys' -- the consensus by product to what we did. So my guess is that's the case but for instance, data center media last year, we did like $16 million. The quarter we just did was $7 million or $8 million, so I think it's probably more heavily weighted towards data center. Also on the cost side, we are about $5 million lower between OpEx and margin than the consensus was. Some of that is going to impact on the revenue side. Most of that will be data protection is what we think. So, yes, I guess everything is lower including expenses and gross margin is higher.

So you said this recently at a conference that your goal was 50% scale-out growth this year and so I'm assuming we're not expecting 50% scale-out growth this year?

What I actually said at the conference and in the last call and today is, to get to 50%, we would need big deals to close to get there. We said that last quarter. It was in -- at the Needham Conference we talked about that extensively. We've excluded those from -- any of those from our guide. So implicitly they are not in there. We just had a record quarter. I think you can assume sort of the 30% to 35% rate without big deals and then if big deals close it will be higher. Everything will be higher.

So tape -- from a product standpoint -- tape product was down 30% year-over-year off of a down 22% last year. Disk was down 26%, so I guess you're implying that if you cut more cost, those numbers would be even worse?

Yes. I'm not implying it. That's what I'm saying. We're trying to maximize for profit there, so the easiest one to talk about is tape media. I mentioned the $16 million. If I added back $3 million or $4 million of media this quarter, we would be in the midpoint of the range on revenue but we probably would be lower than the midpoint that we delivered on profit. And that's just because this market dynamic of these last three quarters has been very, very brutal on pricing. People much bigger than us are setting the table on what the price is and we're not going to chase that.

That happens in other parts of the business as well but media is the easiest place. So we're trying to balance revenue versus profit but the goal is profit first on the data protection side, revenue second and then on the scale-out side, it's about delivering growth.

Okay, so how should we think about -- I know you don't want to give guidance for next year, obviously, but as the tape business continues to decline, as the disk business continues to decline, and as the scale-out business grows but maybe not at the growth rate we were thinking, what's kind of the path to service to debt?

Yes, so the path to growth, which is what would have to ?- what we're trying to talk about here is two things. One, we took out roughly $20 million of annualized costs to reflect the decline off of last year's record revenue to match those up. We think scale-out has a ton of opportunity. When you look at that expense run rate and look at the margin and the growth opportunity, we'll generate cash. Our plan will be to look at the alternatives around the debt both in terms like we have in the past which have included refinancing and using our own cash. And we also -- half of that debt is a convert.

Okay, great. Thanks.

(Operator Instructions). Brian Alger, ROTH Capital Partners.

I guess what I'm struggling with is, on many levels, it sounds as though the scale-out business is going really, really well. You talked about triple-digit kind of growth for this surveillance business, specifically you've talked about deals over a couple hundred thousand dollars being very, very strong. But I think by every measure the total growth for the business isn't matching our expectations, and I suspect not your expectations either, with or without the big deals here. As we look at that business in this challenging environment with enterprises delaying and doing everything else, are we expecting quarter on quarter the scale-out business to grow here in the March quarter?

Yes. We are.

Okay. (multiple speakers)

Earlier what I said to Chad's question, or maybe it was Eric's; I can't remember, I think without big deals this sort of nine months, 31%, 32% growth rate is that's kind of what we've -- each quarter has been about the same and it's really the magnitude of these big deals that -- and it's not an insignificant amount. It's a $9 million or $10 million number that we have to replace and then grow 50% on top of to replace these large deals. So our run rate business is great. As I said, it?s at 49% when we take out the megadeals.

Right. And I understand the math here. If we're talking 30% to 35% growth off last year, that effectively implies that our product sales are only going to grow about 20% year on year here in the March quarter, which kind of continues this downward trend that we've been seeing in the past several quarters.

I am just trying to understand or put that in context when we have the compounding effect of the surveillance business coming on top of media and entertainment. Have we gotten to a point where the M&E side is saturated and all of the growth is coming from surveillance? Or just really what's going on in there because we should be delivering more growth despite the macro environment even without these megadeals.

Let me see if I can add a little more color to that. I think -- I just want to make sure I've got the math right. For M&E, most if not all the megadeals were in M&E, so the M&E growth below megadeals is strong. Overall it's relatively -- it is slightly up. I don't know what the exact percentage is, but it's up. But most of the megadeals are M&E. So that's point one.

Point two is, surveillance is brand-new. Our comps are minimal. As I said we started the initiative this year. We had some surveillance deals that we walked into that turned into a real focused practice.

The thing that has been the most -- growing the fastest in terms of dollars is really this other group that we call other, and the reason that's important is it is kind of a cross vertical opportunity for us. And how we're growing that is we're leveraging our specialists in scale-out but also our broader sales force who we sell backup and data protection products from.

So what we said for a long time is that we think these requirements that we see customers have are going to tip and become more horizontal. We're seeing that a lot this year. And a lot of growth is coming from that particular use case, which is a handful of use cases.

So to summarize real quick, I think next year's scale-out growth will come about from continued growth in M&E. We will have megadeals in M&E again. It's just that has not been the year. We've had some great wins, some high-profile wins and it is growing at a good rate, if you exclude the megadeals.

Surveillance is a brand-new opportunity for us. It's not super material yet. It could become material quickly. And then the real solid thing for the year is this third category that we call technical workflows. I kiddingly call other. And it's across solutions where our performance and our tiering, our ease of access are relevant where people want to have access to a lot of data with real high-performance. And that, we think, will continue.

We think our TAM is expanding. I don't know how to -- you guys cover a bunch of storage companies. I don't know how to -- I'm happy to talk about a storage company of $150 million to $200 million in run rate that's growing 30%. I just don't think there's that many.

Understood. Shifting gears, if I can. Obviously we've restructured the financing. With the new line of credit, are there any major covenants tied to that we need to be aware of whether it's working capital or EBITDA thresholds that we (multiple speakers)?

The only major one is a fixed-charge coverage, one that's in the agreement. We were at [1.72], I think I had it in the script. The covenant itself was 1.2. That's the only one.

Great. All right. Thanks, Jon.

Tim Klasell, Northland Securities.

I know we're beating this horse to death here but on the media business, you said the run rate business is totally steady and providing some nice flow. My question is, are these run rate deals -- are they just adding capacity, or are you seeing new customers come on board with the five-, six-figure type deals?

Yes, you are speaking to not tape media but media and entertainment? Yes. I had in the script, we've added 120 new customers during the quarter. I think that might be a record, pretty darn close for scale-out. I didn't have anybody check that out but that's over 100. Our record I was told is 130, so that's a strong quarter.

It's indicative -- I'm trying to give you guys clarity about what's going well and what isn't going well. Scale-out is going quite well, except for a handful of deals last year that we closed, which is great and more than a handful of deals this year that haven't closed yet that continue to be opportunities for us.

Okay, clear enough. And then second question -- sorry, I got on the call late -- the royalty business actually did a little bit better than we thought and that would actually indicate that maybe that the overall tape market is maybe better than what we thought. Can you walk me through that?

What are you seeing in the overall -- I know it?s in decline -- but is it maybe a little bit better than what your numbers would indicate and you guys are just holding firm on price, or maybe you could walk us through that?

Yes, there's a couple of things. If you recall last quarter, media royalty came in I think about $1 million below what it had been running at and so if you -- I said -- I got asked this on the last call, if you sort of normalize, media has been pretty flat for the last six, seven quarters. It's fluctuated very little. That's the royalty.

When we're talking about tape in media, that's a commodity product. As I mentioned, we did about $16 million in Q3 a year ago. If we do $16 million this quarter, it will be because pricing was such that it made sense for us to sell it. We're trying to generate profit there and we are just not going to sell anything where at the bottom line or at the operating line it doesn't yield positive dollars because that's not what we're doing.

So if you think about media, it is a variable up or down. It's not super high-value revenue to the financials. It can be important to the customer. They will like buying it from us. Some people insist on it. So that's why we carry it. But it has become a pretty wide ranging revenue item that I'm sure drives you guys crazy. At some level it bothers me.

But taking it out in space, you can look how high our gross margin is this quarter compared to last and you can see not what the media market can do and what the cost changes we made does. So we're trying to manage that very actively and hopefully it will get better as the overall market gets better. Maybe some of these larger companies will be less willing to drive price down. We'll see.

The data protection market is what we're talking about. Everybody lumps tape into one category. We include tape -- we sell a lot of scale-out tape. Remember our secret sauce in scale-out is the fact that we have tiered storage, including tape. So we sell tape, the product, in scale-out as well. And our overall archive has been growing.

When you look at the tape media royalty, it doesn't discern between how people use the tape. And we see a growth in tape across use cases, so data protection, archive, even cloud providers, I think, will be using tape media as time goes on here as they drive costs out. So that royalty does have potential.

The other element to the royalty is LTO-7 just launched and historically when you launch -- not historically -- practically when you launch a new media type, the royalty rate for that media type goes up. It's higher than the rest of the media.

Okay, great. And then one follow-on. If you take a look at your scale-out pipeline, how much of that is coming from -- directly from your scale-out sales force and how much comes in from their traditional backup archiving tape and StorNext distributors and channel?

Yes, so we have a real separate channel for M&E. It's a separate ecosystem and so it's about 50/50 that comes from the channel and comes from us, I think, is the last stat I saw. We're seeing an increase in scale-out opportunities in our traditional Quantum backup customers. I brought that up twice in the script. I want to emphasize it.

And the reason I do is one of the ways that the model gets such good leverage is we'll get scale-out growth by using data center resources, if you will. And so we get the best of both worlds. We get leverage and better profitability but we also get scale-out growth.

The reason for that is both our product positioning and our solutions, our messaging, but also the fact that we've got -- we have a lot of customers that we can call into. So that's when I talked about in the script, we're going to leverage that as these use cases broaden out.

Surveillance, I think the overall sales team is probably the most excited about the surveillance portfolio because surveillance is everywhere, whereas M&E, the big centers of M&E are London, New York and LA. So your ability to sell an M&E solution if you are selling in Denver, Colorado is pretty limited. But there is a lot of surveillance opportunity.

So what we like about where the market is headed is it's headed in a direction that fits with our attributes. We think we have a lot of opportunity. We are really hunkered down right now by implementing these cost plans to drive profit. We're going to do that in Q4 again. We want to close some of these big deals which gives us some nice upside in both profitability and revenue. But I don't feel like we're in a position to forecast those and provide guidance on them and so we're just going to have to work to close them during the quarter.

Okay. Good enough. Thank you.

Thank you. With no additional questions, I'd like to go ahead and turn the floor back over to our speakers for any additional or closing remarks.

Great. Thank you very much for taking the time today and listening to the call. As a reminder, March is our fiscal year end and so our call will be a little later as we get through the close process and the audit. Again thanks for your time and we'll talk to you next quarter. Thanks very much.

Thank you. And again, ladies and gentlemen, that does conclude today's conference. Thank you all again for your participation.