Quantum Corp /De/ Q3 FY2021 Earnings Call

Good afternoon, everyone, and thank you for participating in today’s Conference Call to discuss Quantum’s Financial Results for the Third Quarter of its Fiscal Year 2021. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to Leanne Sievers with Shelton Group.

Good afternoon. And thank you for joining today’s conference call to discuss Quantum’s third quarter fiscal 2021 financial results. I’m Leanne Sievers, President of Shelton Group, Quantum’s Investor Relations firm. Joining me today are Jamie Lerner, Chairman and CEO; and Mike Dodson, CFO. This afternoon we issued a press release which you can access a copy on Quantum’s website at www.quantum.com, under the Investor Relations section. There is also a slide presentation that we will be using in conjunction with today’s call that may be accessed through the website link on the IR website and is also posted as a PDF in the Investor Relations section. As a reminder, comments made during today’s conference call may include forward-looking statements. All statements other than statements of historical facts can be deemed as forward-looking. Quantum advises caution and reliance on forward-looking statements. These statements include without limitation, any projections of revenue, margins, expenses, adjusted EBITDA, adjusted net income, cash flows or other financial items, as well as the anticipated impact of the COVID-19 pandemic on Quantum’s financial results, any statements concerning the expected development, performance and market share or competitive performance relating to products or services. All forward-looking statements are based on information available to Quantum on the day 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 the 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 Security and Exchange Commission, 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 SEC. 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. Additionally, the company’s press release and management statements during this conference call will include discussions of certain measures and financial information and GAAP and non-GAAP terms. Included in the company’s press release are definitions and reconciliations of GAAP to non-GAAP items, which provide additional details. Those of you unable to listen to the call at this time, a recording will be available for at least 90 days in the Investor Relations section of Quantum’s website. Now, I’d like to turn the call over to the Chairman and CEO, Jamie Lerner. Jamie, please go ahead.

Thank you, Leanne, and thank you all for joining us on today’s call. Earlier today, we announced very solid results for our fiscal third quarter, with revenue exceeding our guidance and demonstrating our second consecutive quarter of sequential growth coming off the COVID-related lows in the first fiscal quarter. Also, as outlined in the press release, we expect next quarter revenues to be well over the current street consensus and sequentially flat in what is typically a seasonally weak quarter. I’m encouraged by the progress we are making in our transformational growth initiatives, as well as the gradual recovery we are seeing in some of our core vertical markets. Our results in the third quarter reflected a combination of factors, including initial recovery in our core media and entertainment and data protection businesses, as well as sequential and year-on-year growth in new use cases and markets driven by new product introductions and our recent acquisitions. I’ll talk about some of these highlights in a moment. We also made significant progress during the quarter in terms of advancing our strategy and vision to be the leader in video and unstructured data solutions. During the quarter, we expanded our portfolio of solutions to store, manage and protect unstructured data across its lifecycle, while advancing our transition from a hardware-centric business that is representative of a one-time purchase to a software and solutions-oriented company with a recurring revenue model. In November, we introduced StorNext 7, our altering file system ATFS and an expanded ActiveScale object storage portfolio, all of which are targeted to be available on a subscription basis. StorNext 7 is the latest version of our award-winning file system. We’ve added new features so that our customers can leverage the performance of NVMe storage to speed up production, reduce data center costs and simplify their network infrastructure. We’ve also made StorNext 7 easier to manage with a streamlined and simplified user interface. Our ATFS network-attached storage platform offers new levels of visibility into data by integrated data classification. It is easy to deploy, easy to use and prospects can download and install ATFS to trial it and see how it can help them better manage their valuable file data. We also expanded our ActiveScale product line with new models and new features to help customers secure their data against ransomware and other forms of cyber attacks. Although in the very early stages of ramp-up with customers, we are encouraged by the early traction we are seeing in fiscal Q3 from these new products. Also, earlier this week, we announced the launch of the H2000 Series of hybrid storage arrays based on the same software-defined architecture as our award-winning F-Series. This new line is more tightly integrated with StorNext and as a platform, it is the basis for future product offerings, such as an all-in-one media appliance that will run StorNext and CatDV in a single H-Series hyper-converged storage server. We also added CatDV to our portfolio in December through our acquisition of Square Box Systems. CatDV is an AI analytics software platform that helps customers unlock the business value in their data and also adds the growing and profitable software business unit to our portfolio. We are already working on integrating CatDV with our StorNext product to expand our market reach in growing video production segments such as corporate video, sports, government, and education markets. We see potential to eventually expand the software to other markets such as genomic research, autonomous vehicle design, geospatial exploration, and any use case dealing with large unstructured data. We are excited about the potential to grow and scale this business as an AI analytics platform for video, digital images, and other forms of valuable file data. With the addition of CatDV along with other new products we’ve introduced in the last year, we have now built a comprehensive portfolio for analyzing and enriching video, storing and protecting data, and managing it across its lifecycle. Our expanded portfolio further solidifies our leadership position in video and unstructured data solutions. And we are seeing the results materialize, with our average deal sizes steadily increasing as we sell more solutions with more services wrapped around them. Some of the additional highlights from fiscal Q3 include 24% sequential product growth, driven by a combination of market recovery and contributions from our new products and initiatives. Our revenue contribution from new products was up significantly year-over-year and quarter-over-quarter, and although we are starting from a small base, we are encouraged with how our expanded portfolio is resonating with customers and partners. We closed our first software subscription deals for the new products we introduced in November, and we had a solid ActiveScale quarter after rebuilding the pipeline in the first part of this year. We are also pleased with the progress we’ve made transitioning from product to solution sales. Our average deal sizes have been increasing steadily over the past two years and increased 24% year-over-year. We closed a record number of six and seven figure deals in the quarter. We are deploying larger and more complex solutions, and as a result, are increasing our footprint and relevance at key customers and partners. We’re also doing a better job of attaching services, which further contributed to the robust size of these wins. Although our hyperscale business is lower in the first nine months of our fiscal year than the same period last year, for the current quarter hyperscale revenues grew sequentially and year-over-year. We expect for the full year the hyperscale business will be nearly at the same level as last fiscal year. As I’ve been discussing with you in the past, working with these important hyperscale customers has enabled us to truly showcase the competitive advantages Quantum offers and the unrivaled expertise and unique customization that our engineering team is able to provide. These relationships not only help establish strong market credibility for Quantum, but also enable us the opportunity to sell high-value solutions to meet their archiving storage needs. Providing archive solutions and infrastructure to the world’s largest hyperscalers will continue to be a growth driver for us. And we are now extending our leadership position in that market and bringing it to web scale companies, as well as large enterprises. Many of these organizations are also generating massive amounts of valuable unstructured data that must be kept indefinitely, and much of this will not reside in the public cloud. This will be a key initiative for us as we move forward and represent a larger opportunity to deploy Quantum software and services along with tape hardware. Lastly, as further validation of our vision and transformation strategy, over the past few months, we have continued to attract a very high level of top storage, software and services talent to Quantum. Most recently, Brian Pawlowski joined us as our Chief Development Officer, bringing years of experience developing leading innovative storage solutions. As Chief Architect at Pure Storage, Brian improved overall user experience for all flash storage platforms. Previously at NetApp, he was the 18th employee playing a key role in the company’s expansion over nearly two decades, and early in his career, he served as co-architect of the network file system protocol at Sun Microsystems. We also appointed Rick Valentine as our SVP and Customer Service Officer with deep expertise in building and leading services and as a service businesses, including Silver Peak Systems, where he is working and improving the overall customer experience contributed to its acquisition by Hewlett Packard Enterprise. Rick also worked as Chief Customer Officer at Symantec and Veritas Software, leading customer success for the technical support software portfolio. We have also added key executive talent in international and channel sales, with a specific focus on expanding our depth of expertise in advanced software solutions. Dave Clack, the former CEO of Square Box Systems, has been appointed General Manager for our newly formed Cloud Software and Analytics business unit. Prior to Square Box Systems, Dave worked as Head of Technology Delivery and Deputy Chief Technology Officer at LMAX, a diversified financial technology company. In addition, Dave was Director of Engineering, Project, and Program Management at McAfee. His success in attracting key experienced industry talent is a testament to our business transformation strategy and will accelerate our transition to a software and services-led business. With that, I’ll turn the call over to Mike Dodson, our CFO, to discuss the financials. Mike?

Thank you, Jamie. Welcome to everyone who has joined our call today. As Jamie mentioned in his opening comments, our third fiscal quarter 2021 demonstrates the continued sequential revenue growth for the second consecutive quarter from the COVID-related low reported in the March 2020 quarter. Revenue increased 14% sequentially to $98 million, exceeding our guidance of $91 million to $95 million, compared to $85.8 million in the previous fiscal quarter. Revenue growth in the quarter was driven by sequential increases across the revenue categories on our primary and secondary storage systems, royalty, devices and media. This reflects a broad-based recovery across our traditional market verticals, combined with increasing contribution from our new products as our software strategy is resonating with customers. We are also encouraged by the early signs of a recovery in our media and entertainment business. Keeping in mind, the year-to-date revenue is running just over half of last year’s level for the same period. This reflects the significant impact COVID has had on this end market segment. Gross margin in the third quarter was 43.1%, compared to 45.1% in the prior quarter and 45.6% last year. The sequential and year-over-year decline is primarily due to product mix, with product revenues up 24% sequentially, and to a lesser extent, lower contribution from service and royalty revenues on a year-over-year basis. GAAP operating expenses in the third quarter increased $1 million to $36.2 million or 36.9% of revenue, compared to $35.2 million or 41.1% of revenue in the prior quarter and $35.4 million or 34.3% of revenue in the year ago period. Non-GAAP operating expenses during the third fiscal quarter were $33.7 million, an increase of $2.6 million sequentially and $0.7 million on a year-over-year basis. The sequential increase in operating expenses was primarily due to an increase in sales commissions due to the higher product revenues, as well as an increase in marketing efforts to support our new product releases and expansion of our leadership team. GAAP net loss in the third fiscal quarter was $2.7 million or a loss of $0.07 per share, compared to a net loss of $4.6 million or a loss of $0.11 per share in the prior fiscal quarter and net income of $4.7 million or $0.10 per diluted share in the year ago quarter. Excluding stock compensation, restructuring charges and non-recurring charges, our non-GAAP adjusted net income in the third fiscal quarter was $10,000 or breakeven on a per share basis compared to adjusted net loss of $212,000 or a loss of $0.01 per share in the prior quarter, adjusted net income of $7.3 million or $0.116 per diluted share in the prior year period. The share count used to calculate GAAP loss per share was 40.3 million shares, whereas for non-GAAP the fully diluted share count is 49.2 million shares due to the profit in the quarter. Adjusted EBITDA during the third fiscal quarter was $9.4 million, an increase from $8.9 million in the prior quarter, but down from the pre-COVID peak of $14.7 million in the third fiscal quarter of 2020. There’s 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 the balance sheet, liquidity, and cash flows. Cash and cash equivalents were $17.4 million at December 31, 2020, compared to $12.3 million at March 31, 2020. Both balances include $5 million in restricted cash required under the credit agreements and $0.8 million of short-term restricted cash. Adjusted working capital increased by $6.8 million during the third fiscal quarter to $66.7 million from $59.9 million at the end of the prior fiscal quarter. Outstanding debt at December 31, 2020, on a gross basis was $201.2 million and on a net basis was $180.2 million after netting $21 million in unamortized debt issuance costs. This compares to $195.2 million of outstanding debt at September 30, 2020, on a gross basis and on a net basis it was $172.4 million after netting $22.8 million in unamortized debt issuance costs. Related to the term debt credit facilities, there’s a holiday period for certain financial covenants through June 30, 2021. During the third fiscal quarter, there was a small draw on the company’s credit line in the amount of approximately $6 million, which was due primarily to the timing of cash receipts at the end of the quarter used to pay the balance. This amount has been paid down during the fiscal fourth quarter. Since our Analyst Day back in August, we’ve outlined a strategy to address the overhang on our valuation created by the legacy high-cost term debt. As you may recall, we had negotiated a more favorable equity clawback provision that allows us to pay down up to 50% of the outstanding term debt at a reduced call premium of 5%. This is available to us until the expensive make-whole provision expires June 27th of this year. As such, on November 25th, we filed a necessary registration statement for $200 million, $50 million of which has been allocated to an at-the-market or ATM equity facility. We have not yet sold any shares under this facility since we’ve been in our quiet period related to our quarterly release of financial results. We plan to utilize this ATM facility opportunistically since it’s not something we need to do, but rather it is a tool to take advantage of the equity clawback provision to help us reduce the debt over the next several months. Excluding up to $3 million representing the initial cash payment for the Square Box acquisition, all proceeds from this offering will be used to pay down the term debt. Following the expiration of the make-whole provision in June, the optionality to address our capital structure increases significantly and we have stated previously that we will be considering a number of refinancing alternatives. Related to cash flows generated from operations for the first nine months of fiscal 2021. Before the effect of changes in assets and liabilities, net cash generated by operations was $4.4 million. The use of cash resulted from changes in working capital accounts represented $24.5 million consisting primarily of increases in inventory and decreases in accounts payable and deferred revenue. Other uses of cash during the period included capital expenditures of $4.9 million and $2.6 million net for the initial cash payment for Square Box Systems. Other sources of cash during the first nine month period of fiscal 2021 included net borrowings of term debt of $19.4 million and borrowings of $10 million under the Payment Protection Program, which we expect to be forgiven in accordance with the terms of the loan agreement. As our business approaches the pre-COVID levels and we address this significant interest payments on the current term debt, we expect free cash flows on an adjusted basis to surpass the $20 million model from fiscal year 2020, which represented a limited impact from COVID. Finally, turning to our financial outlook. As Jamie mentioned, we expect continued recovery across our market verticals and increasing contribution from our new software solutions, resulting in our expectation of revenue for the fourth fiscal quarter to be $98 million plus or minus $3 million, well over the current street consensus and represent sequentially flat revenue in what is typically a seasonally weak quarter for the company. Non-GAAP adjusted net income/loss is expected to be breakeven plus or minus $1 million, adjusted earnings per share/net loss per share of breakeven plus or minus $0.02 per share, and adjusted EBITDA of $9 million plus or minus $1 million. With that, I’ll turn the call back to Jamie for closing comments.

Thanks, Mike. In summary, this was a very solid quarter for Quantum, the second consecutive quarter of growth and the second quarter of exceeding guidance. We demonstrated significant progress toward our transformational initiatives through our business sequentially both in our core markets and outside of our core markets and added key new products to our portfolio to drive software and recurring revenue growth. With that, we will now take any questions you may have. Operator?

Your first question from the phone lines is coming from Craig Ellis. Your line is live.

Thanks for taking the questions and congratulations on the strong results and outlook guys. Just a housekeeping item to start, Mike versus the fiscal third quarter $93 million guidance midpoint, where was the primary source of upside in the different businesses? And then I think Jamie mentioned and you mentioned that the fiscal fourth quarter is typically seasonally weaker. So given that you’re outperforming that what are some of the gifts and takes across either customer groups or different product groups?

Yeah. Relative to our guidance, as we outlined in the script, we really saw an increase across all the products, all the verticals, everything was up with the exception of service was plus or minus flat. So we really saw a broad-based recovery in our business really explains for large part the $98 million for the quarter.

And then give and takes in the fourth quarter, Mike?

We have provided guidance of $98 million remaining flat, which reflects a stronger business environment compared to the typical seasonal decline. We are seeing strength in the hyperscale business and expect media and entertainment to continue to recover, although we remain cautious. However, it should improve going forward. Those are the key drivers.

Got it. And maybe turning to some of the comments about the new product. So one segue into the question, noting that for the second consecutive quarter product gross margins was 31%. So nice gross margin, I think consistent with what you’ve suggested in the past, Jamie, that you wanted to drive the portfolio towards higher value. So the gross margin question is this, one, is that 31% level in products really a level that is now sustainable or would we expect there to be gifts and takes with that and with regard to Square Box and ActiveScale and some of the products that were refreshed and were launched in the calendar fourth quarter? What should our expectation be for their materiality as we go through calendar 2021? How substantially could those businesses grow and become?

Yeah. Strategically, I mean, our goal is to sell larger deals. A larger deal is a result of combining multiple products together into a solution versus a point product sale. And more and more the glue that ties multiple products together is software, whether it be deployed on-premise or in the cloud. And so our goal is to be driving higher margins with a greater mix of software, a greater mix of services and a greater value by taking on more complex solutions than just an individual product sale. Now, exactly how to model that and how that’s going to take place? From my point of view, we’re in the very early days of that and simply don’t have enough customer and sales data to be able to characterize the speed at which that transition is going to take place. I mean, Mike, you may be able to give better detail than that. But we just started putting these software products out in November, and I just don’t think we have enough data about the speed at which we’re going to make this transformation yet to be able to characterize a multi-quarter trend.

Yeah. Craig, what I would add to that is, it is very difficult for us to forecast the rate of the transition. I mean, every quarter as it builds more scale, we intend to provide more metrics and information related to the software business, the subscription business. But at this point, it’s just hard to tell. We just started. We just announced these products in November. So we’re just starting down the path.

Fair enough, Mike, and thanks for the color, Jamie. Lastly guys, nice progress with the hyperscale revenues within secondary. I’m wondering if you can just give us an update on just engagement with that customer set more broadly. As we go through calendar ‘21, should we expect the number of customer engagements, the number of customers for which you can derive revenue to expand beyond the current three? And if so, any color on geographic mix or other dynamics would be helpful?

Yeah. I mean, I can speak to our strategy. I mean, clearly, we’ve got a tiered strategy. We put a lot of energy in our sales efforts with the top eight to 10 cloud and hyperscale customers just because of just how massive their buying power is. But we also put energy to the next 200 or so accounts beneath that in the web scale companies, maybe not at hyperscale, but they certainly are of scale and then the Global 2000, all of which have data they need to archive for decades, if not longer. And our strategy there is to increasingly solve archive problems with more software, cataloging software, data movement software, all the software that’s needed to organize an archive that could have 100 million to several billion files in it. And that’s our strategy. Obviously, we started at the top of the pyramid, but we’re pressing down. And the goal is, we need much more diversity in our install base. Having one or two very large customers is great. But that comes with all the issues of having just a handful of customers. So we’re broadening out that base much more widely and broadening it to customers that place more value on our software and more value on our services, so that we can drive the margin more aggressively than you can with the top three or four players at the top of that pyramid.

That’s helpful. Thanks, Jamie. Thanks, Mike.

Thanks, Craig.

I have a follow-up question about the media and entertainment sector. I'm interested in understanding your perspective on the recovery you mentioned. You referred to it as an initial recovery, especially considering that this sector's business is down about 50% compared to last year. Could you clarify what leads you to believe that conditions will improve in December and March? Or is it more about stating that things have improved, but it's relative to the previous year's performance?

I believe they improved significantly this quarter. However, it's important to note the challenges we face. Obtaining filming permits in New York and Los Angeles is not as straightforward as it once was. Additionally, sports are still experiencing shorter or limited seasons, and those that rely on ticket sales are under continuous pressure, indicating that the industry is still facing significant challenges. There was a time when the industry came to a complete halt, particularly movies, television, and sports during our first fiscal quarter. Now, while things are moving again, the pace is slow. I expect this recovery to align with the rollout of the vaccine. However, we remain cautious, having witnessed variants and delays in vaccine distribution. So, while I am optimistic about recovery, I am also wary, as we cannot predict the speed at which it will occur or the potential obstacles that may arise. We see improvement, but we maintain a cautious perspective rather than an overly optimistic one.

Yeah. And so if you were to look at pipeline in media and entertainment now versus 90 days ago, how would that change?

I’d say it’s building in strength. But I think people are still spending where they have to and they’re not leaning into projects. I think they’re behaving with caution as well. They’re not buying for one year, two years out. They’re buying for very short-range projects. So I think there’s a lot of pent-up demand, but there’s a lot of caution there too. And I think it’s going to recover in correlation to how quickly they can roll out a vaccine and how effective that vaccine is. I mean, it’s a business that’s entirely characterized by humans assembling, right? Sports is about human assembly, making a movie, especially a feature film is 200 to 300 people assembled in close contact. It’s entirely about our ability to come in close contact and assemble people. And to the extent that we can assemble people quickly with a vaccine, it will recover, and the extent that it’s drawn out, it will take longer. So it’s directly correlated to the vaccine and human assembly.

Okay. And then the progress with the hyperscalers, I think last quarter you said, you were going to add two new in the December quarter and then a fourth in the fourth quarter. Is that still on track?

Yeah. The business is on that trajectory. Again, they don’t always share their plans with us. But yeah, we’re loading more hyperscalers. We’re starting to load some web scale, some telcos, some other businesses as well further down that pyramid. But I think you characterize the rollout accurately.

Okay. Mike, regarding margins, considering that revenue is expected to be roughly equivalent at the midpoint for Q4 compared to Q3, should we expect similar operating expenses in Q4 and a comparable gross margin to achieve an EBITDA that aligns with the midpoint versus Q3?

Yes. The gross margin should remain fairly stable, and the product mix will also be similar between Q3 and Q4. We did experience a slightly unfavorable product mix in Q3 compared to Q2, which led to the observed decrease in margin. What was your second question?

Yeah. The operating expense was…

Yeah. Plus or minus as we enter Q4, some of the operating expenses become under pressure as it relates to the annual audit and those types of things. But plus or minus they’re going to be in the same range.

Okay. Lastly, you've been successful in attracting quality talent, Jamie. You have two lines of business within Quantum: primary storage systems and secondary storage systems. You've been introducing new products in both areas. From a product perspective, what do you think makes Quantum appealing to potential new hires?

Yeah. I mean, I would characterize we have four core lines of business, certainly primary and secondary storage. But our cloud and analytics software is really where we’re really expanding the business and differentiating, and then our fourth line of business and our biggest business is our services business. And more and more of our products are going to be delivered as a service. So as we press that out, there’s really I think two things, maybe three that are bringing the top industry insiders here. First is strategy. I think the strategy is resonating with a lot of people who’ve been at very large bulge bracket infrastructure and storage companies. I think they view this strategy as a thought leadership, and they actually combine that with a culture that they feel, and I certainly feel, that allows us to not only have that strategy but to execute on it, make the acquisitions, build the products, make the moves we have to move to get it done. So I think it’s both the validation of the strategy and the validation of this as a culture where we can just get that work done. I think those things were question marks two years ago, and now with the amount of customers, it’s resonating with the top executives. I think people just view it as, it’s a good strategy and a culture where people can come and execute and be successful.

Got it. Thanks for taking my question and good luck. Thank you both.

Thanks, Eric.

Your next question is coming from Chad Bennett. Your line is live.

Great. Thanks for taking my questions. So few questions just around the hyperscaler progress that you have made and I think it was Jamie on last call. I think you indicated a fourth hyperscaler making production buys by the end of the fourth quarter. Are we still on track for that?

Yes. I think we’re on track with them finishing their qualifications. Production buys, as many of you track this closely. There have been delays in the LTO-9 rollout. So a lot of the rollout that’s happening with these three newcomers coming on around now, it’s not coincidental that they correlate to the rollout of LTO-9. And LTO-9 has now been delayed at least until June. So there may be some impact of these newer customers looking at the fourth player maybe holding out to LTO-9 and we’ll have to see. But they’re certainly coming to the end of their analysis, their trials, they’re testing and they’re coming down to their production rollout. And I think we’ll just have to see how hard they hit the throttle on LTO-8 or if they wait a little longer for LTO-9.

Got it. And then, probably a different one of them, but you also mentioned, which I thought was pretty interesting, a new primary storage product into I think it was one of your hyperscalers that you thought you’d be able to sell into in early fourth quarter.

Yeah.

And then also on the software side, some management software around primary storage or maybe both primary and secondary that you thought you make headway in this quarter. Can you address those? I assume those aren’t really LTO tied, right, so.

Not necessarily. I think you’re referring to friends. A cloud company has many different types of storage—fast, slow, and inexpensive. They offer various tiers of storage capabilities. As we gain more customers, an increasing number are expressing their desire not just for our hardware but also for our software that enables data writing to tape, data retrieval, and data organization. We're witnessing a rise in the attach rate of software, while some hyperscalers prefer to use only our hardware and manage everything independently. The trend is shifting towards a preference for tape along with the software that manages tape, as well as the storage and management software that facilitates the creation of large archives on that tape. Some customers are also indicating interest in our high-speed products for various applications, not just for slow-speed archive storage and software. We are actively rolling out our high-speed storage solutions with the top three cloud providers, and we will make further announcements about that. We’re deploying on their edge storage and engaging with several hyperscalers on different storage tiers. Therefore, we have transitioned from merely selling tape hardware to now offering tape hardware, tape management software, storage software, and some of our main software and hardware.

Got it. You mentioned that now that the new software products are available, it's still early, but you are experiencing some initial success in software and solution selling, and you are exploring new use cases. Additionally, it's notable that your product revenue has remained strong, particularly in the December quarter, despite significant challenges in media and entertainment. Can you elaborate on this?

Yeah.

Can you provide an overview, Jamie, of the use cases and solutions you are currently selling? Also, how is your focus shifting incrementally, whether in primary storage, software, or any management level within the overall storage ecosystem compared to where you were a year ago? Additionally, what are you replacing, or what competitors are emerging now that weren't present a year ago?

I think there are both technical and market-related aspects to address. Two years ago, our sales were primarily focused on media, entertainment, and enterprises seeking backup solutions. Fast forward to today, and we now cater to both traditional customers by offering enterprise backup alongside media and entertainment options, which has expanded our product offerings. We have introduced tiers of storage that were previously unavailable, such as flash storage, which we had previously ceded to competitors. Now, with our ATFS, we also have mid-range storage. This allows us to meet the full range of storage needs for our existing customers without the need for them to rely on other vendors for any gaps. Additionally, we are making headway into new sectors like genomics, which is becoming increasingly significant. For example, during the COVID-19 pandemic, genomes are being sequenced to analyze the effects of vaccinations and illness. As we analyze more genetic data, which resembles large TV commercial data in terms of volume, we are seeing rising demand for our help in organizing this information. Companies are seeking our metadata software solutions, and it’s crucial to create extensive metadata for vast collections of genes. We have developed software solutions that we previously lacked, enabling us to sell more to our existing verticals while also branching out into genomics and medical imaging, including MRI and CAT scans. We are experiencing growth in our surveillance business as well, engaging in video collection and surveillance technology. Overall, we are expanding our sales to our long-time customers while exploring new verticals. As we enter these new markets, we are offering multiple products and solutions, which allows us to address complex business challenges. That's why we are witnessing a recovery and why our strong performance this quarter and our optimistic outlook stem from a combination of recovery and successful market traction from our new products.

Got it. Great insight on the future and nice job on the quarter, guys.

Thank you.

Thanks, Chad.

Your next question is coming from Eric Suficher. Your line is live.

Yeah. Thanks for taking the question and congrats on a solid quarter. Can you talk about your supply chain and if there was any component constraints or anything like that? Obviously, you were able to deliver, but can you just talk about kind of the state of the supply chain and where you get your components from?

Yeah. We really didn’t see any constraints in the supply chain during the quarter. We subcontract out the majority of our manufacturing on a hardware side. We use one of the largest firms with a Mexico footprint. So we really haven’t seen any impact on that front.

Okay. Can you talk about any customer concentration issues, any customers that were sighs?

Yeah. Historically, we haven’t had any 10% customers with the exception of every now and then we’ll have a distributor that really doesn’t represent concentration per se in the classic customer concentration meaning. So we have very limited impact from that standpoint. Historically, our largest customer would have been our hyperscaler customer and that customer historically hasn’t reached the 10% point. So really, not much of an issue from our standpoint, our business model standpoint.

Okay. Okay. And then, you talked a little bit about NVMe. In the NVMe environments, can you discuss how broadly NVMe has been adopted by the customers? Is it end-to-end or how are they using it?

Yeah. I think the way they’re using it is in a tiered model. In that they put the data that needs to be processed, accessed, modified in very high speed, they put that data on flash NVMe and then when they’re done with it, they get it off of there. So, if you’re a wealthy organization, you could do end-to-end NVMe, but I just rarely see that. What I typically see is a thin tier of NVMe then a broader tier of disk and then the biggest tier of object storage or tape archive storage. And they use our software, which is a new, very deeply developed technology that we launched in StorNext 7 that dynamically organizes that for you. It decides for you when does your storage need to be on high speed NVMe, when should it be on disk, and when should it be archived. And it could do it based on policies or rules. And the idea would be, if you’re sequencing a gene or doing visual effects on a movie, you’re going to be up in NVMe. And then as soon as you’re done doing that work, it can slide down to disk, where it’s still fast enough to watch that movie, review the movie, have editorial review, you can even play it out to movie theaters. And then when that movies kind of come and gone, it can then slide down to an object store for a deeper cold archive and we have the software that organizes that. And that’s the way we see it deployed. So and I’m seeing more and more customers buying all of those tiers from us and even when they tier to cloud, they use our software to tier things to cloud and move it back from the cloud and use our policy engine to orchestrate all the movements of those files as they go through their workflows.

Okay. And then a last one, the S3, I think you introduced an S3 solution to work with AWS. Any comment in terms of adoption there?

I think what we talked about regarding S3 was that our object store ActiveScale has the most complete, most thorough S3 implementation in the object storage space. And we have had just very strong pickup of that product, in part because of the thoroughness of the S3 implementation, but also just how incredibly elegantly that product scales, how robust it is and easy to run, and we’ve recently added a lot of ransomware protection functions in it, to make it not only very scalable, very easy to use, but really lock down your data so that it’s near impossible to or someone from the outside to lock up your files or modify your files and lock you out of them and hold you for ransom.

Very good. Thank you.

Thanks, Eric.

Your next question is coming from David Duley. Your line is live.

Thank you for taking my question. Most of them have already been asked, but I have a couple of follow-ups. You mentioned the current quarter's seasonality, specifically for March. What is the historical seasonality for the March quarter?

I’d say, it ranged from the mid-to-high single digits, decrease quarter-over-quarter.

Okay. When considering the transition of your hardware products to software, what percentage do you anticipate will ultimately shift to a software model over a three to five-year period? I'm aware that some aspects may not transition, so I'm trying to understand what you expect to move towards this software-oriented model within that timeframe.

Yeah. On our Analyst Day when we did our three-year to five-year model, as we transition, what we characterized as recurring revenue would be 70% of our total revenue. Today, it’s plus or minus 40%. That is non-product. So we’re really looking at, the 60% that is product today, half of that will move to software and half of it will remain, round numbers.

Okay. And then in your slide presentation, you have a pyramid slide there where you have the hyperscalers on top and then a couple of other incremental opportunities. I am just wondering how much bigger do you view the web scale guys in the Fortune 2000. How much bigger are those markets than that top tier of the top 10 hyperscalers? Just trying to understand what sort of…

I believe the distinction between those tiers is less about size and more about value. A hyperscaler aims to deliver all technical value independently, minimizing dependence on third parties—this is their business model. In contrast, web scale companies and enterprises are open to collaborating with other technology firms. They welcome the use of your software and services and appreciate your assistance, viewing it as a benefit rather than a hindrance to their business model. Although the deals with them might be smaller in size, the proportion of software and services they utilize is considerably higher, resulting in significantly larger margins and profitability from these lower tiers. Therefore, while the total dollar amounts may not exceed those from hyperscalers, the margins could potentially be more than double from the two lower tiers.

Okay. Thank you.

Okay. Thanks, Dave.

There are no further questions at this time. I would now like to turn it back to Jamie for closing remarks.

All right. Well, thanks, everyone. It was a great quarter. We’re looking forward to more quarters and we’ll keep everyone updated on our transformation as we move as quickly as we can to transform ourselves into a more profitable, more earnings-rich company as we transition to software, services and subscriptions. So, thanks, everyone, and we’ll be talking soon.

Thank you for your participation, ladies and gentlemen. You may now disconnect.