Quantum Corp (QMCO) Q1 2023 Earnings Call Transcript

Good afternoon, everyone. And thank you for participating in today’s conference call to discuss Quantum’s financial results for the first quarter of fiscal year 2023. 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 call is being recorded. I would now like to turn the conference over to Brian Cabrera from Quantum.

Good afternoon. And thank you for joining today’s conference call to discuss Quantum’s first quarter fiscal 2023 financial results. I am Brian Cabrera, Quantum’s Chief Legal and Compliance Officer. Joining me today are Jamie Lerner, our Chairman and CEO; and Mike Dodson, our CFO. This afternoon, we issued a press release, which you can access under the Investor Relations section of our website at www.quantum.com. We are using a slide presentation in conjunction with today’s call, which is also accessible under the same section of our website. During today’s call, our comments may include forward-looking statements. All statements other than statements of historical facts should be viewed as forward-looking. These statements include any projections of revenue, margins, expenses, adjusted EBITDA, adjusted net income, cash flows, backlog, or other financial items. These statements may also concern the expected development, performance, and market share or competitive performance of our products or services. All forward-looking statements are based on information available to Quantum as of today’s date. We advise caution in relying on these statements as they may involve known and unknown risks, and uncertainties we refer to as risk factors. Risk factors may cause our actual results to differ materially from those implied by the forward-looking statements, including unexpected changes in our business. We include detailed information about these and additional risk factors under the section labeled the Risk Factors in our quarterly report on Form 10-Q and our annual report on Form 10-K, which we file with the Securities and Exchange Commission. We do not intend to update or alter our forward-looking statements, whether as a result of new information, future events, or otherwise, except of course, as we are required by applicable law. Please note that our press release and the management statements we make during today’s call will include certain financial information in GAAP and non-GAAP measures. We include definitions and reconciliations of GAAP to non-GAAP items in our press release. If you are unable to listen to the entire call at this time, we will make a recording available for at least 90 days in the Investor Relations section of our website. Now, I would like to turn the call to our Chairman and CEO, Jamie Lerner.

Thank you, Brian, and thank you all for joining us today. Earlier this afternoon, we announced results for our first quarter of fiscal year 2023, with revenue results that exceeded the high end of guidance. Our revenue growth was driven by continued strong hyperscale sales, as well as sequential growth in our video surveillance business. In addition to the strong revenue results, our backlog, as of July 31st, was $67 million, a near record level. So demand continues to be strong, and we are confident in the prospects for growth. We also delivered our fifth consecutive quarter of growth in the number of subscription customers, now at over 450, which is an increase of 200% year-over-year and 29% sequentially. We are pleased with the progress we have made thus far, but this only represents a fraction of the total opportunity that still lies ahead. Currently, we have over 10,000 active customers and 23,000 systems under support contracts, which represents huge potential toward growing recurring revenue over the next few years. As these customers come up for renewal or have a need to refresh their Quantum products, they have been very receptive to moving to subscription licensing, most on multiyear contracts. As one example, in May, we closed a large StorNext 7 subscription deal with a well-known shoe and apparel company, which has been a customer for many years, using Quantum storage solutions to create all of their advertising and marketing content. As they have expanded their brand, the amount of video and image data they are creating has increased, and their legacy infrastructure was constraining their creative teams. To address this need, they upgraded their old StorNext infrastructure to StorNext 7, moving to subscription software on a five-year contract and added F-Series NVMe storage to their infrastructure to provide increased performance and better efficiency. StorNext software licensing was the largest component of this deal, and this is a great example of how large brands and enterprises are creating more video and image data, as well as a very repeatable sale we can make to our installed base of customers around the world. We are also continuing to expand our software offerings and customer adoption of our services technology. StorNext software is now available for purchase on the Amazon Web Services marketplace, giving customers a new way to purchase StorNext and run it on the public cloud. We will be showcasing this new offering later this quarter at the International Broadcasting Conference in Amsterdam. We have close to 1,000 customers that are now using the MyQuantum Service Delivery Platform that we announced in April. And we now have over 2,500 customers and close to 4,000 products connected to our cloud-based analytics software, where we are collecting hundreds of thousands of data points to help our customers improve their operations every day. This service delivery platform enables Quantum to become more connected with our customers, increase the value we are providing, and ultimately monetize these services as we continue to drive growth in recurring revenue. Also, during the quarter, some of our largest wins were at international government agencies, for national film and sound archives, and digital preservation of valuable cultural artifacts. In addition to the size of these opportunities, these wins are also notable because they combine Quantum file or object storage software with disk and tape, and in some cases, CatDV, which is used to index, catalog, and browse the archive. These wins provide a good example of a unique end-to-end architecture for data archiving and digital preservation that only Quantum can provide. I am also pleased to report that we had a very strong quarter in our video surveillance business, where we had big wins at one of the world’s largest transportation companies, as well as wins with transportation authorities, for surveillance and public transit systems, universities, hospitals, and casinos. These wins provide further evidence of our success with the Pivot3 acquisition, while also serving as an example of the large opportunities available to significantly grow this business. As demonstrated this quarter, the business is characterized by large wins, and although it may fluctuate from quarter to quarter, we are excited about this initial momentum as we continue to ramp the business. All of these organizations, cloud providers, Fortune 500 enterprises, household brands, hospitals and research institutions, and government agencies around the world trust Quantum to store, manage, and protect their most valuable assets, their digital data. The products and solutions we provide are more relevant than ever with the exponential growth in video and unstructured data that is mission-critical to these organizations. With the strong position we have in these accounts, combined with our large installed base of customers, we are poised to significantly grow recurring revenue over the next few years, while driving improved margins and more predictable revenue streams. In summary, I believe we have taken the necessary steps to position Quantum for continued improvements in our future operating performance. The programs we have put in place to control purchase price variance, manage discounting, and adjust pricing will begin to show more meaningful results in fiscal Q2, in which we expect to deliver sequential improvements in both gross margin and EBITDA, as Mike will discuss. Demand remains strong with backlog currently at record levels. We are continuing to increase the conversion rate of customers to a subscription model and build our recurring revenue. We are committed to disciplined execution on our initiatives, delivering improvements in gross margin, and reducing operating expenses that are collectively expected to result in substantial year-on-year improvements to adjusted EBITDA over the coming quarters. Now, I’d like to turn the call over to Mike to provide more detail on the results, then we can take questions.

Thank you, Jamie. Welcome, everyone, and thank you for joining the call today. Now, turning to the results for the first quarter. Revenue came in just above the high end of guidance at $97.1 million, representing an increase of 9% year-over-year and 2% compared to $95.2 million in the prior quarter. Backlog at the end of the first quarter was approximately $47 million, primarily reflecting the timing of large orders, and subsequently increased to a new record of approximately $67 million as of July 31, 2022. Approximately 75% of the first quarter ending backlog was related to hyperscaler customers, and approximately $25 million of the ending backlog was shippable to customers if we were not supply constrained. Although we are seeing some signs of improved supply, we continue to be constrained primarily on tape drives, as well as broad-based shortages of components. During the first quarter, secondary storage revenues were up 1% sequentially, primarily driven by ongoing strong demand from hyperscaler customers, largely offset by a decrease in backup and data protection products. Primary storage systems had another solid quarter and was up 9% sequentially, primarily driven by a significant increase in shipments of video surveillance solutions. In conjunction with our focus on driving the transition to a recurring software subscription model, last quarter we introduced a series of supplemental metrics to track our quarterly progress. The first of these metrics was annual recurring revenue, or ARR, which increased 11% sequentially to $8.2 million. This figure includes recurring software subscription revenue across all of our transaction product offerings, including StorNext, ActiveScale, DXi, and CatDV. Additionally, at quarter-end, the cumulative number of customers under a subscription contract increased to over 450 active customers, which represents 200% year-over-year growth and sequential growth of 29%. Another key metric we introduced was total contract value, or TCV, which sequentially increased by 16% to $16 million at the end of the first quarter, up from $15.8 million in the prior quarter. Gross margin in the first quarter was 35%, compared to 38% in the prior quarter. The sequential decrease reflected several factors, including our projected peak and purchase price variance driven from constraints in the supply chain, continued inflationary cost pressures, and logistics costs, and a product revenue mix that was more heavily weighted toward our hyperscaler customers. Roughly 1% of the sequential decline in gross margin is attributed to the less favorable product mix and 2% of the sequential decline in gross margin is due to the higher purchase price variance and other logistics supply chain costs. Assuming no meaningful deterioration in the overall market environment or supply chain dynamics, the company believes the gross margin in the first quarter represents a low point. As stated last quarter, it will take additional time to realize meaningful improvements in terms of both product mix and our higher pricing targeted to offset the inflationary cost environment. GAAP operating expenses in the first quarter were $41.1 million, compared to $41.8 million in the prior quarter. Non-GAAP operating expenses during the first quarter decreased by $0.9 million to $36.3 million, as compared to $37.2 million in the prior quarter. I want to emphasize that operating expense in the first quarter does not reflect the full anticipated benefit of cost reductions that were implemented in early June. We continue to expect to reduce the quarterly operating expense run rate, targeting approximately $35 million by the end of fiscal 2023. Excluding stock compensation, restructuring charges, and nonrecurring charges, non-GAAP adjusted net loss in the first quarter was $3.7 million or $0.04 per share, compared to an adjusted net loss of $2.8 million or $0.05 per share in the prior quarter. Adjusted EBITDA for the first quarter was just above the midpoint of guidance at $0.3 million, compared to $0.4 million in the prior quarter. As we have discussed previously, driving continued improvements in our adjusted EBITDA remains one of our highest priorities. We expect to achieve this through a combination of growing revenue, expanding gross margins, and reducing operating expenses. We expect the cost reduction actions, together with product price increases and supply chain initiatives, will increasingly contribute to positive EBITDA results during the second half of fiscal 2023. There is a full reconciliation of our non-GAAP results to the most directly comparable GAAP measure in both the press release and Form 10-Q released today. Now turning to the balance sheet, liquidity, and cash flows, all of which now reflect the company’s successful rights offering that was closed in April. Cash and cash equivalents at the end of the quarter were $26.8 million, compared to $5.5 million in the prior quarter. Outstanding term debt at the end of the first quarter decreased to $78.4 million from $98.7 million at the end of the prior quarter. This decrease of approximately $20 million reflects the payoff of term debt after completing the rights offering. At the end of the first quarter, the outstanding balance on the company’s revolving line of credit was $17.3 million, compared to $17.7 million in the prior quarter. In the first quarter, interest expense decreased to $2.1 million, compared to $2.5 million in the prior quarter and $3.9 million during the same quarter a year ago. Our cash and cash equivalents increased by $21.3 million during the quarter. Net cash used in operating activities was $18.3 million. Excluding changes in assets and liabilities, net cash used by operating activities for the quarter was $3.1 million, of which approximately two-thirds represented interest expense. The net cash used related to changes in assets and liabilities was $15.2 million, driven primarily by seasonality related declines in deferred revenue. Historically, the heaviest cash collections for service contract renewals have been in the December and March quarters, with decreases in cash collections in the June and September quarters. In addition to the normal seasonality, one other factor contributing to the current quarter sequential decline of $13.6 million in deferred revenue was the lengthy contract renewal negotiation with one of our largest customers that was not completed by the end of the quarter and represented an annual contract value of just over $4 million. Also, a use of cash during the quarter was an increase in other current assets of approximately $2.7 million, represented by the prepayment for key inventory, as well as the annual subscription for group insurance. Net cash used in investing activities was $5 million, which included CapEx of $3 million and a $2 million deferred business acquisition payment. The net cash provided by financing activities during the quarter was $44.6 million and primarily represented the net proceeds of the rights offering, less approximately $20.6 million used to pay down outstanding term debt. Now moving to our financial outlook, as we have outlined, our fiscal 2023 plan is to continue to grow our revenues while implementing cost reduction programs. We anticipate the most challenging area will be to address the pressure on gross margins. We do expect in the back half of fiscal 2023 to see measurable improvements in adjusted EBITDA. We expect revenue for the second quarter to be in the range of $95 million, plus or minus $4 million. The non-GAAP adjusted net loss is expected to be $1.5 million, plus or minus $1 million, and adjusted net loss per share of $0.02, plus or minus $0.02 per share, using an anticipated basic share count of 94.5 million shares. We expect adjusted EBITDA in the second quarter to be $2.5 million, plus or minus $1 million. With that, I will turn the call back to Jamie for closing remarks.

Thanks, Mike. In closing, demand continues to be strong with strong revenue results and a large backlog. We are very pleased with the growth in subscription customers, and we see huge potential to continue to grow recurring revenue over the next few years. We have taken the steps to improve supply chain and deliver improvements in gross margin and adjusted EBITDA in the coming quarters. With that, we will open it up for questions.

Our first question is from Craig Ellis with B. Riley Securities. Please proceed with your question.

Thanks for taking the question, and I will start with a clarification on the gross margin outlook. So, Mike, if I step three months, I think, or looking at gives and takes in gross margin that at the time we were going to sustain a 38% gross margin until we got some benefit from some of the initiatives that we had underway, and now we are at 35%, and I think the view is that this will be the bottom, and we hope for leverage against that bottom in the back half of the year. So given the significant change versus our recent gross margins could potentially bottom. What gives you the confidence that 35% is the bottom? And maybe certainly, what are the specific things that are going to drive materially higher gross margin from here?

Yeah. Sure, Craig. What we experienced in Q1, we really expected, and we understood our purchase price variance, in a lot of the broker buys that we did were two or three quarters ago, but the inventory didn’t move out until this quarter. So we knew that this was going to be the toughest quarter for gross margin, and in our prepared remarks last quarter, we really expected to see meaningful improvement in the back half of the year. So we knew it was going to be tough, especially with the purchase price variance because we knew that was being amortized, right? The inflationary cost pressures continued, but we do feel confident we can see purchase price variance getting a lot better. We are no longer putting things on airplanes or on boats. We have done a lot that we can to control those costs. So we feel confident, unless there are some other macro events that impact the supply chain, that this should be the low point.

Okay. Then let me just ask a follow-up, because I think when we talked about the potential for gross margin in the current quarter, it was relatively late in the quarter. So I think the inputs would have been known, and yet we were still basis points below. So how do you feel about the business’s ability to really drive the kind of inputs for forecasting, as we knew the inputs that you need so that we have got the outlook for a line item like that and the ability to execute on that line item?

Yeah. I think we have very clear visibility into purchase price variance, and we know that’s improving. We also have more traction on the price increases that we put into place as well as efforts to reduce our discounts. We are seeing more and more traction there. So we have a number of programs in place that we are seeing improvements in. It still will be gradual improvement; we would expect next quarter and then more improvement further in Q3 and Q4.

And finally, just to clarify, Mike, are you intimate that gross margin should be flattish in fiscal Q2 and then you get those initiative benefits in the back half, or are you looking for something up or down in Q3?

No. We are definitely expecting an improvement in Q2.

Okay. I will just ask one more to Jamie, and then I will hop back in the queue. So, Jamie, nice to see the customers go up by almost 100, but when I look at the incremental value for ARR customer, it looks like sequentially it went from $13,000 to $8,000. So that’s down pretty significantly from where we started, and I know that we have gone from store-centric mix with subscription to some of the other areas but talk about what a reasonable set of expectations would be from this level of incremental ARR per customer and where should we normalize long-term.

The mix of products available under subscription has changed significantly. We initially focused on StorNext, which usually has larger deal sizes, and we have now added DXi, which is a popular product but typically sells for under $25,000. This means we are gaining momentum and attracting more customers, but the average selling prices are decreasing because we have introduced more high-demand products. We are still in the process of fully understanding the average selling price over three years, so there is still work to be done in that area. Currently, we are assessing how customers feel about switching to subscription and whether they have any concerns, and so far, we are not encountering significant issues. We are focused on increasing our momentum. As mentioned in our previous earnings call, our goal is to double our annual recurring revenue this year, and I believe we are on track to do that, which gives me confidence in that aspect of the business. A considerable amount of our efforts is directed towards improving EBITDA, which has increased from $300,000 to $2.5 million, demonstrating our effectiveness in managing pricing, discounting, expenditure on operating costs, supplier management, and addressing unexpected price rises. This improvement in EBITDA is particularly encouraging, and we are committed to continuing this growth every quarter. We expect to maintain this trend and return to our historical levels. To echo Mike’s remarks, we consider 35% to be our low point, and this quarter appears to be around 100 to 200 basis points above that, which is a positive indicator for us moving forward.

Got it. Thanks, Jamie. Thanks, Mike.

Thanks, Craig.

Our next question is from Eric Martinuzzi with Lake Street. Please proceed with your question.

Yeah. My question is on the revenue guidance for Q2. I am not expecting a lot of volatility in the service of the royalty revenue, but based on the midpoint of the guidance, we would be down sequentially. So I am assuming that’s in the product area; is that assumption correct and why would that be given normal seasonality?

I believe those assumptions are not accurate. Two quarters ago, I provided guidance of $92 million, followed by $94 million, and now we are guiding to $95 million this quarter. So, I have been increasing my guidance each quarter. We have experienced some supply fluctuations near the end of the quarter, where suppliers have unexpectedly informed us that they couldn't deliver the promised quantities. My guidance of $95 million accounts for the need to set aside several million dollars for these unforeseen circumstances. If those surprises do not happen, I expect we will achieve the top end of our range. Currently, I am anticipating quarter-on-quarter growth, but I am factoring in several million dollars as a precaution until the supply chain issues and last-minute surprises are resolved. If we avoid surprises, I believe we will reach the high end of the range. Any surprises that do occur won't be due to business performance but rather related to shortages from suppliers. Our sales are largely meeting our expectations, and the correlation between shipments and revenue is primarily dependent on the availability of materials. Currently, approximately 93% of our limited materials are associated with tape drives.

I understand your point about being conservative on the product side. Moving to the services side, we typically see an increase in service revenue with strong product sales, but that has leveled off in the 33% to 34% range. Can we expect service revenue to grow as we return to positive comparisons in product sales?

I think when we look at service, we are considering the cash implications and the seasonality. In the long term, the challenge we face is the golden glide. While we are growing the service, we are also contending with the golden glide, which involves older established products that are no longer being renewed. That is likely why you are seeing a bit of a stall, Eric; it reflects that struggle.

Okay. And then just macro commentary, you guys do have a global view, given thousands of customers worldwide. Curious to know what you are seeing in Europe; is your guidance being impacted? This is both an FX question and a macro demand question, but just curious to hear what your larger customers in Europe are on track. Are they getting more tentative? Have we seen any sales cycle extended? And then is there an FX impact in your outlook?

I can...

Yeah, Mike. Why don’t I cover the macro and you talk FX.

Okay. Okay. Right now in Europe, we are not seeing anything that I would call widespread, broad-based slowing down on technology spending. I think people are being judicious. So I am seeing more process steps, where people are seeking greater approval. There are process steps to justify and make sure that people are making justified orders. But at this stage, we are not seeing a broad-based slowdown. Okay. And on the FX side, to date we haven’t seen a significant impact on our business due to FX. First, when you think of our revenue streams after you back out the service business since that’s basically amortizing deferred revenue down, the level of business that we have outside the U.S. denominated in foreign currency is about 20% of our total revenues, and when you look at that level and the mix of currency movements, we just haven’t seen a significant impact.

Okay. That’s encouraging. Then a couple of housekeeping items, if I may. The weighted average share count upon which you are basing your guidance for non-GAAP adjusted net loss per share for Q2 is 94.5 million shares, and I saw in the Q that you filed as of August 1st, we have got 102.7 million shares. So help me understand the delta there?

I am not familiar with the 102 million, but when we review our share counts over the past few quarters, it’s a result of the rights offering. Since we are currently operating at a loss, we do not experience the dilutive effect of other equity instruments. For Q4, our share count was at 60.3 million, and in Q1 it increased to 83.6 million. Looking ahead, I expect it to reach 91.6 million for Q2. The 94.5 million figure includes a dilutive effect, but that would only apply if we were profitable.

Okay. Sorry, 91.6 versus 94.5.

Yeah.

Got it. And then last housekeeping on what should we use for interest expense in Q2? I know you had $2.1 million in Q1, but that had some puts and takes in it.

Yeah. I think that, I mean, the $2 million is a good number for right now.

Got it.

Yeah.

Our next question is from Nehal Chokshi with Northland Capital. Please proceed with your question.

Yeah. Thank you. It seems like solid results. Congratulations on that. Your slide nine shows your shippable backlog and an order schedule for future quarters. Within those orders scheduled for future quarters, that is what happened within the June quarter, so does that mean that there are orders that are shippable within this September quarter?

Let me take a look at that slide. Are you referring to the light blue shippable items or the orders?

I am just wondering if, because those are orders scheduled for future quarters within the June quarter, it does not mean that any of it is shippable in the September quarter. Is some portion of that shippable in the September quarter?

Not necessarily, because I took a lot beyond the quarter.

But I guess the question is some of that still shippable within the September quarter?

Yes. The…

Okay. Yeah. Because otherwise what it looks like is that you have very little visibility into your September quarter guidance relative to your June quarter guidance. And so that’s essentially what my question is. What gives you this confidence to guide the last Q2 with what appears to be, if I were to just use a Q-to-Q change in shippable backlog plus your revenue as a gauge for what your orders were in the quarter, it looks like it went down significantly. But what you are trying to say is that, no, that’s not the case. Orders that are shippable within the September quarter remain quite robust actually and that gives you confidence to guide the way that you have guided, is that correct?

Yeah. Definitely when you look at the July orders, that has Q2 business ahead.

Got it. Very good. Okay. Jamie, in the last quarter, you mentioned your four strategies for reaching a $25 million EBITDA in the near future, and eventually a target of $50 million in annualized EBITDA in the mid to long-term. How do you think those strategies have been progressing since you outlined them last quarter?

I believe we are on track with our plan. This quarter, we are improving our gross margin and aiming for an increase of 50 to 100 basis points each quarter. I expect to exceed that this quarter. We are working on increasing our supply, and while we are selling faster than we are receiving supply, it is improving. We need to position the company to surpass $100 million in EBITDA based on our product mix, and I see that happening. Our pricing and discounting strategies have been implemented and are generally accepted now. Initially, there was some resistance, but people understand that we are navigating an inflationary environment. We have also completed a series of operating expense reductions that are now taking effect. It's encouraging to see our EBITDA increase from $300,000 to $2.5 million. This is the type of growth our investors expect, and we need to continue that upward trajectory. Reaching $2.5 million is a significant improvement, but our goal is to increase it to $5 million, then $25 million, and eventually $50 million. Most importantly, I feel optimistic that our supply chain issues are largely resolved. We are no longer incurring broker or expedite fees, and 93% of our supply chain challenges are related to tape drives. We have everything else we need for building tape libraries; the main issue now is getting the tape drives shipped to us so we can integrate them into our libraries and distribute them.

Okay. That’s very helpful. And just with that 93% perspective, where was that a quarter and two quarters ago?

It was still pretty high. It was in the low 80s. So we had, I think, of it as 80% of our issue with tape drives; 20% was other sundry items. We have gotten all those items kind of worked down, and basically, our supply chain issue is laser-focused on a single supplier.

Okay. If I recall correctly, we had a longer-term key levers was territory and vertical sales fill-ins. Presumably, that’s something that’s going to be worked on as you go through this fiscal year, not something that you worked on in this most recent fiscal quarter, correct?

We have been working on that as well. I mean, we are putting those people in place now. The hiring environment has changed drastically. There’s a lot of talent available. I think there are a lot of people coming out of companies right now that are doing reductions in force. So, I am seeing a much more favorable hiring environment for Quantum, and we are getting really good talent that we are placing into key territories. So I feel like we are getting much closer to full strength in our sales organization, and we will see that as we get people through boot camps, training. I think we are going to see the sales come through. And we are hiring people to address mix; I mean, everyone knows a big part of our mix is hyperscalers. Those are big volume deals, but they are lower margin. And I feel really good about how that business is performing. So the people we are hiring are in higher margin businesses to help us with mix. They are going after enterprise, media and entertainment, and Federal; other key verticals for us that will help us get our mix more balanced.

Okay. Great. Thank you.

We have reached the end of the question-and-answer session, and I will now turn the call over to Jamie Lerner for closing remarks.

Okay. Thanks, everyone. Thanks for attending today, and this concludes our call. We will see you next quarter. Thanks, everyone.

Thank you.

This concludes today’s conference, and you may disconnect your lines at this time. Thank you for your participation.