Quantum's (QTM) CEO Jonathan Gacek on Q4 2014 Results - Earnings Call Transcript

| About: Quantum Corporation (QTM)

Quantum (NYSE:QTM)

Q4 2014 Earnings Call

May 07, 2014 5:00 pm ET


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

Jonathan W. Gacek - Chief Executive Officer, President and Director

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


Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Eric Martinuzzi - Lake Street Capital Markets, LLC, Research Division

Ryan MacDonald - Northland Capital Markets, Research Division

Glenn Hanus - Needham & Company, LLC, Research Division


Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Quantum Corporation Fourth Quarter 2014 Conference Call. [Operator Instructions] This conference is being recorded today, Wednesday, May 7, 2014.

And I would now like to turn the conference over to Shawn Hall, General Counsel. Please go ahead.

Shawn D. Hall

Thank you. Good afternoon, and welcome. Here with me today are Jon Gacek, our CEO; and Linda Breard, our CFO. The webcast of this call, our earnings release and a quantitative reconciliation of any GAAP and non-GAAP financial measures discussed today can be accessed at the Investor Relations section of our website at www.quantum.com and will be archived for 1 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 would like to caution you that our statements are based on current expectations and involve risks and uncertainties that could cause actual results to differ materially. We refer you to the risk factors and cautionary language contained in today's press release, as well as to our reports filed with the Securities and Exchange Commission from time to time, including our most recent 10-Q filed on February 7, 2014. These risk factors are incorporated by reference into today's discussion, and we undertake no obligation to update them in the future.

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

Jonathan W. Gacek

Thanks, Shawn. Welcome to our Q4 fiscal 2014 conference call. Today, we reported revenue and bottom line results above the midpoint of our guidance range we provided in our Q3 earnings call. In addition, we generated $20 million in cash from operations and ended the period with over $100 million in cash, the highest level in 4 years.

Before I turn the call over to Linda to walk through the details, I wanted to take some time to highlight the significant progress we've made in fiscal 2014 financially, operationally and strategically, which positions us well for growth in our core business and increased profitability in fiscal '15.

First, improvement in our financial model. During the year, we undertook a series of steps that while lowering revenue had the intended result of reducing our cost structure and increasing our profitability and cash flow, but still positioned Quantum for revenue growth in fiscal '15. Total revenue declined from $587 million in fiscal '13 to $553 million in fiscal '14. However, non-GAAP gross margin increased from 42% to 44.3% and non-GAAP operating expenses declined from $251 million in fiscal '13 to $222 million in fiscal '14. In addition, non-GAAP operating income and net income increased $27.2 million to $23.3 million and $13.7 million, respectively. We generated $35 million in cash from operations in fiscal '14 compared to $8 million in fiscal '13. And we ended the year with $102 million in cash, up from $72 million a year earlier.

Our second area of progress was in operational efficiency and effectiveness. During the year, we successfully completed our outsourcing of our remaining manufacturing operations, streamlined our service capabilities and refined our sales model. We also aligned our engineering and product groups to leverage our product development strength from our data center products, mostly tape and DXi, to be applied to our scale-out products, StorNext and Lattus, with the goal of increasing our overall product development capabilities, improving our time to market in launching new scale-out storage products as the market opportunity continues to grow, lowering our operational costs and increasing our operational leverage across the company.

The first example of this was our new StorNext Pro Solutions announced at the end of the quarter. Built on our re-architected StorNext 5 platform launched in February of this year, these solutions are optimized for the modern digital workflows in media and entertainment, enabling us to expand our market reach.

Another action we took was focusing our StorNext and Lattus go-to-market activities and sales teams on the vertical markets of media and entertainment and federal government intelligence and surveillance to drive results in those specific markets, while enabling our larger data center sales teams to focus on driving tape and DXi revenue while still identifying StorNext and Lattus opportunities in the data center around very specific use cases. We have a large installed base of data center customers that we are leveraging not only to sell DXi and tape but also to sell StorNext and Lattus for addressing such needs, as managing marketing training videos and preserving large content volumes in disc archives ready -- for ready access. This sale structure gives us both a focus in the key vertical markets and leverage in the broader market, and we saw the benefits the past year. We generated record StorNext revenue, with key vertical wins amongst the top studios, major broadcasters and new cutting-edge content creators and began to see traction selling StorNext and Lattus to data center customers.

To cite just a few examples, we sold Lattus to one of the top U.S. public universities. And just last quarter, it turned several small tape library opportunities into 200,000-plus-sized deals incorporating StorNext for video, for video storage streamlining including at one of the largest athletic shoe companies in the world, which uses our systems to manage its marketing videos.

To sum up, the operational and organizational changes we've made over the past year lowered our headcount from 1,700 to 1,300 people, reduced our operating expenses, provided greater leverage for our strength and scale across the company and positioned us for growth in fiscal '15.

A third area of progress I wanted to discuss is our strategic positioning and relevance to end-user customers and channel partners in our core markets of tape, purpose-built dedupe appliances products, DXi and our scale-out storage solutions, StorNext and Lattus.

Starting with tape, which represented approximately 65% of our total revenue in fiscal '14. Based on analysts' data, the overall tape market, automation, drives and media, declined 7% in calendar '13. In the open systems, automation market was down 11%. During that same period, Quantum remained the market share leader in the open systems market at 31%, the same level as last year. We were followed by Oracle and IBM at 20% and 18%, respectively.

During the year, we launched our Scalar i6k high enterprise -- or high-density enterprise library, offering best-in-class scalability and density, dual robotics and new high availability in management features. This library scales to more than 75 petabytes and was designed to address customers' large archives and long-term retention needs.

Tape is a mature market. But the growth in data over all, longer retention requirements and even the potential for tape as a low cost tier in the cloud, it's our goal to invest in technology and go-to-market resources where we can add unique value to the solution, leverage our installed base and grow our overall tape market share.

Moving to the DXi product family, which represented approximately 15% of our total revenue in fiscal '14. According to IEC, the open systems purpose-built backup appliance market was $2.7 billion in calendar '13.

Looking at the market for open systems, target appliances, which is a segment that we participate in, our share was 4% compared to EMC at 75%, HP at 9%, Fujitsu at 3% and IBM at 1%. Despite our overall market share, our DXi line is very strong with industry-leading technology and win rates of over 50%. And we further expanded the portfolio during fiscal '14.

In addition to introducing a larger DXi virtual appliance and making it a key part of our own cloud in MSP partner offering last summer, in Q4, we launched the DXi4700. It provides best-in-class scalability, density and a cost per terabyte under a pay-as-you-grow model, along with security, performance and value features that make it a particularly good fit in the data center, hosted environments and remote sites. To this point, we exceeded our DXi4700 forecast for the quarter we just completed.

Looking forward, the open systems purpose-built backup market is projected to grow at an annual rate of 18% to $5.3 billion in 2017, and we will continue to enhance our DXi line.

We also see significant customer overlap at the solution level between tape as a backup target and DXi as a backup target, and have, therefore, organized our data center sales model to focus on selling both tape and DXi and to leverage our installed base for both tape and DXi customers. However, our main challenge is that we compete with much larger companies that have significantly greater end-user access, including leading primary disk vendors. So our goal is to leverage our strong product portfolio to target our growth at the market rate growth and focus on adding strategic or channel partners to gain greater access to end-users and grab additional share.

Turning to StorNext and Lattus products, which we also refer to as scale-out storage offerings, these products represented 10% of our total revenue in fiscal '14 with 12% year-over-year growth. This market is very large and encompasses many different storage solutions and capabilities. While there is no analysts' data that encompasses all the elements of StorNext and Lattus, scale-out file systems like StorNext are currently a $3 billion market and are expected to grow nearly 20% annually over the next 5 years.

In the case of object storage solutions, such as Lattus, the market is approximately $300 million and growing at about 20% annually, according to analysts. As I mentioned, for StorNext and Lattus, we are focused on the media and entertainment and federal government intelligence and surveillance verticals, and we are increasingly getting opportunities in general corporate video and disk archive applications across many industries.

Fiscal '14 was a year of significant product development and launches in our scale-out storage portfolio, which I'll discuss in context of 4 cornerstones that support this portfolio.

The first important cornerstone is our StorNext software. Last fall, we announced StorNext 5, our new software platform. As a reminder, StorNext 5 was built from the ground up to provide the most advanced end-to-end workflow management, including best-in-class performance and scalability for file sharing and collaboration, while enabling customers to leverage the vast StorNext ecosystem developed over the past 10 years. With the product launch of StorNext 5, which actually occurred in January, we have dramatically improved our differentiation and have also opened up potential new addressable use cases in such areas as high-performance computing and cyber-security.

The second cornerstone of our scale-out storage portfolio is our StorNext appliances, which tightly integrates StorNext software into a server and storage hardware. In fiscal '14, we introduced 5 new StorNext appliances, including a flash-based metadata appliance, primary disk offerings optimized for collaborative workflow environments and archive-enabled libraries designed for smaller work groups. As I mentioned earlier, we also introduced our new StorNext Pro Solutions, complete storage solutions based on StorNext 5 software and our StorNext appliances, designed and optimized to meet today's toughest workflow challenges. The 3 -- the initial 3 Pro Solution offerings provide high-performance storage for refreshing or enhancing older Apple Xsan environments, meeting the new 4K workflow demand of M&E customers and supporting end-to-end content production and library management.

Third cornerstone is StorNext connect, which is our new storage management framework. StorNext connect provides simplified installation, management and maintenance of StorNext appliances, Lattus and tape systems, providing optimization and monitoring at a glance on any browser-enabled PC, Mac, tablet or smartphone. This is similar to how we manage our data center products today.

The final cornerstone of our scale-out storage portfolio is Lattus, an instantly scalable for every disk archive, providing much greater durability than traditional RAID, including true self-healing and self-protection capabilities and delivering multi-site protection without the need for replication. Based on next-generation object storage technology, it can be deployed as near-line tier storage and also serve as a foundation for a private cloud.

In fiscal '14, we introduced Lattus-D, a lower-capacity, lower-cost system targeted towards data center environment and also announced joint solutions combining Lattus and CommVault Simpana 10 backup and archiving software, as well as Lattus and Rocket Arkivio archiving software. Last month at NAB, we illustrated the unique value we can provide to the integration of Lattus and StorNext by demonstrating StorNext in the cloud, StorNext-enabled -- cloud enabled media workflow running concurrently in both our booth and in our customer demonstration facility at Switch’s SUPERNAP data center. In the demonstration, we partnered with Adobe, Levels Beyond and Telestream to show automated ingest, edit, transcode and distribution in the cloud. A private demonstrations for 30 prospective customers at SUPERNAP was extremely well received, and a number of attendees visited our booth the following day to discuss the solution in greater depth. We are very excited about what we're able to actually do in the cloud with these technologies.

To sum it up, before I turn the call over to Linda, in fiscal '14, we delivered improved profitability and cash flow, reorganized to leverage our scale and drive greater efficiency and focus and significantly expanded both our data center and scale-out storage portfolios. We believe all of this has positioned Quantum to achieve growth in our core business and higher profitability in fiscal '15, and I'll discuss this further after Linda provides further details on the quarter. Linda?

Linda M. Breard

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

Revenue for our fourth quarter ended March 31 was $128 million compared to $139.9 million a year ago, a 9% decrease. Revenue from our StorNext and Lattus scale-out storage solutions was up 9% year-over-year, driven by a 50% increase in North America revenue. Offsetting our scale-out storage growth was a year-over-year decline in tape automation, disk systems and related service revenue of approximately 20% each.

For the quarter, non-royalty revenue totaled $117 million, of which 87% was branded and 13% was OEM, slightly up from 85% branded and 15% OEM a year ago.

Royalty revenue was $11 million for Q4 compared to $10.4 million in the same quarter a year ago. LTO royalty showed growth year-over-year, mostly offset by declines in DLT.

Looking further at various revenue classifications. Devices and media totaled $18.7 million in Q4 compared to $16.9 million in the prior year. The primary driver of the increase was in LTO media.

Tape automation systems revenue was $36.2 million compared to $45.9 million in Q4 of fiscal 2013. Branded tape revenue declined 20% or approximately $5.7 million year-over-year, primarily due to a decline in revenue from our enterprise tape automation systems.

In the mid-range, branded revenue was relatively flat year-over-year, while branded entry sales were moderately down over the same period.

In Q4, year-over-year declines in North America commercial business were the primary geographic driver, along with reduced revenues from the federal sector. While win rates remain strong, overall tape automation systems deals that closed in Q4 were down 9%. And revenue from large deals, those over $200,000, was down 50% from the same period in the prior year.

Despite the year-over-year revenue decline, we acquired nearly 115 new branded mid-range and enterprise customers in Q4, which was up slightly from the prior year, for a total of approximately 445 new customers in fiscal '14. On an OEM perspective, tape automation revenue was down 24% or $4 million over Q4 of '13. The decline in OEM tape automation revenue was driven by reductions across entry, mid-range and enterprise tape automation sales.

Disk systems software and related service revenue was $34.1 million in Q4. This was down 10% from the prior year. Of the $34.1 million, approximately 57% was from disk systems and related service revenue and 43% was from StorNext and Lattus solutions and related service revenue. For the year, disk systems software and related service revenue was $139 million. Approximately 60% was from disk systems and related service, and approximately 40% was from StorNext and Lattus scale-out storage and archive solutions and related service revenue.

Disk systems and related service revenue, as I mentioned, was down approximately 20% from a year earlier. The primary contributor to the lower year-over-year revenue was the 42% decline in revenue from big deals, as we had a number of very big deals in Q4 of last year. Revenue in our over 80-terabyte systems was flat year-over-year, where we saw our year-over-year decline within our 10- to 80-terabyte systems, primarily related to the higher number of big deals last year.

In the entry space, where we introduced our DXi4700 during Q4, we saw strong year-over-year revenue growth and new customer adoption. Our overall DXi win rates remain strong, approximately 55% in the quarter. We also added 90 new customers in Q4 and approximately 375 in fiscal '14.

Turning to StorNext and Lattus scale-out storage solutions. Our product and related service revenue increased 9% year-over-year. In addition, revenue from big deals, again defined as deals over $200,000, increased by 20% over the same quarter in the prior year. We also saw an increase in the number of worldwide partners selling our StorNext products compared to Q4 of last year and continue to experience strong win rates in our solutions offering.

On a geographic basis, we continue to see strength in our North America business, where revenue was up 50% on a year-over-year basis. Our business in North America is more mature and further along in implementation of our business plans and demonstrates the strength of the opportunity.

APAC increased revenues approximately 35%, while EMEA was down over 40% from the same quarter in the prior year. Our Next appliances and related disk revenues continue to ramp nicely from the prior year, and stand-alone StorNext software sales were up moderately compared to Q4 last year.

Overall, from a customer acquisition standpoint, we added over 70 new StorNext and Lattus customers in Q4 and approximately 285 new customers in fiscal '14.

Moving to service revenue, it was $37.6 million in Q4, up 2% from $36.9 million in the same quarter the prior year. The increase was driven by growth in branded contracts related to our StorNext appliance strategy.

Turning to gross margins. Non-GAAP gross margin was relatively consistent at 41.9% in Q4 compared to 41.8% in the fourth quarter of fiscal '13 despite the reduced revenue levels, which reflects the positive impact of the cost reductions we have driven over the past 1.5 years.

Looking at expenses. Non-GAAP operating expenses were down $8.3 million or approximately 13%, totaling $54 million in Q4 compared to $62.2 million in the prior year. Year-over-year, our sales and marketing costs decreased by $5.1 million. The primary driver of the reduction relates to lower salaries and benefits, resulting from the headcount reductions we have implemented over the past year, as well as lower commissions associated with the year-over-year revenue decline. Similarly, research and development spend decreased approximately $1.9 million, primarily as a result of headcount and other cost reduction actions taken over the past year. General and administrative costs declined by $1.3 million, primarily related to lower infrastructure costs.

Q4 non-GAAP operating loss was $159,000 compared to an operating loss of $3.7 million in the same quarter a year earlier. This resulted in a 260 basis point improvement in operating margin. The largest contributor to this improved operating performance was the cost reduction actions, which were somewhat offset by lower overall revenue.

Interest expense for the quarter was $2.4 million, which is the same as it was a year ago. This included cash interest expense of $2 million and amortization of debt issued cost of $400,000. The average interest rate for our $203.7 million of convertible debt is 3.96%.

For the fourth quarter, we had other income of $500,000, primarily related to an investment in a private technology venture limited partnership. We also recognized a net tax benefit of $15,000, primarily related to a refund of foreign taxes, which more than offset our state income taxes.

Summing it up for Q4, we had non-GAAP net loss of $2.1 million or $0.01 per share compared to a non-GAAP net loss of $6 million and $0.03 per share in the same quarter a year earlier. On a 9% year-over-year revenue decline, our bottom line improved 55%, due to the changes we've made in our business model over the past 1.5 years, particularly the reductions in our cost structure and increased focus on driving profit and cash flow.

Focusing on cash flow for the quarter and the balance sheet at March 31, I would like to highlight several key points. Cash flows provided by operations for the quarter were $19.9 million and $35.5 million for the fiscal year. We ended the quarter with $101.9 million in cash and cash equivalents, up over 40% from $72 million in the same quarter last year and our highest cash balance in 4 years.

We were able to repurchase $1.3 million of the November 2010 convertible debt at a discount and retire it. At March 31, our debt consisted of $203.7 million of convertible debt with no covenant. There were no amounts drawn on our revolver at quarter end. Therefore, we have no financial covenant compliance requirements.

EBITDA for the last 12 months was $44 million compared to $18.7 million a year ago. On a sequential basis, due to our outsourcing to third-party manufacturers, manufacturing inventory decreased $8.8 million to $34.8 million and will continue to decline over the upcoming quarters with quarter-end level of approximately $20 million to $25 million. Accounts receivable decreased $2.7 million due to lower sequential revenues, offset by the discontinuation of accelerated payments from 1 customer. OpEx was $900,000.

Last week, as filed on our Form 8-K and press release, we finalized an amendment to our credit agreement with Wells Fargo Capital Finance. This amendment increased the availability on our lines from $55 million to $75 million and allowed for additional flexibility in utilization of the line to prepay or pay when due the convertible debt.

With over $100 million in cash in our balance sheet as of March 31, the availability of the $75 million line and the cash we expect to continue to generate over the next 1.5 years, we feel very confident in our ability to retire the November 2010 bonds when they become due in November 2015 or earlier if it makes economic sense for Quantum. After payoff, we would have sufficient cash remaining to operate the business.

Now let me turn the call back over to Jon.

Jonathan W. Gacek

Thanks, Linda. In my opening comments, I described the progress we've made in fiscal '14. Let me now turn to fiscal '15, where we will focus on driving results and shareholder value through several strategic initiatives that will leverage our product and installed base strength and capitalize on the market trends in data protection and scale-out storage.

First, we will drive the data center products for profitability and growth. Scalar tape libraries and the DXi dedupe products are the best -- are best-in-class products. We are the market share leader in open system tape automation, and we have a very, very large installed base. As I said earlier, we have organized our data center sales and marketing team to drive revenue in both these products and to leverage the fact that they are both backup targets for data.

In addition, the tiered archive workflow and video in the enterprise use cases are becoming more and more applicable in general commercial enterprises that we expect to identify opportunities and get leverage in our data center installed base for our StorNext and Lattus products. We believe that focusing on these products together will enable us to hold combined revenue of roughly flat on a year-over-year basis despite the overall decline in the tape market.

The second strategic initiative is to drive growth in our scale-out storage products with a focus on media and entertainment and federal government intelligence and surveillance verticals. For media and entertainment, we have a dedicated sales and marketing resources, as well as specific product combinations in our StorNext Pro Solutions to drive growth. We are focused on expanding our footprint among the large broadcasters, studios and new cutting-edge content creators as they implement 4K and 8K workflows. StorNext 5's performance capabilities, combined with Lattus, create unique solutions.

In the mid-market, we are focused on using the Pro Solutions to replace or add to existing Apple Xsan installations, leveraging StorNext 100% compatibility with the Apple products. This market is growing dramatically as content is being created by an increasing number of entities and the demand of the 4K workflows create a large opportunity for Quantum.

We also have increased our channel partners tenfold in the space over the past 2 years to over 200.

On the government side, we continue to get design into solutions because of our installed base and strong product portfolio. In fiscal '15, we believe we are in programs that will get funding, and we expect growth in our federal space for the year.

Finally, we will build on our scale-out storage success we had in North America this past year, nearly 50% growth despite a very soft federal market, by implementing a similar model in Europe and Asia. Given all this, we have targeted 50% overall revenue growth for scale-out storage in fiscal '15.

A third initiative relates to our single biggest strategic challenge: greater access to end-users. We will continue to focus on adding new routes to market through both ecosystem and channel partners. Over the past 2 years, we've expanded our ecosystem partnerships in tape with Teradata, in DXi with Fujitsu, in StorNext with Adobe, Apple, Autodesk, Dalet, Dell, Quantel Snell, Reach Engine, Telestream and Vizrt, and in Lattus, with CommVault and Arkivio. We've also added a range of new VAR partners.

As we begin fiscal '15, we have the strongest product portfolio we've ever had, and we will be aggressive in leveraging it to add new partners, which will generate incremental revenue and profit to our financial results this year.

Leveraging our technology in public, private and hybrid cloud opportunities is our fourth initiative. In fiscal '14, we launched Q-Cloud, our MSP program, managed service provider program. And just recently in NAB we demonstrated StorNext cloud workflow solution. The combination of performance, tiering, scalability and value make our solutions very unique in specific workflows and verticals. Over the course of fiscal '15, we will increase our capabilities and partnerships related -- providing solutions in and for cloud-based architectures.

Finally, we will continue to generate cash and opportunistically look to improve our balance sheet. As Linda said, our recent amendment to our Wells Fargo credit line agreement, along with our March 31 cash balance of $102 million, gives us the resources to pay off our $135 million November 2010 convert right now, as in today, and still effectively operate the business.

In addition, we expect to generate free cash flow of $30 million to $40 million in fiscal '15, which in total give us liquidity of approximately $205 million to $215 million a year from now. Between now and November 2015, we will opportunistically look to refinance or pay off the convert early if it makes economic sense for Quantum.

With that background for fiscal '15, let me now to turn to guidance. For Q1, we expect revenue of $125 million to $130 million based upon typical seasonality. We expect non-GAAP gross margin of 44% to 45%; non-GAAP operating expense of $54 million; interest expense of $2.5 million; and taxes of $500,000.

For the full fiscal year, we are targeting revenue of $540 million to $550 million; non-GAAP gross margin of 45% to 46%; non-GAAP operating expenses of $215 million to $220 million; interest expense of $10 million; and taxes of $2 million.

In summary, we have positioned Quantum to profitably grow total revenue in our core business for fiscal '15 and beyond by: one, leveraging our market leadership position in tape automation; two, penetrating growing markets where we are well positioned from a technology and go-to-market perspective with DXi, StorNext and Lattus; three, leveraging our large installed base across our entire product portfolio to achieve efficiency and scale; and four, enabling customers to implement public, private and hybrid cloud solutions using Quantum technology. We are also aggressively pursuing go-to-market partnerships that would drive incremental revenue and profit. And our current cash and balance sheet resources are sufficient to pay off our 2010 debt and fund additional investments to drive additional growth opportunities.

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

Question-and-Answer Session


[Operator Instructions] And our first question comes from the line of Chad Bennett with Craig-Hallum.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

I guess, on the fiscal '15 guidance, I think you gave some good color into kind of what you think could potentially grow, and I think you're even more specific about your scale-out storage business growth rate there. But I guess how do we get there? And any more detail there? And how should we think about the different segments, if you can give kind of a -- in line with market growth rates, better than growth -- market growth rates, kind of a qualitatively, directionally, however you want put it?

Jonathan W. Gacek

Those are in the script. Let me summarize them again for you. I'm happy to, because I think it's a key point, we specifically put those in there. So let me start and work my way through. With tape, we think will be a share grabber, that's our goal. We grew share slightly this last year, but our goal is to grab share, but we also recognize that market has -- there's pressure in certain segments. On DXi, we think we're in a position to grow with the market, and if we were to add more incremental channel or routes to market, we could do better than that. The combination of those 2, tape and DXi, we think will be pretty flat for the year. So in other words, whatever decline we might have in tape, we would expect to see some growth in DXi. Even within tape, it's hard for us to take anything but the market when we're dealing with our OEM partners, because we don't control what they're doing. On the branded side, we think we have an ability to do better than the market. On scale-out and StorNext, we -- there really isn't market data. Our target is to double, or sorry, to grow 50%. And we actually -- in my part of the script, gave some color about how big the StorNext business is. So we were looking at growing 50%. That's a whole combination of things, Chad. It's the new StorNext 5; it's Pro Solutions, for the M&E space; it's Lattus; it's we think some of the federal programs we're in, we're pretty well positioned. We think we've won, we're just waiting for funding, which we think will happen during the year. We also are starting to get traction in deals outside of our traditional verticals, but for our traditional workflows. So I used an example on the call about an apparel company who is a long-time customer who brought in us to solve their marketing video problem. We had a deal recently at a very large police force that was a long-time data center customer. So we think we'll get further penetration in the verticals where we're strong. And we see a growing set of opportunities in our general population where our specific solutions can be deployed. And then, finally, the things that are more speculative that really aren't in our numbers are adding verticals to StorNext. Because we think with 5, we've already seen we're getting pulled into vertical markets for use cases that aren't generally our sweet spot, but with the new technology, we solve problems for people. And then, laid over all that is incremental growth that could occur as we add more channel or strategic partnerships. That's kind of a summarization of that last section.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Okay. And then, one other thing I wanted to ask on the DXi business, I think you talked about an industry growth rate for '14. I don't think I heard a growth rate for last year? Do you have that?

Jonathan W. Gacek

The growth rate we gave actually was for '14 and then we said was going to grow in the future, 18% I believe. Yes, I'm getting nod on that. I don't know what grew, it's in that kind of range. Our shares remain relatively flattish. We're around 4% in the open system space.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

How does that math work, because if it grew and your DXi business was down pretty decently, how does that math work?

Jonathan W. Gacek

I'm looking at the math. Let me get back to you on that. I think what we're -- the discussion we're having is around what's included but -- and timing. I think it's a timing issue. We're March versus fiscal calendar. But for sure, as a strategy, we pulled back on revenue -- well we pull back on expense which had the result of pulling back on revenue. Now we think, with the leverage were getting in the way that Bill's organized the sales force, we'll be able to grow at a market rate and that's what our goal is. And so combining tape and DXi together, really tightly, in a sales force kind of way, some of that will matter less because the margin profiles are good in both products. And we're going to try and hold that flat to slightly up in fiscal '15.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Okay. And I'm not sure, it's probably more of a kind of a strategic question but, and I'm not sure how investment is allocated, but considering the movement you have between high-end tape, mid-range tape, entry tape, every quarter and the same thing on that DXi business, and also a little bit on the OEM and branded side across products and probably product range. I -- do we need to have -- do we need to be in all these segments of the markets we're in? And maybe from an investment standpoint, it's -- not enough to matter to kind of segment them. But it just seems like we're getting dinged by the high-end or the low end or something like that every quarter. Does it make sense to focus a little bit more?

Jonathan W. Gacek

Well, I think in some ways we have focused a lot more, but not so much around products but where we are selling. We reduced our sales resources, really, we pulled back from investment markets where we just didn't have traction yet. All of those segments that you talk about are now to a spot where they contribute incremental profitability. And so, a lot of what we have done is financially what you just described, and so we think about them discretely, but also in a leveraged way. So you get benefit of having a complete product portfolio when you go in and sell to a big Fortune 1000 company where you can sell them all the products. So we definitely look at that data center business from a profitability perspective overall, and then within the major categories, so we do that. And a lot of what we've done to make the company more profitable, even over the last 7 years, is to do exactly what you asked about, which is get out of our businesses where we're not making money, and we think that's where we have done that in those products you mentioned.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Okay, couple last quick ones for me, probably for Linda. I think it was Jon or Linda talked about free cash flow of $30 million to $40 million this year based on kind of the revenue range that you gave. You saw a pretty big benefit this year on the working capital line and as you outsourced manufacturing, obviously inventories get down quite a bit. How should we think about cash flow from operations or free cash flow this year? Just pure net income versus kind of working capital benefits, from a mixed standpoint if you can look at it like that?

Jonathan W. Gacek

Yes, I think we'll still get some benefit off the balance sheet. But if you go through the guidance that we gave, you can calculate an EBITDA number. I think, frankly, I think this is probably one of the most conservative estimates that we've put out because the balance sheet is still working its way through. We didn't completely sell everything that we have previously manufactured, if you will, just because there is mix and it's not financially or efficiently. So the inventory will continue to come down. Receivables probably will go up because we're planning on growing revenue, so those can offset. But we'll definitely get some balance sheet benefit. But the majority that was based upon the operating model.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Okay, Linda, D&A for this year, do you kind of have an estimate?

Linda M. Breard

It's going to be around probably $8 million to $10 million, I would say for the year. And then amortization comes slightly down from last year. We have some things are that are falling off in the year, Chad, so it's down probably closer to $8 million to $10 million also.


And our next question comes from line of Eric Martinuzzi with Lake Street Capital Markets.

Eric Martinuzzi - Lake Street Capital Markets, LLC, Research Division

Just curious to know on the gross margins, you've laid out for the year a gross margin scenario and I'm talking non-GAAP here of 45% to 46%. And that would be definitely up and I understand it's in March part due to the manufacturing outsourcing. But just wanted to know, for modeling purposes, is that kind of stair-stepped throughout the year beginning with the Q1 44% to 45% guidance range and then kind of tweaking higher? Or is there seasonality to take into account there?

Jonathan W. Gacek

I think there's a couple things you hit on, 2 of them. One is, we're still kind of, as I mentioned when I was answering Chad's question around the balance sheet, we still have some of the inventory we have built. While our manufacturing model is now 1, our balance sheet still has sort stood mixed -- on a manufactured and will have new manufactured from the outsourced partners. So that transition occurs mathematically we think during the year. I think we'll get most of that out, we'll certainly know at the end the year. The next is really sort of volume and mix related. And while we are outsourced, we still have fixed costs around procurement and the inventory management on the service side and service. There are still fixed elements within the COGS piece. So as revenue grows, the margin will be better for that, too. So for our modeling purposes, Q1 would be the low point, I would say, by sort of Q3 and Q4 would be more on track to that, and then Q4 gets a little bit of a negative impact based upon just volume. That makes sense?

Eric Martinuzzi - Lake Street Capital Markets, LLC, Research Division

Okay. Yes, that makes sense. And then, shifting down to the operating expenses. We've just finished out the year $223 million or so -- what was the OpEx? I'm talking non-GAAP, I mean, OpEx for 2014, what was that?

Linda M. Breard

It was $222 million.

Eric Martinuzzi - Lake Street Capital Markets, LLC, Research Division

$222 million, okay. And that end looking to $215 million to $220 million as the guidance range for 2015. Just curious to know, the headcount that you talked about where you've got I think you were at 1,300 exiting 2014, does that headcount stay the same and maybe we throttle back some of the non-personnel issues? How does the -- well let's start with that question. How, does the headcount change in 2015?

Jonathan W. Gacek

Yes, I think it'll be flattish. We have open racks and we've had people churning through. And I think the thing that you're hitting on 2 points. One, our sales costs, on a run rate level, will go up some right? Because you get the growth number we're, talking about, the branded revenues is going to grow. So we'll have a little bit of higher sales costs and commissions, which I would gladly pay more as we grow more. The second is that you haven't really seen the full benefit of all the changes that we made. So that pushes it the other way, right? And then, that gets worked in to the -- into fiscal '15. So it's really those 2 things offsetting each other. And as you know, people drag expense, I think what really what your point is. So having fewer overall team members, we'll have less travel, we'll have less cell phones, we'll have less stuff and that impacts as well.

Eric Martinuzzi - Lake Street Capital Markets, LLC, Research Division

Okay, and then shifting back to the revenue. Just kind of from a macro storage perspective, as we've come through the calendar Q1 earnings cycle, there's definitely been some hiccups out there, certainly on the hardware side, from people who saw delays at quarter end, so towards the tail end of March, on high-end system sales, elongated sales cycles. Obviously, you guys hit the higher end of your guided range, but was that due to maybe more conservatism? Or did you not see some of those things that other hardware folks have spoken about?

Jonathan W. Gacek

I mean, you're kind of asking a market perspective, and I think we had a solid quarter. We were too -- actually thought we even could have been better. So there's always some deals that slip. Our biggest area of prize really was on our OEM business which is in the list -- a number of those companies are the list of companies who you are referring to who struggled this quarter. Our branded business, I mean, we were actually quite strong. Having said that, we always think we can do better. So I think the markets pretty good. I think we're in the right markets for the growth opportunities. Chad asked about it earlier. Our -- the feedback we have gotten on StorNext 5 and the Pro Solution have been very strong. Lattus technology is really starting to get some momentum underneath it. It's going to be lumpy and we'll have to be cautious about that and we'll try to share that with people as we land those deals. But overall, the market feels pretty good, other than, I would say, in the federal government. And eventually, everybody believes they're going to have to spend money. Our results -- I don't -- not going to use it as an excuse, but our results could have been better even with sort of a more normal Fed season. Our Fed team is actually -- has been rebuilt and we're very strong there. We like the team, and we're in some very, very good deals. We think are in the right programs. I think Linda mentioned that and so I expect that to rebound this year and actually be better than this past year. So a long-winded answer to say, I appreciate the comment about where we sit relative to everybody else. We think we've got good momentum, we think we have the right products and we think we got the right overall structure, financially, to drive growth and sales but have it be at increased profitable levels.


And our next question comes from the line of Ryan MacDonald with Northland Capital Markets.

Ryan MacDonald - Northland Capital Markets, Research Division

I guess, first and foremost with StorNext and Lattus, obviously North America's been very strong or has had a very strong reception for those products and solutions. I'm just wondering, I think, you said in the quarter, Europe was down or EMEA was down by 40%. I mean, looking ahead to fiscal '15, I mean, where do you expect the improvements in that market? And then obviously, how do you expect to improve with those products outside of North America? What's your, I guess, goals for that?

Jonathan W. Gacek

Yes. So we made some changes in North America when Bill took over sales, which was in July of this past year, to drive this vertical focus and to expand our channel. And then we've hired great people, and we've hired some really, really strong people in North America, and we've seen the results. And the markets in the start, with Europe -- in Europe, are a little bit different, they're more fragmented, channel partners are different. The go-to-market motion is different. And so, it isn't like we're just starting. We actually started during the year. But we have a lot more confidence about our model to really drive it into Europe. I'm going to start with Europe, in particular. Driving into Europe this year, and so, a number of those partners that I mentioned, Dalet, Snell, [indiscernible] RT, they all have a real European presence. We're going to take what we have done well here, and we've been in process of replicating it. We think we'll get uptick from just how we're structured, the type of people we've hired and then what we've asked them to do. In Asia, it's similar but it's even more of a partner-centric model. So we'll be looking for go-to-market partners over there. We have some in the works already that should help expand it. But the same is true, focusing on the right markets, focusing on the right partners and really positioning the bundled products, in the M&E, in particular, will be the focus for this coming year. We expect both Asia and Europe to grow, but we expect our highest expectations around North America to be in this coming year.

Ryan MacDonald - Northland Capital Markets, Research Division

Okay, okay, got you. And can you talk a little bit more about what your expectations for Q-Cloud are for the year? I mean, obviously, it's still very, very small, in terms of the overall business, but I mean how -- I mean, is it mostly greenfield opportunities? Or is there something that you're going to focus more on leveraging existing customer base to help grow that?

Jonathan W. Gacek

Yes, so Q-Cloud has really morphed in both how we think about it but also how it's utilized. So what tends to happen is by having our own cloud, and this is, today, it's just for DXi. By offering our own sort of OpEx based cloud solution for DXi, it allows us to enter the conversations differently than some of the competition. Oftentimes, the result of it is we still end up selling them hardware. The other thing that it's led to though is we're selling our template, if you will, to particularly VARs but also MSPs, that then take our hardware and implement their own branded version of what we would have called Q cloud. And that led to the MSP program that I referred to that we launched during the year. I think our biggest deal on DXi this last quarter was in fact an MSP deal for DXi. It was over $1 million. So think of it as both we're selling the OpEx, but we're also selling the template to other people who implement it. The other leg on the Q-Cloud stool is we will add more than just DXi to it over time. We mentioned this StorNext and Lattus workflow in the cloud. We called it that so you guys can understand what it is, but that will be ultimately part of our Q-Cloud offerings. A number of our big installed base customers would like to have hybrid type solutions where they have some data, and we have some data. So architecturally, it takes some time to implement. So you're going to see us expand it. It's not -- I don't think it will be -- it's not going to be something we report separately, I don't think, but we're going to talk about it a lot more because it's clearly where the market's going. And we have a unique technology foundation that really gives customers a different kind of solution. The response we got -- I was at this presentation at SUPERNAP, the response we get from these CIOs was unbelievable. I mean, we were the -- we were actually demonstrating something that changed their business in a way that nobody else could do. So you're going to hear us talk about it more, and I think it's going to be a key part of our growth in '15 and beyond.

Ryan MacDonald - Northland Capital Markets, Research Division

And then, finally, I guess, with obviously the cash flow levels, you talked a lot about really using where you are at right now to improve the balance sheet. I mean, any other ideas or goals for uses of the cash for the year? I mean, just looking at, obviously, you're over $100 million cash right now. And it sounds like you're pretty positive on the amount of cash flow that'll be generated throughout the year. I mean, any thoughts of using that towards M&A opportunities, to improve some technology or in terms of like a share buyback? I mean, what's your thoughts around that?

Jonathan W. Gacek

Yes, it's funny that -- in the first time that I can remember, since we merged with -- Quantum [indiscernible] merged, our balance sheet really is -- feels taken care of. And so talking about those things has begun. It's the first time, in a long time, I've been able to discuss with the Board the possibility even of strategic acquisitions to further accelerate our growth and progress, particularly in the scale-out business. I don't really think we need anything right now. But as this business takes off, it's good to be in a position to start looking forward more. And talking about it at the Board level, what can we do to further accelerate our growth and not being constrained by our capital structures? So that's a long-winded answer to say it feels like we're back on offense a little bit. We don't really need anything. But as we get momentum here and there is a lot of activity, we're going to be balanced about growth and profitability for sure, but the balance sheet constraint feels gone.


Our next question comes from the line of Glenn Hanus with Needham & Company.

Glenn Hanus - Needham & Company, LLC, Research Division

Let me just sort of give you the high level question. You gave us a lot of good stuff there so thank you for that. So if you just kind of at a high level look at what your real -- if you take the '15 guidance you give us, particularly the revenue and the gross margins, where do you see sort of the greatest risk? And where do you see sort of the greatest opportunity to sort of show some upside? Just kind of go through it, the tape and the StorNext. Where's the risk and the opportunity here, sort of rank some of that stuff for us?

Jonathan W. Gacek

Yes. I think the first risk is one that we've faced a couple of years ago, which are things we are just are not in control of. Market dynamics, IT spending all of that. We can't -- we are super conscious of that. We think we've done the right things around our model. We gave some stats in there. Tape's still 65% of our revenue. It is a market that's mature. We're hyper focused on it, but it is a mature market.

Glenn Hanus - Needham & Company, LLC, Research Division

So the tape market this year, like what are the -- are they yours? Or the forecasts for the rate of decline of the tape market this year?

Jonathan W. Gacek

I think it's the mid-teens -- or the mid-single digits, is what I recall, I think it's 7%.

Glenn Hanus - Needham & Company, LLC, Research Division

Yes, about the same as last year?

Jonathan W. Gacek

Yes, and that actually turned out to be slightly higher than that, last year. So I mean because the big part of our market, for sure that's on the risk side of the house. We're still -- we still have customer access challenges. And so, I mean challenges in that that's a hurdle for us. So we haven't really built into the model adding any new channel. I've -- I think that's a big opportunity given what's going on it the market around us. And so on the opportunity side of those products, I think there is an opportunity to add channel. We're going to pursue them, that makes sense for us. We have talked about this a lot, as you know. You and I have talked about this. It takes [indiscernible] parties to agree on something like that. So we're going to continue to pursue there. On DXi, generally, I just think it's a good product. It's better than I think the market share leader's product. It's well positioned. A risk always is we got to compete with the Goliaths, it's just the world that we live in. And then, on the scale-out side, I think there's much more opportunity than risk to the 50% growth. I think we have done a really good job of positioning the portfolio and the roadmap in markets where we have unique capabilities and we have hired some really good people -- people from industry-leading companies who have helped drive changes into the productization, we're good at getting products out. We have hired some great sales people. So I think the most upside opportunity is around -- on the scale-out stuff and/or adding new channel on the data center stuff, would be the 2. Just in closing on that, we feel good about where we are positioned and good about the guidance that we gave on the parts that we can control in the markets that we're in.


And that's all the time we have for questions. I would like to turn the call back over to management for closing remarks.

Jonathan W. Gacek

Well, thank you. I know it was a long quiet period for us given our audit period. We're couple of weeks further along than typical, but we appreciate all the support on the call. We'll be out this quarter at least 1 or 2 conferences, and we look forward to talking to everybody again at the end of Q1. Thank you very much.


Ladies and gentlemen that does conclude our conference for today. If you would like to listen to a replay of today's call, please dial (303) 590-3030 or 1 (800) 406-7325 with access code 4678239. Thank you for your participation. You may now disconnect.

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