Quantum Corporation (NYSE:QTM) Q3 2016 Results Earnings Conference Call January 28, 2016 5:00 PM ET
Shawn Hall - General Counsel
Jon Gacek - CEO
Eric Martinuzzi - Lake Street Capital Markets
Chad Bennett - Craig-Hallum Capital
Brian Alger - ROTH Capital Partners
Tim Klasell - Northland Securities
Please stand by. Good day and welcome to the Quantum’s Third Quarter Earnings Call Conference. Today’s call is being recorded.
At this time, I’d like to turn the conference over to Shawn Hall, General Counsel. Please go ahead, sir.
Thank you and good afternoon and welcome. Here with me today is Jon Gacek, our CEO. The webcast of this call, our earnings release, and a quantitative reconciliation of any GAAP and non-GAAP financial measures discussed today can be accessed at the Investor Relations' section of our website at www.quantum.com and will be archived for one year.
During the course of today’s discussion, we will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements include statements regarding our business strategy, opportunities and priorities, anticipated product launches and plans, and future financial performance.
We like to caution you that our estimate and our statements are based on current expectations and involve risks and uncertainties that could cause actual results to differ materially.
We refer you to the risk factors and cautionary language contained in today’s press release, as well as to our reports filed with the Securities and Exchange Commission from time-to-time, including our most recent 10-K filed on June 12, 2015, and 10-Q filed on November 06, 2015. These risk factors are incorporated by reference into today’s discussion and we undertake no obligation to update them in the future.
With that, I’ll turn the call over to Jon Gacek.
Thanks Shawn. Thanks for joining our third quarter conference call. First let me start-off by addressing the 8-K we filed today regarding Linda's departure to pursue another opportunity.
Linda has been a valuable Quantum team member for the past 17 years and over that time has made significant contributions and provided leadership to the organization. We wish her well in her new endeavor.
Moving forward, Chris Willis, VP, Financial Planning and Analysis, an 18 veteran of Quantum will take the role of Interim CEO -- CFO, sorry, as we conduct our search for a permanent CFO.
Moving to our third quarter results, I want to note first given the overall market conditions and the magnitude of the business changes we implemented during the quarter to lower our cost structure, I'm pleased with the overall outcome.
As we describe each quarter, our objective is to increase shareholder value by growing our scale-out revenue and investing to drive future scale our growth, while also delivering on our operating profit goals.
This approach requires us to make balanced investment choice, evaluate our best opportunities for growth and consider our capital structure.
For the third quarter, our scale-out storage and related service grew to an all-time high of $35.7 million, up 31% year-over-year and 19% sequentially. For the nine months ended December, 31st, scale-out storage and related service has grown 32%. That growth was achieved without the benefit of any megadeals which we described as deals over a $1 million, but we did see significant growth in big deals which we classify as transactions between $200,000 and $1 million.
For the third quarter, excluding mega deals, scale-out storage and related service grew 48%. And for the first nine months of fiscal 2016 and again excluding mega deal revenue, scale-out storage and related service revenue has grown 49%.
We introduced this metric last quarter to provide additional detail about where we're growing and underlying health of the core scale-out product line. We have multiple mega deals in our pipeline and in the future we expect to close some of those mega deals and add additional mega deals to our funnel overtime.
Turning to operating profit, due to the overall market environment, we took several series of actions this quarter to reduce our capital structure without impacting our scale-out revenue growth. The changes implemented improved gross margin and also lowered operating expenses. Although these changes had some revenue impact, they did not materially affect it.
To summarize, the impact of the changes that we took during the quarter on $11 million sequential revenue increase that included a better revenue mix, our non-GAAP operating profit increased $13 million. The point I want to emphasize is that these changes were made in response to storage market that deteriorate in Q1 and even more in Q2.
We have taken what we think are appropriate changes to increase overall profitability, while protecting the opportunity to have substantial growth from our scale-out revenue in the future. I'll spend additional time describing the opportunity later in the call.
The last item I want to address is the continued momentum and recognition we're receiving in the marketplace for our new product and solutions. Specifically, Artico, our NAS archive appliance; Xcellis, our next generation storage systems powered by StorNext; and our new Q-Cloud offerings including Q-Cloud Wallet and Q-Cloud Protect for Amazon web services.
Artico provides customers including scale-out NAS users, a flexible low cost entry point for archiving data, both on premise and in the cloud. Powered by StorNext, Artico offers substantial savings by providing the ability to move large, unstructured data files off primary storage to low cost tier of storage as Lattus object store, tape, or the cloud, while maintaining full access to all the files.
With its NAS interface and multi-tiered storage support, Artico simplifies data management for customers and expands our addressable market in scale-out storage. As a side note, Artico is recently named a finalist in storage magazine in SearchStorage.com's Product of the Year Awards.
Xcellis is our next-generation high performance storage system also powered by StorNext. Xcellis overcomes a limitation of scale-out NAS by automating and simplifying data management through unique combination of converged architecture, continuous scalability and unified access in a single system.
Xcellis consolidates multiple workflow components simplifying the overall storage architecture, operations and management, as well accessed the third-party applications in the StorNext environment.
Xcellis users can also start with a small system and smoothly scale to the largest possible system without having you replaced original hardware or take the system down, thereby protecting past investments.
Lastly, by providing direct NAS support and StorNext environment, it allows all users regardless of whether they connect via SAN or NAS to access the same data within a multi-tiered storage architecture that encompasses object storage, tape, and the cloud.
All of this helps drive increased productivity in collaboration for customers and expands Quantum's addressable market with an existing scale-out verticals and to adjacent markets.
Xcellis recently won the Visionary Award at Storage Visions 2016, which recognizes company that are advanced in the state-of-the-art in storage technology and showcases visionary digital storage products.
In addition to adding Xcellis to our scale-out portfolio this quarter, we also released our Q-Cloud bulk service. Announced earlier this year, enabled by the release of StorNext 5.3, the new service provides cold storage in a public cloud for long-term data retention and the vast recovery.
Key features benefits beyond general cloud advantages include; first, foreign integration as a tier in StorNext manage workflow as automated policies and data movement; second, no additional hardware, separated application of programming needed and third, straight forward pricing and billing directly from Quantum.
Customers can now use Q-Cloud bulk in conjunction with Artico or Xcellis creating hybrid cloud solution that combines on premise storage with the cloud. All this reinforces a fact that we are fully embracing the cloud as part of the hybrid architecture hoping customers to migrate data and maximizes value in a most cost effective way possible.
Finally, this quarter we began offering third cloud solution in the form of Q-Cloud protect for Amazon web services. It enables customers to replicate data from either physical or virtual DXi appliance on premise to a virtual DXi instance in the Amazon Web Services cloud.
Requiring no additional applications or processes, it allows customers to store copies of their data in the Amazon public cloud for offside access and the vast recovery. Now because Q-Cloud Protect uses Quantum’s deduplication customers can minimize the cost associated with transferring the data over the WAN and storing it at the Amazon cloud.
I will now walk through our financial results in detail. Before I do so, I would like everyone to refer to the financial statements and supporting schedules included in the press release and on our website. It will be helpful to reference those documents as I comment.
Total revenue for the quarter ended December 31st, with $128 million compared to $142.1 million a year ago. Non-royalty revenue totaled $116.8 million of which 89% was branded and 11% was OEM compared to 88% branded and 12% OEM a year ago.
As I mentioned above, products and related service revenue for scale-out storage solutions with $35.7 million an all-time record and a 31% increase year-over-year. We have grown quarterly revenue from our scale-out solution on a year-over-year basis for 18 consecutive quarters.
Revenue from large deals those in access of 200,000 was up nearly 50% compared to the same quarter in the prior year. Our scale-out storage momentum was particularly strong in surveillance which grew nearly 300% during the first nine months of Fiscal '16 and technical applications which grew 165% during the same period.
I would also note that our growth was driven by North America and EMEA and that the number worldwide partners selling our scale-out solutions increased 32% over the same period last year. Overall, win rates for the quarter remained strong at 77% and we added over 120 new scale-out customers in Q3.
Turning to our data protection products, our revenue in this area were impacted by the overall market weakness in both general storage and data protection and backup. In total, tape automation systems and related service was $51.2 million for the quarter compared to $66.7 million in Q3 of fiscal 2015.
OEM tape automation and related service revenue was down $1.2 million or 9% year-over-year. This reflected lower sales in entry and mid-range libraries partially offset by an increase in enterprise revenue. Branded tape automation in related service decreased $14.3 million or 27% year-over-year due to lower revenue in all products categories.
Revenues from large deals those over 200,000 were down 40% from the same period in the prior year. However, our win rate remained strong at 76% and we acquired approximately 80 new branded mid-range in enterprise customers.
This system’s backup and related service revenue was $19.6 million down $4.4 million from the prior year. Revenue from large deals increased slightly by 4%. Overall, DXi win rates remained strong in the upper 60th percentile, and we added over 50 new customers in Q3.
Finally, as it relates to data protection, devices and media revenue totaled $10.2 million in Q3 down from $13.5 million in the prior year due primarily to lower media revenue. However, their continuous to significant pricing pressure on tape media products and we continue to make conscious decisions to not pursue unprofitable revenue opportunities.
Moving to service, it was $37.1 million in Q3 down 5% from 39.2 in the same quarter last year. The decrease is primarily driven by a decline in service contracts or tape automation systems partially offset by growth in contracts for scale-out storage solutions.
Royalty revenue was $11.3 million up 5% from 10.7 a year ago. LTO 6 royalties grew 133% offset by a decrease in royalties for LTO generations 1 through 5. LTO 7 launched during the quarter and is expected to grow in future quarters.
Turning to gross margins, non-GAAP gross margin was 44.6% in Q3 compared to 46.2% in the third quarter of fiscal '15. This decline is attributable to both year-over-year decrease in total revenue and a decrease in material margin related to changes in our overall revenue mix for the quarter.
Higher margin service revenue decreased $2.1 million, and lower margin products comprised a larger portion of our product revenue. In addition, the pricing environment is tougher than it was a year ago. These impacts were partially offset by $600,000 increase in royalty revenue and the cost management actions we took during the quarter.
Comparing sequentially, non-GAAP gross margin increased from 39.9% in Q2 to 44.6% in Q3 due to revenue growth, revenue mix and the implementation of the cost management actions we took during the quarter.
Looking at expenses, non-GAAP operating expenses decreased $2.1 million, totaling $49.9 million in Q3, compared to $52 million in the prior year. Year-over-year, our research and development expenses declined $2.6 million, primarily as a result of lower salaries and benefits due to lower head count, benefits, savings and no bonus expenses in Q3 fiscal 2016.
Sales and marketing cost increased $1 million; primarily due to a higher marketing spend in markets with significant growth opportunities, partially offset by lower commissions due to lower revenue. Sequentially, despite the increase in revenue total non-GAAP operating expenses decreased from 52.5 in Q2 to 49.4 in Q3 due to the cost management actions we took during the quarter.
Q3 non-GAAP operating income was $7.2 million compared to $13.6 million in the same quarter a year earlier. This represents a non-GAAP operating margin of 5.6% for Q3. As I mentioned earlier, but I want to repeat the point given a significance non-GAAP operating income increased $13 million sequentially on $11 million increasing revenue.
Interest for the quarter was $1.4 million, which included cash interest expense of $1.2 million, and amortization of debt issuance cost of $200,000. Interest expense decreased $1.1 million from a year ago, as we repaid our convertible debt due November 2015 during the first and third quarters of calendar 2015. The average interest rate for our $138.9 million our main debt was 3.88%.
In Q3, other income was less than $100,000. We recognized tax expense of $400,000, primarily related to foreign and state taxes. We had non-GAAP net income of $5.3 million, or $0.02 per share compared to non-GAAP net income of $10 million, or $0.04 a share in the same quarter last year.
Let me now turn to cash flow for the quarter and the balance sheet. Cash flows used in operations for the quarter were 13.6. On a sequential basis, accounts receivable increased $9 million and manufacturing inventories declined $4.4 million. EBITDA for the last 12 months was $15.8 million, CapEx was $1.2 million, fixed charge coverage ratio was 1.73.
At December 31st, our debt consisted of $70 million of convertible debt due November 2017 and $68.9 million of outstanding borrowings on Wells Fargo revolver. At December 31st, we are in compliance with dead agreements and expect to be incompliance with them over the next 12 months.
During Q3, we repaid $83.7 million of convertible debt due November 15, 2015, on October 5th, we repaid $81 million of these notes for $82.4 million, which included $1.1 million of accrued interest and resulted in $400,000 loss on extinguishment of debt. On November 13, will repay remaining $2.7 million in notes plus accrued interest.
To fund these transactions, we used a combination of cash on hand in $68.9 million from our $75 million. Including our January 2015 repayment of $15 million of these notes we repaid the original $135 million balance of the convertible debt due November 2015 with roughly equal repayments from cash generated from operations and our revolver.
In summary, despite and overall difficult environment we improved our balance sheet adjusted our spending levels delivered solid profitability that significantly improves sequentially delivered record scale out revenue and related service of $35.7 million despite no mega deals and still position Quantum to have a significant opportunity grow in the future.
I’ll spend the next few minutes describing that opportunity and strategy and then provide guidance for the fourth quarter.
We believe we are well positioned to grow scale out revenue and increase overall company profitability. To do so, we will build on a momentum in three main overarching categories.
First, video, which includes Media & Entertainment generally and specific use cases such as corporate video and sports video, animation and visual effects. Second, intelligence and surveillance, which encompasses government, video surveillance, and network forensics use cases.
And third, technical applications, a broad category that includes oil and gas, geospatial applications, genomics, and other scientific research. Would all these have in common is demanding workflows involving large valuable data files that must be quickly be captured, cost-effectively retain for analysis or reuse, and maybe easily available for sharing and collaboration.
In other words, these markets and use cases require storage that provides high-performance, low-cost capacity, and easy access, and our ability to provide all three attributes in a single integrated tiered storage solution encompassing flash, spinning disk, object storage, tape and the cloud is very differentiated.
In fiscal -- to-date in fiscal 2016, all of these market categories have grown and contributed to our scale-out revenue growth despite the lack of mega-deals this year and we have built a foundation for growth into the future.
I want to spend few more minutes on the storage opportunity for video surveillance which is growing rapidly. There is a move to higher resolution cameras, more and more cameras and much longer retention times for captured video. All of these to as requirements for more storage and the numbers are staggering. Storage newsletter published in article yesterday that indicated that 566 terabytes of video surveillance data is produced daily by the cameras that were installed in 2015.
To add some for further context to the magnitude of that, a typical large discount retail store would have 500 to 600 cameras per store. Our video surveillance initiative began at the start of this fiscal year. Since that time we have certified storage solutions with a broad range of industry leading company including video management system companies from 3VR, Amadeus, Genentech, Milestone and IP Video solutions from AirCon Vision, Access Communication and HotSpot Networks.
In addition, we signed up the leading global distributor for video surveillance along with dozens of new reseller and integration partners specialized in surveillance and security solutions.
So, why are we so excited about this opportunity and why are those entities excited about using scale-out solutions from Quantum. First is our performance. We can handle more cameras per server than our competition. This lowers the overall cost of the solution. Second is our ability to tear stored video to lower cost storage on tape or to the cloud. This also lowers the overall cost of the solution.
To put numbers behind this, a video surveillance project of 500 cameras or more would result in storage making at 50 to 60% of the total cost of the project with cameras, servers and software making up the bulk of the balance.
With the Quantum scale-out solution, we’ve lower the cost of storage to 27 to 33% of the total cost of project or roughly half of the storage cost. As a result, integrators can quick can add more cameras for better coverage or provide longer retention period for better analytics or just save the customer money by using Quantum scale-out storage versus the competition.
This business alignment with the ecosystem partners and video surveillance is why have been able to make so much progress so quickly during the nine months since we kicked this initiative off. We’re very excited about this opportunity and we’re just getting started. Today, these partnerships have led to customer wins at a large government agency and major metropolitan shopping mall, a large public transport organization and a state-of-the-art data center.
Moving on to data protection, our strategy to continue to leverage technological leadership our extensive customer base and our channel and technology partnerships to generate profit and cash from our offerings. While the enterprise storage market is clearly challenging, our best of class technology in both disc and tape and the tight integration of the two are key strength in data protection.
We also believe that customers are looking for new ways to manage and preserve their data seeking alternatives traditional backup. We’ve seen this transition and demand in markets like M&E, oil and gas and the federal government applications or tiered storage and archiving is deployed instead of batch backup.
We expect this to happen in the data center and will aggressively position our archiving solutions like Artico; Lattus and Q-Cloud vault has superior approaches to unstructured data management.
In December, we began offering LTO-7 technology in our Scalar tape libraries with our StorNext AEL archives libraries to follow in subsequent months. This latest generation of LTO tape offers a low-cost, highly energy-efficient, long-term storage solution for organizations struggling to manage the massive growth of unstructured data and maximize the value of the digital content.
We are well-positioned to capitalize in LTO-7 as the long-standing market share leader in LTO tape automation, and the fact that our Scalar in StorNext AEL systems delivered best-in-class management, monitoring, and data protection. We also continue to engage with other ecosystem players in data protection around opportunities for collaboration, as this is the case with our new Veeam partnership.
By bringing together Veeam Backup and Replication software and our QXS storage and DXi deduplication appliances, we are enabling customers to restore files in just seconds and virtual machines in minutes, while reducing both on premise and disaster recovery site storage costs compared to traditional backup applications. This combination also shortens backup windows and dramatically simplifies Veeam Backups.
As we look towards the remainder of the fiscal year and into fiscal 2017, we believe we are well positioned to deliver significant value to customers with longstanding expertise in a powerful product portfolio. We also believe that our focus on growing scale-out storage revenue on leveraging our data center installed base and infrastructure and increasing overall profitability that’s how we best can deliver shareholder value.
Now let me close with guidance for the fourth quarter. As you may recall, we didn’t provide any guidance for Q4 on last conference call just given the market conditions, so this will be our first guidance for the quarter. Based on the current market conditions, we expect revenue of 118 to 122, but I’d like to highlight two additional factors that are important to understand I wouldn’t consider in the guidance.
First, that revenue range does not include any of the mega deals that we are working on. One or more of them to close in the quarter, but the timing of them is too uncertain to include them in our forecast. Second, the pricing of commodity products in the markets specifically tape, media remains quite challenging and as was a case in Q3 we will manage our tape media revenue to maximize profitability versus trying to maximize revenue.
We expect non-GAAP gross margin of 43 to 44%, Non-GAAP OpEx of 48 to 49 million. This quarter we expect typical seasonal increases in OpEx in spending due to payroll taxes which we said January 1st and sales commissions that increased for people who had their annual compensation accelerators. We expect 1.5 million in interest, $400,000 in taxes which results in non-GAAP EPS of 0 to $0.01.
With that, I’d like to turn it over to the operator for questions.
[Operator Instructions] We’ll go first to Eric Martinuzzi with Lake Street Capital Markets.
Thank you. Regarding, Linda’s departure, is she is staying the same industry, in other words is she moving to another storage or data protection company or is she just pursuing an opportunity outside of the industry?
Yes, I’m gone to ultimately let her disclose where she is going, but it is not in storage or IT.
Okay. Alright. And then as far as the -- when the numbers came in for the current quarter I know you guys don’t give guidance by product line or expectations by product line but I think on the product side I was actually -- usually I’m rolling on tape, media this time I was wrong -- backup and the scale-out understanding the scale-out did in fact grow which is great but didn’t grow as much as I thought, would start there that’s product there that you’ve been able to grow pretty well in excess of 50 and then down to 40% and if I look for the year now we’re averaging about 30 to 35% growth. What’s your expectation for scale-out growth going forward?
That’s a great question. We as you know, Eric, we broke out the concept of mega deals. This year -- we just haven’t had anywhere near the magnitude and we have none this quarter and a mega deals -- deal over a 1 million that obviously contributed lot last year. When we exclude the mega deals 30 to 35% is correct when we exclude mega deals to just look at the underline health of the business. We’re growing at just under 50%; we are at 49% I believe for the first nine months.
I would say people asked me what are the characteristics of the mega deal. I could tell you story about each one of them. They all have a different sort of cadence to them generally where they are common on consistent, is that they are largely architectural high designs which are very cross functional in nature and just take time to plan and implement and they are also high value type deals. In my prepared remarks, the 31 to 35%, 33 to 35% is right. Even in our mid-range $200,000 to $ 1 million we grew 50% year-over-year.
So we do have sort of good momentum underneath the core of the business which is kind of overall health. We’ve just lacked any of these real large deals that we’ve been in – I don’t pursue not the right word because we know where they are. They just need to decide to close them. So that rolled into our guidance as well. We felt like – handicapping whether or not those will close in a quarter we would just exclude them give the guidance without them and then continue to drive to close them.
Okay. And then DXi business were [indiscernible] to obviously not where you guys want to be, talk about your win rates being pretty strong. So when you’re seeing deals, you’re winning them, but obviously there is price competition out there. There is a macro issue. It directs kind of the macro demand what’s going on now where you think that head and nobody is happy with minus 18% comp when I look at the data backup and service versus a year ago, this backup and service has to sustain or is there some relief?
Yeah. We took out roughly $5 million in costs during the quarter. And as we said at the last quarter and I repeated again. Our goal is to not reduce the opportunity in scale-out and so those costs are very much centered around the data protection side of the company. What happens when you do that is, if you know you just don’t spend incremental dollars trying to drive revenue there and so there's a trade-off. You get some profitability, but you'll have some revenue impact. What's going on there is the data protection products sit behind storage -- would sit behind servers.
And if you seem -- I think one of the big storage companies are reporting today, one of the big OEMs reported last week, those businesses are under pressure, we're going -- we sold sell backup unless there's something to backup. I mean we don't sell primary storage there.
So, we're really focused on investment and incremental growth opportunity would scale out. We think we're very differentiated there. We think that the data protection products are important and a key part of our cash flow and our profit and that's why I don't take the lot of cost -- more cost out because if I did, we're going to be less profitable.
We are still investing the scale-out and we want to continue to do that. We think got better this quarter, it was more predictable for sure, even though the results from last quarter -- a year-ago quarter are down, sequentially, it was much better I said on the last call tape and DXi would grow sequentially, they both did. We thought scale-out would grow and as you pointed out it did.
So, we're trying to manage both things, we're trying to manage profitability and the cash flow from the data protection, and make wise choices there and not take away from the opportunity that just keeps materializing for some scale-out. I just don't know of any other sort of major storage-type vendor who is growing at the 30% plus range this year or as we grew that same product line 70% last year, so.
Okay. And then just a later deep run, the two new offering, Xcellis, is there a CAM expansion here, or is this kind of just the evolution the next-gen scale-out, started the workflow solution and then Q-Cloud, is there a potential I was looking for you to be playing in new markets here that could topline going [ph].
Yeah, Xcellis -- actually what's great about that product is both things. It’s the next-generation, but it also enables an expansion by adding the cloud capability by adding the NAS connectivity and the thing is real nice about it is that it simplifies the implementation for customers.
So, you don't have too many specialty pieces which allows us to kind of get into more run rate type opportunities, which we -- as I mentioned earlier, we've been growing at a quite high clip, 50% plus year-to-date.
So, we're excited about that. It's been really well received. I mean actually we had to buy more of them during the quarter. We brought it out pretty late in the quarter, right around Thanksgiving and then we had to go find more. So, we're excited about that.
We think that the ability to use Amazon as a tier for cold storage is important. We're big supporters of hybrid-type model. When you use the Amazon could with StorNext, it just looks like one big name space for a non-technical people like me, one big C drive. It virtualizes over the top of all the storage including Amazon and we've had a lot of positive feedback about its applicability. So, we like it a lot. And we do think it expanded -- we do think it expands our market opportunity.
Okay. Thanks for taking my question.
Thank you. We'll now hear from Chad Bennett with Craig-Hallum.
Good afternoon. Thanks for taking my questions. So, Jon, in the guidance you gave for the March quarter, with backing out the big deals which I think is the right way to think about it. I guess that would imply relative to estimates the guidance range is kind of everything is equally lower relative to expectation kind of a cross-product groups and that includes scale-out?
To be fair Chad, I didn’t actually compare year guidance -- the consensus by product to what we did. So, I would -- my guess is that's the case, but for instance, data center media last year, we did like $16 million. The quarter we just did was $7 million or $8 million. So, I think it's probably more heavily weighted towards data center.
Also on the cost side, we're about $5 million lower between OpEx and margin than the consensus was. Some of that is going to impact on the revenue side, most of that will be data protection is what we think. So, when you -- so, yes, I guess everything is lower including the expenses and gross margin is higher.
So, you said this recently at a conference that your goal is 50% scale-out growth this year and so I'm assuming we're not expecting 50% scale-out growth this year?
Yeah, no, what I actually said at the conference and in the last call and today is to get to 50%, we need big -- we would need big deals to close to make it get there. We said that last quarter was in our -- at the Needham Conference, we talked about that extensively.
We've excluded those from our -- any of those from our guide. So, implicitly, they are not in there. The -- we just had a record quarter. I think you can assume sort of the 30% to 35% rate without big deals and then a big deal close, it will be higher, everything will be higher.
So, tape -- from a product standpoint, tape product was down 30% year-over-year off of down 22% last year, disk was down 26%, so I guess you're implying that if you cut more cost, those numbers would be even worse?
Yeah, I'm implying, that's what I'm saying. I mean we're trying to maximize for profit there. So, the easiest one to talk about is tape media. I mentioned the $16 million, if I added back $3 million or $4 million of media this quarter; we would be in the midpoint of the range on revenue. But we probably would be lower than the midpoint that we deliver on profit. And that's just because this market dynamic of these last three quarters has been very, very brutal on pricing. People much bigger than us are setting the table on what the price is and we're not going to chase that.
That happens in other parts of the business as well, but media is the easiest place. So, we're trying to balance revenue versus profit, but the goal is profit first on the data protection side, revenue second. And then on a scale-out side, it's about delivering growth.
Okay. So, how should we think about -- and I know you don't want to guidance for next year obviously, but as the tape business continues to decline, as the disk business continues to decline, and as the scale-out business grows, but maybe not as the growth rate were -- we were thinking, what's kind of the path two service to debt?
So, the path to growth which is what we would have to -- what we're trying to talk about here is two things. One we took out roughly $20 million of annualized cost to reflect the decline off of last year's record revenue to match those up.
We think scale-out has a ton of opportunity. When you look at that expense run rate and look at the margin and the growth opportunity, we'll generate cash. Our plan will be to look at the alternatives around the debt both in terms like we have in the past which have included refinancing and using our own cash. And we also -- half of that debt is a convert.
Okay, great. Thanks.
Thank you. [Operator Instructions]
We'll go to Brian Alger with ROTH Capital Partners.
Hi Jon, good afternoon.
I guess what I'm struggling with is on many level, it sounds as though the scale-out business has gone really, really well. You talked about triple-digits kind of growth for this surveillance business, specifically you talked about deals over couple hundred thousand being very, very strong.
But I think by every measure the total growth for the business, is it matching our expectations, I mean I suspect not your expectations either with or without the big deals here. As we at that business in this challenging environment with enterprises delaying and doing everything else. Are we expecting quarter-on-quarter the scale-out business to grow here in the March quarter?
Yeah, we are.
So, when I summarize through--
What I said in the Chad's question is -- or maybe it was Eric's, I can't remember. I think without big deals, this sort of nine months, 31%, 32% growth rate is -- we -- that's kind of what we've -- each quarter has been about the same. And it's really the magnitude of these big deals that -- and it's not an insignificant amount. I mean it’s a $9 million or $10 million number that we have to replace and then grow 50% on top off to replace these large deals. So, our run rate business is great. I think as I said it’s 49% when we take out the negatives.
Right. And I understand the math here. I mean we're talking 30% to 35% growth off last year that effectively implies that our product sales are only going to grow about year-on-year here in the March quarter which kind of continues this downward trend that we've been seeing in the past several quarters.
I'm just trying to understand or put that in context when we have the compounding effect of the surveillance business coming on top of Media & Entertainment. Have we go to a point where the M&E side is saturated and all of the growth is coming from surveillance or surely [ph] what's going on in there, because we should be delivering more growth despite the macro environment even without this mega deal.
Yeah, I don't know if I -- I mean -- let me see if I can add more color to that. I think I must make sure I've got the math right. The -- for M&E, most if not all of the mega deals were in M&E. So, the M&E growth below mega deals is strong. Overall, it's relatively -- it's slightly up, I don't what the exact percentage is, but it's up. But most of the mega deals were M&E. So that point one.
Point two is, surveillance is brand new. I mean our comps are minimal. As I said we started the initiative this year, we had some surveillance deals that we walked into that turned into a real focus practice. The thing is it has been the most -- growing the fastest in terms of dollars is really what this other group that we call Other.
And the reason that's important is it is a kind of a cross vertical opportunity for us. And how we're growing that is we're leveraging our specialists in scale-out, but also our broader sales force who we sell back up and did affliction products from.
So, what we said for a long time is that we think these requirements that we see customers have are going to tip and become more horizontal. We've seen that a lot this year and a lot of growth is coming from that particular used case, which is handful of used cases.
So to summarize real quick, I think next year scale-out growth will come about from continued growth in M&E. we'll have mega deals in M&E again, it's just that's not been the year. We had some great wins, some high profile wins and it is growing at a good rate if you exclude the mega deals.
Surveillance is a brand new opportunity for us. It's not super material, yet it could become material quickly. And then the real sort of solid thing for the year is this third category that we call technical workflows. I kiddingly call Other and it’s a cross solutions where our performance in our tiering, our ease of access are relevant, for people want to have access to a lot of data with real high performance.
And that we think will continue. We think our TAM is expanding. I don't know how to -- I mean you guys, you cover a bunch of storage companies, I don't know how to -- I'm happy to talk about a storage company of $150 million or $200 million run rate that's growing 30%, I just don't think there's that many.
Yeah understood. Shifting gears if I can, obviously, we've restructured the financing, with the new line of credit, are there any major covenants tied to that that we need to be aware of whether working capital or EBITDA thresholds that we--
Yeah, the only major one is a fix charge coverage. One it's in the agreement. We were at 1.72 I think I had it in the script. We were -- with covenants up as 1.2, yeah. That's the only one.
Great. All right. Thanks Jon.
And we'll take our next question from Tim Klasell with Northland Securities.
Yeah, hey guys. I know we're beating this horse to death here, on the media business; you said that run rate business is fairly steady and providing some nice flow. My question is are these run rate deals, are they just adding capacity or are you seeing new customers come on board with sort of five six [ph] type deals?
Yeah. I know you're speaking to -- not tape Media & Entertainment. Yeah, I had in the script, we've added -- we added 120 new customers during the quarter. I think that might be a recorded, pretty darn close for scale-out. I think everybody checked that. But that over a hundred, our record had been towards 130.
So, that's a strong quarter. I mean it's indicative. I guess I'm trying to be give you guys clarity about what's going well and what isn’t going well. Scale-out is going quite well, except for a handful of deals last year that we closed, which is great and more than a handful of deals this year that haven’t closed yet, that continue to be opportunities for us.
Okay. Fair enough. And then second question just -- sorry I got on the call late, the royalty business actually did a little bit better than we thought and that would actually indicate that maybe the tape -- overall tape market is maybe better than what we thought. Can you walk me through that, what are you seeing is sort of overall -- I know there has been decline, but is -- maybe a little better than what your numbers would indicate and just holding firm on price or maybe you could walk us through that.
Yeah. Well, there's a couple of things. If you recall last quarter media royalty came in I think about $1 million below what it had been running at. And so if you -- I said at the -- I got to ask this, on the call, if you start to normalize, media has been pretty flat for the last six, seven quarters, it fluctuated very little. That's the royalty.
When we're taking about tape media, that's a commodity product, as I mentioned, we did about $16 million in Q3 a year ago. If we do $16 million this quarter, it will be because pricing was such that it made sense for us to sell. We're trying to generate profit there and we're just not going to sell anything. We're at the bottom-line or top-end line; it doesn’t yield the positive dollar, because that's not what we're doing.
So, if you think about media, its variable up or down, I don't -- it's not super high value revenue to the financials. It can be important to the customer, they like buying it from us, some people insist on it, so that's why we carry it. But it has become a pretty wide ranging revenue item that I'm sure drives you guys crazy.
At some level, it bothers me, but taking it down its face, you can look how higher gross margin is this quarter compared to last and you can see what not -- what the media market can do and what the cost changes we made there.
So, we're trying to manage that very actively and hopefully, it will get better as the overall market gets better. Maybe some of these larger companies will be less willing to drive price down, we'll see.
So, we're -- the data protection market is what we're talking about everybody wants tape into one category. We include tape; we sell a lot of scale-out tape. Remember, our secret sauce in scale-out is the fact that tiered storage including tape. So, we sell tape, the product in scale-out as well. And our overall archive is been growing.
When you look at the tape media royalty, it doesn’t discern between how people use the tape. And we see growth in tape across used case. So, data protect, archive, even cloud providers, I think, will be using tape media as time goes on here as they drive cost out.
So, that royalty does have potential. The element of the royalty is LTO-7 just launched and historically when you launched -- not historically, practically when you launch a new media tape, the royalty rate for that media tape goes up, its higher than the rest of media.
Okay, great. And then one follow-on. If you take a look at your scale-out's pipeline, how much of that is coming from directly from your scale-out salesforce and how much comes in from the attribution back archiving tape and StorNext distributors and channel?
Yeah. So, we have a real separate channel for M&E. That's a separate ecosystem and separate and so it's about 50-50 that comes from the channel and comes from us I think is the last stat I saw.
We’re seeing increase in scale-out opportunities in our traditional Quantum backup customers. I brought that up twice in the script, I want to emphasize is it. And the reason I do is one of the ways that the model gets such good leverage is we'll get scale-out growth by using data center resources if you will.
And so we get the best of both worlds. We get leverage and better profitability, but we also get scale-out growth. The reason for that is both our product positioning and our solutions, our messaging, but also the fact that we've got where we have a lot of customers that we can call into. So, that's when I talked about in the script, we're going to leverage that as these used cases broaden out.
Surveillance, I think this overall sales team is probably the most excited about the surveillance portfolio, because surveillance is everywhere, whereas M&E, the big centers of M&E are London, New York, and LA. So, your ability to sell an M&E solution if you're selling in Denver, Colorado is pretty limited. But there's a lot of surveillance opportunity.
So, what we like about where the market is headed is it's headed in the direction that fits with our attributes. We think we have a lot of opportunity. We're really hunkered down right now by implementing these costs and to drive profit, we're going to do that in Q4 again. We want to close some of these big deals which gives us some upside in both profitability and revenue, but I just -- I don't feel like we're in a position to forecast those and provide guidance on them. And so we're just going to have to work to close them during the quarter.
Okay, good enough. Thank you.
Thank you. And with no additional questions, I'd like to go ahead and turn the floor back over to our speakers for any additional or closing remarks.
Great. Thank you very much for taking the time today and listening to the call. As a reminder, March is our fiscal year end and so our call will be a little later as we get through the close process and the audit. Again thanks for your time and we'll take to you next quarter. Thanks very much.
Thank you. And again ladies and gentlemen that does conclude today's conference. Thank you all, again, for your participation.
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