Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements, the accompanying notes, and other information included in this Annual Report. In particular, the risk factors contained in Item 1A may reflect trends, demands, commitments, events, or uncertainties that could materially impact our results of operations and liquidity and capital resources.
The following discussion contains forward-looking statements, such as statements regarding COVID-19's anticipated impacts on our business, our future operating results and financial position, our business strategy and plans, our market growth and trends, and our objectives for future operations. Please see "Note Regarding Forward-Looking Statements" for more information about relying on these forward-looking statements.
Overview and Fiscal Year 2021 Highlights
We are a technology company whose mission is to deliver innovative solutions to forward-thinking organizations across the world. We design, manufacture and sell technology and services that help customers capture, create and share digital content, and protect it for decades. We emphasize innovative technology in the design and manufacture of our products to help our customers unlock the value in their video and unstructured data in new ways to solve their most pressing business challenges.
We generate revenue by designing, manufacturing, and selling technology and services. Our most significant expenses are related to compensating employees; designing, manufacturing, marketing, and selling our products and services; data center costs in support of our cloud-based services; and income taxes.
Highlights from fiscal year 2021 compared with fiscal year 2020 included:
• We ended fiscal 2021 with $27.4 million in cash and cash equivalents, representing an increase of $21.0 million from the end of fiscal 2020. Our cash flows used in operating activities during 2021 was $0.8 million, compared to $1.2 million during 2020.
• We completed an equity offering which generated $96.8 million in net proceeds and reduced our total outstanding debt by approximately 50%.
• We fully integrated our Active Scale acquisition to expand our footprint in the object storage space, and completed the acquisition of SBS and their CatDV Media Asset Manager to continue to broaden our solutions and leadership position in video and unstructured data.
• We increased research and development investment 15% as we released several new product lines including StorNext 7, ATFS, and our H-Series platform.
• We began a project to replace and modernize our IT infrastructure and most notably our ERP system which will significantly enhance our operational capabilities and efficiency.
• We hired new leadership with expertise across multiple industries to drive innovation and fuel our next growth phase.
Square Box Systems Acquisition
In December 2020, we expanded our portfolio that classifies, manages, and protects data across its lifecycle by adding technology advancements to further enrich video, digital images and other forms of unstructured data with the acquisition of SBS, a specialist in data cataloging, user collaboration, and digital asset management software. This acquisition will strengthen our ability to provide software solutions to help companies unlock the business value contained in their data, both on-premises and in the cloud.
Impact of COVID-19 Pandemic
Since the beginning of March 2020, COVID-19 has led governments and other authorities around the world, including federal, state and local authorities in the United States, to impose measures intended to reduce its spread, including restrictions on freedom of movement and business operations such as travel bans, border closings, business limitations and closures (subject to exceptions for essential operations and businesses), quarantines and shelter-in-place orders. These measures may remain in place for a significant period of time.
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In light of these events, we have taken actions to protect the health and safety of our employees while continuing to serve our global customers as an essential business. We have implemented more thorough sanitation practices as outlined by health organizations and instituted social distancing policies at our locations around the world, including working from home, limiting the number of employees attending meetings, reducing the number of people in our sites at any one time, and suspending employee travel. This was then followed by a gradual stabilization in our business during the second half of fiscal 2021 as customers increasingly adapted to the COVID-19 environment. Partially offsetting the headwinds from COVID-19 were reduced operating expenses in the areas of travel and marketing costs. In addition, we effected certain restructuring activities to streamline our operations, such as limited workforce realignments and vacating certain office leases.
We continue to actively monitor the situation and may take further actions altering our business operations that we determine are in the best interests of our employees, customers, partners, suppliers, and stakeholders, or as required by federal, state, or local authorities. See “The COVID-19 pandemic could adversely affect our business, results of operations and financial condition” in Part II, Item 1A, Risk Factors, of this Annual Report on Form 10-K for more information regarding the risks we face as a result of the COVID-19 pandemic.
RESULTS OF OPERATIONS
Year Ended March 31,
(in thousands) 2021 2020 2019
Total revenue $ 349,576 $ 402,949 $ 402,680
Total cost of revenue (1)
198,823 230,441 235,066
Gross profit 150,753 172,508 167,614
Operating expenses
Research and development (1)
41,703 36,301 32,113
Sales and marketing (1)
54,945 59,524 69,400
General and administrative (1)
42,001 54,457 65,277
Restructuring charges 3,701 1,022 5,570
Total operating expenses 142,350 151,304 172,360
Income (loss) from operations 8,403 21,204 (4,746)
Other income (expense) (1,312) (261) 2,878
Interest expense (27,522) (25,350) (21,095)
Loss on debt extinguishment, net (14,789) — (17,458)
Loss before income taxes (35,220) (4,407) (40,421)
Income tax provision 239 803 2,376
Net loss $ (35,459) $ (5,210) $ (42,797)
(1) Includes stock-based compensation as follows:
Year Ended March 31,
(in thousands) 2021 2020 2019
Cost of revenue $ 672 $ 452 $ 334
Research and development 2,881 984 440
Sales and marketing 1,757 1,165 179
General and administrative 4,314 4,147 2,456
Total $ 9,624 $ 6,748 $ 3,409
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Comparison of the Years Ended March 31, 2021 and 2020
Revenue
Year Ended March 31,
(in thousands) 2021 % of
revenue 2020 1
% of
revenue $ Change % Change
Product revenue
Secondary storage systems $ 89,000 25 % $ 111,672 28 % $ (22,672) (20) %
Primary storage systems 69,644 20 % 77,152 19 % $ (7,508) (10) %
Devices and media 51,164 15 % 62,344 15 % (11,180) (18) %
Total product revenue $ 209,808 60 % $ 251,168 62 % $ (41,360) (16) %
Service revenue 124,904 36 % 131,050 33 % (6,146) (5) %
Royalty revenue 14,864 4 % 20,731 5 % (5,867) (28) %
Total revenue $ 349,576 100 % $ 402,949 100 % $ (53,373) (13) %
1 Primary and Secondary storage system revenue has been adjusted for fiscal year 2020 due to certain reclassifications from Primary to Secondary storage systems.
Product Revenue
In fiscal 2021, product revenue decreased $41.4 million, or 16%, as compared to fiscal 2020. Secondary storage systems decreased by 20%, driven by fluctuating purchase cycles with our hyperscale customers. Primary storage systems decreased 10%, driven by early disruption in the media and entertainment market as COVID-19 significantly decreased major television and film production. We have since returned much closer to our pre-COVID quarterly run rate in this vertical as we closed out the fiscal year. Devices and media decreased $11.2 million driven partially by unusually high demand in fiscal 2020 following the resolution of a legal dispute, which had caused a constraint on LTO tape supply between the two principal suppliers in the market.
Service Revenue
Service revenue decreased $6.1 million, or 5%, in fiscal 2021 compared to fiscal 2020. This decrease was due to reduced support renewals from our legacy backup customers, partially offset by new customer support agreements and installations.
Royalty Revenue
We receive royalties from third parties that license our LTO media patents through our membership in the LTO consortium. Royalty revenue decreased $5.9 million, or 28%, in fiscal 2021, as compared to fiscal 2020, related to overall declines in market unit volumes as the primary use of tape transitions from backup to archive workflows.
Gross Profit and Margin
Year Ended March 31,
(in thousands) 2021 Gross
margin % 2020 Gross
margin % $ Change Basis point change
Product gross profit $ 59,551 28.4 % $ 71,408 28.4 % $ (11,857) —
Service gross profit 76,338 61.1 % 80,369 61.3 % (4,031) (20)
Royalty gross profit 14,864 100.0 % 20,731 100.0 % (5,867) —
Gross profit $ 150,753 43.1 % $ 172,508 42.8 % $ (21,755) 30
Product Gross Margin
Product gross margin was flat comparing fiscal 2021 to fiscal 2020.
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Service Gross Margin
Service gross margin decreased 20 basis points for fiscal 2021, as compared with the same period in 2020. This decrease was due primarily to reduced service revenues from some of our legacy backup customers, partially offset by a reduction in service costs.
Royalty Gross Margin
Royalties do not have significant related cost of sales.
Operating expenses
Year Ended March 31,
(in thousands) 2021 % of
revenue 2020 % of
revenue $ Change % Change
Research and development $ 41,703 12 % $ 36,301 9 % $ 5,402 15 %
Sales and marketing 54,945 16 % 59,524 15 % (4,579) (8) %
General and administrative 42,001 12 % 54,457 14 % (12,456) (23) %
Restructuring charges 3,701 1 % 1,022 — % 2,679 262 %
Total operating expenses $ 142,350 41 % $ 151,304 38 % $ (8,954) (6) %
In fiscal 2021, research and development expense increased $5.4 million, or 15%, as compared with fiscal 2020. This increase was partially attributable to an increase in research and development headcount and professional services cost related to new product development. Most notably this includes headcount related to business acquisitions and integration of the associated development teams.
In fiscal 2021, sales and marketing expenses decreased $4.6 million, or 8%, as compared with fiscal 2020. This decrease was driven by a decrease in compensation as the result of lower sales performance and a decrease in marketing programs and professional services costs. Travel expenses were also significantly reduced during the fiscal year due to restrictions from the COVID-19 pandemic.
In fiscal 2021, general and administrative expenses decreased $12.5 million, or 23%, as compared with fiscal 2020. This decrease was driven primarily by lower costs related to our prior financial restatement and related activities, which we primarily incurred during fiscal 2019 and fiscal 2020 and decreased facilities expenses as we consolidate our physical footprint. These decreases were partially offset by increases to software expense as we modernize our existing IT infrastructure.
In fiscal 2021, restructuring expenses increased $2.7 million, or 262%, as compared with fiscal 2020. This increase was primarily due to footprint and associated headcount reductions that occurred in fiscal 2021, as well as changes in key leadership positions.
Other Income (Expense)
Year Ended March 31,
(in thousands) 2021 % of
revenue 2020 % of
revenue $ Change % Change
Other income (expense) $ (1,312) 0 % $ (261) 0 % $ 1,051 403 %
Interest expense (27,522) (8) % (25,350) (6) % 2,172 9 %
Loss on debt extinguishment (14,789) — % — — % 14,789 100 %
In fiscal 2021, other (income) expense, net increased $1.1 million or 403%, compared to fiscal 2020. The increase was primarily related to differences in foreign currency gains and losses during each period.
In fiscal 2021, interest expense increased $2.2 million, or 9%, as compared to fiscal 2020. This increase was primarily due to a higher average principal balance of our outstanding debt.
In fiscal 2021, we incurred a loss on debt extinguishment related to our Senior Secured Term Loan.
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Year Ended March 31,
(in thousands) 2021 % of
revenue 2020 % of
revenue $ Change % Change
Income tax provision $ 239 — % $ 803 — % $ (564) (70) %
Our income tax provision is primarily influenced by foreign and state income taxes. In fiscal 2021, the income tax provision decreased $0.6 million or 70%, compared to fiscal 2020, related primarily to an unfavorable $1.4 million valuation allowance recorded in fiscal 2020 for certain foreign deferred tax assets.
Due to our history of net losses in the U.S., the protracted period for utilizing tax attributes in certain foreign jurisdictions, and the difficulty in predicting future results, we believe that we cannot rely on projections of future taxable income to realize most of our deferred tax assets. Accordingly, we have established a full valuation allowance against our U.S. and certain foreign net deferred tax assets. Significant management judgement is required in assessing our ability to realize any future benefit from our net deferred tax assets. We intend to maintain this valuation allowance until sufficient positive evidence exists to support its reversal. Our income tax expense recorded in the future will be reduced to the extent that sufficient positive evidence materializes to support a reversal of, or decrease in, our valuation allowance.
Comparison of the Years Ended March 31, 2020 and 2019
Revenue
Year Ended March 31,
( in thousands) 2020 % of
revenue 2019 1
% of
revenue $ Change % Change
Product revenue
Primary storage systems $ 77,152 19 % $ 58,811 15 % $ 18,341 31 %
Secondary storage systems 111,672 28 % 126,528 31 % (14,856) (12) %
Devices and media 62,344 15 % 59,315 15 % 3,029 5 %
Total product revenue $ 251,168 62 % $ 244,654 61 % $ 6,514 3 %
Service revenue 131,050 33 % 134,696 33 % (3,646) (3) %
Royalty revenue 20,731 5 % 23,330 6 % (2,599) (11) %
Total revenue $ 402,949 100 % $ 402,680 100 % $ 269 — %
1 Primary and Secondary storage system revenue has been adjusted for fiscal years 2019 due to certain reclassifications from Primary to Secondary storage systems.
Product Revenue
In fiscal 2020, product revenue increased $6.5 million, or 3%, as compared to fiscal 2019. Primary storage systems represented $18.3 million of the increase driven by growth across both our Media & Entertainment and government vertical markets. Devices and media increased $3.0 million driven by the resolution of a legal dispute, which had caused a constraint on LTO tape supply between the two principal suppliers in the market. This was offset in part by a $14.9 million decrease in Secondary storage systems due to declines in our legacy enterprise backup business for both branded and OEM products.
Service Revenue
Service revenue decreased $3.6 million, or 3%, in fiscal 2020 compared to fiscal 2019. This decrease was due to reduced support renewals from our legacy backup customers, partially offset by new customer support agreements and installations.
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Royalty Revenue
We receive royalties from third parties that license our LTO media patents through our membership in the LTO consortium. Royalty revenue decreased $2.6 million, or 11%, in fiscal 2020, as compared to fiscal 2019, related to overall declines in market unit volumes as the primary use of tape transitions from backup to archive workflows.
Gross Profit and Margin
Year Ended March 31,
(in thousands) 2020 Gross
margin % 2019 Gross
margin % $ Change Basis point change
Product gross profit $ 71,408 28.4 % $ 64,808 26.5 % $ 6,600 190
Service gross profit 80,369 61.3 % 79,476 59.0 % 893 230
Royalty gross profit 20,731 100.0 % 23,330 100.0 % (2,599) —
Gross profit $ 172,508 42.8 % $ 167,614 41.6 % $ 4,894 120
Product Gross Margin
Product gross margin increased 190 basis points in fiscal 2020, as compared with fiscal 2019. This increase was due primarily to cost reductions across a wide range of product offerings, and a mix weighted towards more profitable products.
Service Gross Margin
Service gross margin increased 230 basis points for fiscal 2020, as compared with the same period in 2019. This increase was due primarily to reductions in cost of service.
Royalty Gross Margin
Royalties do not have significant related cost of sales.
Operating expenses
Year Ended March 31,
(in thousands) 2020 % of
revenue 2019 % of
revenue $ Change % Change
Research and development $ 36,301 9 % $ 32,113 8 % $ 4,188 13 %
Sales and marketing 59,524 15 % 69,400 17 % (9,876) (14) %
General and administrative 54,457 14 % 65,277 16 % (10,820) (17) %
Restructuring charges 1,022 — % 5,570 1 % (4,548) (82) %
Total operating expenses $ 151,304 38 % $ 172,360 43 % $ (21,056) (12) %
In fiscal 2020, research and development expense increased $4.2 million, or 13%, as compared with fiscal 2019. This increase was partially attributable to an increase in research and development headcount and professional services cost related to new product development.
In fiscal 2020, sales and marketing expenses decreased $9.9 million, or 14%, as compared with fiscal 2019. This decrease was driven by a decrease in compensation and benefits as the result of lower headcount and a decrease in marketing programs and professional services costs.
In fiscal 2020, general and administrative expenses decreased $10.8 million, or 17%, as compared with fiscal 2019. This decrease was driven primarily by lower costs related to our prior financial restatement and related activities, which we primarily incurred in fiscal 2019 compared to fiscal 2020, lower software expenses as we streamline our processes and tools throughout the company, decreased facilities expenses as we consolidate our physical footprint, and decreased bank fees. These decreases were partially offset by increases to stock compensation expense.
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In fiscal 2020, restructuring expenses decreased $4.5 million, or 82%, as compared with fiscal 2019. This decrease was primarily due to the higher level of headcount reductions that occurred during fiscal 2019.
Other Income (Expense)
Year Ended March 31,
(in thousands) 2020 % of
revenue 2019 % of
revenue $ Change % Change
Other income (expense) $ (261) 0 % $ 2,878 1 % 3,139 (109) %
Interest expense (25,350) (6) % (21,095) (5) % 4,255 20 %
Loss on debt extinguishment — — % (17,458) (4) % (17,458) 100 %
In fiscal 2020, other income (expense), net increased $3.1 million or 109%, compared to fiscal 2019. The increase was primarily related to a gain on the disposal of an investment that occurred in fiscal 2019, and differences in foreign currency gains and losses during each period.
In fiscal 2020, interest expense increased $4.3 million, or 20%, as compared to fiscal 2019. This increase was primarily due to a higher average principal balance of our outstanding debt.
In fiscal 2019, we incurred a loss on debt extinguishment related to our Term Loan.
Income Tax Provision
Year Ended March 31,
(in thousands) 2020 % of
revenue 2019 % of
revenue $ Change % Change
Income tax provision $ 803 — % $ 2,376 1 % $ (1,573) (66) %
Our income tax provision is primarily influenced by foreign and state income taxes. In fiscal 2020, the income tax provision decreased $1.6 million or 66%, compared to fiscal 2019, related primarily to an income tax benefit of $0.6 million recorded in fiscal 2021 for foreign currency related gains recognized in other comprehensive income.
Due to our history of net losses in the U.S., the protracted period for utilizing tax attributes in certain foreign jurisdictions, and the difficulty in predicting future results, we believe that we cannot rely on projections of future taxable income to realize most of our deferred tax assets. Accordingly, we have established a full valuation allowance against our U.S. and certain foreign net deferred tax assets. Significant management judgement is required in assessing our ability to realize any future benefit from our net deferred tax assets. We intend to maintain this valuation allowance until sufficient positive evidence exists to support its reversal. Our income tax expense recorded in the future will be reduced to the extent that sufficient positive evidence materializes to support a reversal of, or decrease in, our valuation allowance.
Liquidity and Capital Resources
We consider liquidity in terms of the sufficiency of internal and external cash resources to fund our operating, investing and financing activities. Our principal sources of liquidity include cash from operating activities, cash and cash equivalents on our balance sheet and amounts available under our Amended PNC Credit Facility (as defined below). We require significant cash resources to meet obligations to pay principal and interest on our outstanding debt, provide for our research and development activities, fund our working capital needs, and make capital expenditures. Our future liquidity requirements will depend on multiple factors, including our research and development plans and capital asset needs. We are subject to the risks arising from COVID-19 which have caused substantial financial market volatility and have adversely affected both the U.S. and the global economy. We believe that these social and economic impacts have had a negative effect on sales due to the decline in our customers' ability or willingness to purchase our products and services. The extent of the impact will depend, in part, on how long the negative trends in customer demand and supply chain levels will continue. We expect the impact of COVID-19 to continue to have a significant impact on our liquidity and capital resources.
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We had cash and cash equivalents of $27.4 million as of March 31, 2021, compared to $6.4 million as of March 31, 2020. These amounts exclude, as of both dates, $5.0 million in restricted cash that we are required to maintain under our Amended PNC Credit Agreement and $0.7 million and $0.8 million of short-term restricted cash, respectively. As of March 31, 2021 we had $32.7 million available to borrow under the Amended PNC Credit Agreement.
We believe that our existing sources of liquidity including the Amended PNC Credit Facility will be sufficient to fund our cash flow requirements for at least the next 12 months. We may need or decide to seek additional funding through equity or debt financings but cannot guarantee that additional funds would be available on terms acceptable to us, if at all. We believe we were in compliance with all covenants under the Credit Agreements as of the date of filing of this Annual Report on Form 10-K.
Our outstanding long-term debt amounted to $90.9 million as of March 31, 2021, net of $9.7 million in unamortized debt issuance costs and $1.9 million in current portion of long-term debt, and $146.8 million as of March 31, 2020 net of $13.7 million in unamortized debt issuance costs and $7.3 million in current portion of long-term debt.
We are subject to various debt covenants under our debt agreements. Our failure to comply with our debt covenants could materially and adversely affect our financial condition and ability to service our obligations. See "Risks Related to our Indebtedness" section of Item 1A Risk Factors.
Cash Flows
The following table summarizes our consolidated cash flows for the periods indicated.
Year Ended March 31,
( in thousands) 2021 2020 2019
Cash provided by (used in):
Operating activities (767) (1,181) $ (16,859)
Investing activities (9,586) (4,599) 235
Financing activities 31,328 1,211 16,210
Effect of exchange rate changes (108) (16) 62
Net change in cash, cash equivalents, and restricted cash $ 20,867 $ (4,585) $ (352)
Net Cash Used In Operating Activities
Net cash used in operating activities was $0.8 million for the year ended March 31, 2021, primarily attributable to greater net loss, offset in part by a $10.1 million non-cash adjustment pertaining to the debt refinancing.
Net cash used in operating activities was $1.2 million for the year ended March 31, 2020, primarily attributable $20.9 million of changes in assets and liabilities due primarily to lower deferred revenue and manufacturing inventories, offset in part by certain non-cash items.
Net cash used in operating activities was $16.9 million in fiscal 2019, mainly reflecting changes in working capital accounts including inventories and accounts payable.
Net Cash Provided by (Used in) Investing Activities
Net cash used in investing activities was $9.6 million for the year ended March 31, 2021, primarily attributable to $6.9 million of capital expenditures and $2.7 million for the acquisition of SBS.
Net cash used in investing activities was $4.6 million for the year ended March 31, 2020, primarily attributable to $2.6 million of capital expenditures and $2.0 million for the purchase of the ActiveScale business.
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Net cash provided by investing activities was $0.2 million in fiscal 2019, reflecting investment income of $2.9 million related to an investment in an equity fund that was liquidated during the period, which more than offset $2.7 million in capital expenditures.
Net Cash Provided by (Used in) Financing Activities
Net cash provided by financing activities was $31.3 million for the year ended March 31, 2021 due primarily to a secondary equity offering which generated net proceeds of $96.8 million, Senior Secured Term Loan borrowings of $19.4 million (net of lender fees of $0.6 million), $10.0 million in borrowings under the Paycheck Protection Program, offset in part by the prepayment of $92.3 million of our Senior Secured Term Loan.
Net cash provided by (used in) financing activities was $1.2 million and $16.2 million for the years ended March 31, 2020 and 2019, respectively. Net cash provided by financing activities during the year ended March 31, 2020 related primarily to net borrowings under the Amended PNC Credit Facility. Activity during the year ended March 31, 2019 related primarily to our debt refinancing activities.
Commitments and Contingencies
Our contingent liabilities consist primarily of certain financial guarantees, both express and implied, related to product liability and potential infringement of intellectual property. We have little history of costs associated with such indemnification requirements and contingent liabilities associated with product liability may be mitigated by our insurance coverage. In the normal course of business to facilitate transactions of our services and products, we indemnify certain parties with respect to certain matters, such as intellectual property infringement or other claims. We also have indemnification agreements with our current and former officers and directors. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of our indemnification claims, and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under these agreements have not had a material impact on our operating results, financial position or cash flows.
We are also subject to ordinary course of business litigation, See Note 11, Commitments and Contingencies , to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Contractual Obligations
Contractual obligations are cash amounts that we are obligated to pay as part of certain contracts that we have entered into during the normal course of business. Below is a table that shows our contractual obligations as of March 31, 2021 (in thousands):
Payments Due by Period
(in thousands) Total 1 year or less 1 – 3 Years 3 –5 Years More than
5 years
Long-term debt (1)
$ 92,426 $ 1,850 $ 90,576 $ — $ —
Interest on long-term debt (2)
27,390 10,154 17,236 — —
Operating leases (3)
14,408 3,818 5,368 4,220 1,002
Purchase obligations (4)
39,615 39,615 — — —
Total $ 173,839 $ 55,437 $ 113,180 $ 4,220 $ 1,002
(1) Represents nominal principal amount of debt outstanding under the Senior Secured Term Loan as of March 31, 2021. See Note 5: Debt , to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
(2) Estimated interest payment obligations have been calculated for all periods assuming an interest rate of 12.0%, which was the rate applicable to outstanding amounts under the Senior Secured Term Loan as of March 31, 2021.
(3) Operating leases include leases of certain facilities under non-cancelable lease agreements and equipment leases for various types of office equipment. Some of the leases have renewal options ranging from one to ten years and others contain escalation clauses.
(4) Includes primarily contractual commitments to purchase inventory from contract manufacturers and other suppliers.
See Note 5: Debt , to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
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Off-Balance Sheet Arrangements
We do not currently have any other off-balance sheet arrangements and do not have any holdings in variable interest entities.
CRITICAL ACCOUNTING ESTIMATES AND POLICIES
The preparation of our consolidated financial statements in accordance with U.S. GAAP requires management to make judgments, estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes included elsewhere in this Annual Report on Form 10-K. On an ongoing basis, we evaluate estimates, which are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. We consider the following accounting policies to be critical to understanding our financial statements because the application of these policies requires significant judgment on the part of management, which could have a material impact on our financial statements if actual performance should differ from historical experience or if our assumptions were to change. The following accounting policies include estimates that require management’s subjective or complex judgments about the effects of matters that are inherently uncertain. For information on our significant accounting policies, including the policies discussed below, see Note 1: Description of Business and Significant Accounting Policies , to our consolidated financial statements.
Revenue Recognition
Our revenue is derived from three main sources: (1) Products, (2) Professional services and (3) Royalties. Our performance obligations are satisfied at a point in time or over time as stand ready obligations. The majority of our revenue is recognized at a point in time when products are accepted, installed or delivered. Product revenue is recognized at the point in time when the customer takes control of the product, which typically occurs at the point of shipment. Professional services revenue primarily consists of installation, consulting and training and hardware and software support. Installation services are typically completed within a short period of time and revenue from these services is recognized upon completion, while revenue from support plans is recognized ratably over the contractual term of the service contract. We license certain products under royalty arrangements, pursuant to which our licensees periodically provide us with reports containing units sold to end users subject to the royalties. The reports substantiate that our performance obligation has been satisfied and we recognize royalty revenue based on the reports or when amounts can be reasonably estimated.
There are significant judgements used when applying ASC Topic 606 to contracts with customers. Most of our contracts contain multiple goods and services designed to meet each customers’ unique storage needs. For contracts with multiple performance obligations, we allocate the transaction price to each performance obligation based on the relative standalone selling price of the good or service underlying each performance obligation. Where standalone selling price may not be directly observable (e.g., the performance obligation is not sold separately), we maximize the use of observable inputs by using information including reviewing discounting practices, performance obligations with similar customers and product groupings. We determined that invoice price is the best representation of what we expect to receive from the delivery of each performance obligation. This judgment is based on the fact that each storage solution is customizable to meet an individual customer’s needs and every product’s transaction price can vary depending on the mix of other products included in the same purchase order and there are no identifiable trends that provide a good representation of expected margin for each product.
Product revenue may be impacted by a variety of price adjustments or other factors, including rebates, returns and stock rotation. We use the expected value method to estimate the net consideration expected to be returned by the customer. We use historical data and current trends to drive our estimates. We record a reduction to revenue to account for these items that may result in variable consideration. We initially measure a returned asset at the carrying amount of the inventory, less any expected costs to recover the goods including potential decreases in value of the returned goods.
Income Taxes
Deferred tax assets and liabilities are recognized based on temporary differences between the financial reporting and tax bases of assets and liabilities, measured at the enacted tax rates expected to apply to taxable income in the
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years in which those tax assets or liabilities are expected to be realized or settled. Based on the evaluation of available evidence, both positive and negative, we recognize future tax benefits, such as net operating loss carryforwards and tax credit carryforwards, to the extent that realizing these benefits is considered to be more likely than not.
A valuation allowance is provided if we believe it is more likely than not that all or some portion of the deferred tax asset will not be realized. An increase or decrease in the valuation allowance, if any, that results from a change in circumstances, and which causes a change in our judgment about the realizability of the related deferred tax asset, is included in the tax provision.
We recognize the financial statement effects of an uncertain income tax position when it is more likely than not, based on technical merits, that the position will be sustained upon examination. We reevaluate these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances and changes in tax law. We recognize penalties and tax-related interest expense as a component of income tax expense in our consolidated statements of operations. See Note 10: Income Taxes , to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Inventories
Manufacturing Inventories
Our manufacturing inventory is recorded at the lower of cost or net realizable value, with cost being determined on a first-in, first-out (“FIFO”) basis. Costs include material, direct labor, and an allocation of overhead in the case of work in process. Adjustments to reduce the cost of manufacturing inventory to its net realizable value, if required, are made for estimated excess, obsolete or impaired balances. Factors influencing these adjustments include declines in demand, rapid technological changes, product life cycle and development plans, component cost trends, product pricing, physical deterioration and quality issues. Revisions to these adjustments would be required if these factors differ from our estimates.
Service Parts Inventories
Our service parts inventories are recorded at the lower of cost or net realizable value, with cost being determined on a FIFO basis. Service parts inventories consist of both component parts, which are primarily used to repair defective units, and finished units, which are provided for customer use permanently or on a temporary basis while the defective unit is being repaired. We record adjustments to reduce the carrying value of service parts inventory to its net realizable value and dispose of parts with no use and a net realizable value of zero. Factors influencing these adjustments include product life cycles, end of service life plans and the volume of enhanced or extended warranty service contracts. Estimates of net realizable value involve significant estimates and judgments about the future, and revisions would be required if these factors differ from our estimates.
Business Acquisitions, Goodwill and Acquisition-Related Intangible Assets
We allocate the purchase price to the intangible and tangible assets acquired and liabilities assumed in a business combination at their estimated fair values on the date of acquisition, with the excess recorded to goodwill. We use our best estimates and assumptions to assign fair value to the assets acquired and liabilities assumed as well as the useful lives of the acquired intangible assets. Examples of critical estimates in valuing certain intangible assets we have acquired include, but are not limited to, future expected cash flows, expected technology life cycle, attrition rates of customers, and discount rates. We estimate the useful lives of each intangible asset based on the expected period over which we anticipate generating economic benefit from the asset. The amounts and useful lives assigned to acquired intangible assets impact the amount and timing of future amortization expense.
While we use our best estimates and assumptions as part of the purchase price allocation process to value assets acquired and liabilities assumed, these estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the estimated fair value of the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to the consolidated statements of operations.
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Recently Issued and Adopted Accounting Pronouncements
For recently issued and adopted accounting pronouncements, see Note 1 : Business Description and Significant Accounting Policies , to our consolidated financial statements.
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