QUANTUM CORP /DE/ 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 15 Table of Contents 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 quarterly report and our annual report for the year ended March 31, 2021. In particular, the disclosure contained in Item 1A in our annual report, as updated by Part II, Item 1A in this quarterly report, 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, and our objectives for future operations. Please see "Note Regarding Forward-Looking Statements" for more information about relying on these forward-looking statements. OVERVIEW We are a technology company whose mission is to deliver innovative solutions to 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 first quarter of fiscal year 2022 included: • Revenue increased 22% year-over-year to $89 million. • Gross profit was $37 million, an increase of 21% from $31 million. Product gross profit was $13 million, an increase of 230 basis-points from $9 million in the same quarter last year. • Operating expenses were 42% of revenue compared to 47% in the same quarter last year. • We increased research and development investment 11% over the prior year, as we announced a new StorNext architecture and new line of StorNext appliances with the H4000. • We announced a new partnership with Supermicro and our ActiveScale 6.0 software and storage platform, as we expand our Object Storage line of business. • We increased Sales & Marketing expense 21% over the prior year as we see accelerated customer activity and invested for growth in strategic markets. • We continue to hire new leadership across the organization, including industry veterans in our Emerging Markets business unit, and our General Council & Chief Compliance Officer. COVID-19 IMPACT AND ASSOCIATED ACTIONS 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. 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 16 Table of Contents marketing costs. In addition, we effected certain restructuring activities to streamline our operations, such as limited workforce realignments and vacating certain office leases. We will 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 recent COVID-19 pandemic could adversely affect our business, results of operations and financial condition” in Part II, Item 1A, Risk Factors, of our most recent 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 Three Months Ended June 30, (in thousands) 2021 2020 Total revenue $ 89,099 $ 73,305 Total cost of revenue (1) 51,821 42,453 Gross profit 37,278 30,852 Operating expenses Research and development (1) 11,291 10,162 Sales and marketing (1) 13,952 11,570 General and administrative (1) 11,825 11,563 Restructuring charges 266 1,052 Total operating expenses 37,334 34,347 Loss from operations (56) (3,495) Other expense (198) (385) Interest expense (3,886) (6,437) Loss before income taxes (4,140) (10,317) Income tax provision 13 419 Net loss $ (4,153) $ (10,736) (1) Includes stock-based compensation as follows: Three Months Ended June 30, (in thousands) 2021 2020 Cost of revenue $ 293 $ 169 Research and development 1,532 471 Sales and marketing 500 336 General and administrative 876 982 Total $ 3,201 $ 1,958 17 Table of Contents Comparison of the Three Months Ended June 30, 2021 and 2020 Revenue Three Months Ended June 30, (dollars in thousands) 2021 % of revenue 2020 % of revenue $ Change % Change Product revenue Primary storage systems $ 11,312 13 $ 10,214 15 $ 1,098 11 Secondary storage systems 28,205 31 18,492 25 9,713 53 Devices and media 12,614 14 10,981 15 1,633 15 Total product revenue 52,131 58 39,687 55 12,444 31 Service revenue 32,831 37 30,386 41 2,445 8 Royalty revenue 4,137 5 3,232 4 905 28 Total revenue $ 89,099 100 $ 73,305 100 $ 15,794 22 Product revenue In the three months ended June 30, 2021, product revenue increased $12.4 million, or 31%, as compared to the same period in 2020. Primary storage systems represented $1.1 million of the increase, driven by market improvements across the media & entertainment industries. Secondary storage systems represented $9.7 million of the increase, driven by higher demand in our hyperscale, backup and archive use cases. Devices and media represented $1.6 million of the increase, driven by a higher volume of LTO media sold through our high-volume channel partners. Service revenue We offer a broad range of services including maintenance, implementation, and training. Service revenue is primarily comprised of customer field support contracts which provide standard support services for our hardware. Standard service contracts may be extended or include enhanced service, such as faster service response times. Service revenue increased 8% in the three months ended June 30, 2021 compared to the same period in 2020 largely driven by increased demand for installation and professional services as well as increases in our managed service offerings. Royalty revenue We receive royalties from third parties that license our LTO media patents through our membership in the LTO consortium. Royalty revenue increased $0.9 million, or 28%, in the three months ended June 30, 2021 compared to the same period in 2020 due to increased market volume of LTO media. Gross Profit and Margin Three Months Ended June 30, (dollars in thousands) 2021 Gross margin % 2020 Gross margin % $ Change Basis point change Product gross profit $ 13,389 25.7 $ 9,305 23.4 $ 4,084 230 Service gross profit 19,751 60.2 18,315 60.3 1,436 (10) Royalty gross profit 4,137 100.0 3,232 100.0 905 — Gross profit $ 37,277 41.8 $ 30,852 45.6 $ 6,425 (380) Product Gross Margin Product gross margin increased 230 basis points for the three months ended June 30, 2021, as compared with the same period in 2020. This increase was due primarily to a more favorable mix of products towards our enterprise solutions, as well as overall gross margin improvements in our secondary storage business line. 18 Table of Contents Service Gross Margin Service gross margin remained consistent with the prior year. Royalty Gross Margin Royalties do not have significant related cost of sales. Operating expenses Three Months Ended June 30, (dollars in thousands) 2021 % of revenue 2020 % of revenue $ Change % Change Research and development $ 11,291 12.7 $ 10,162 13.9 $ 1,129 11 Sales and marketing 13,952 15.7 11,570 15.8 2,382 21 General and administrative 11,825 13.3 11,563 15.8 262 2 Restructuring charges 266 0.3 1,052 1.4 (786) (75) Total operating expenses $ 37,334 41.9 $ 34,347 46.9 $ 2,987 9 In the three months ended June 30, 2021, research and development expense increased $1.1 million, or 11%, as compared with the same period in 2020. This increase was primarily driven by an increase in personnel costs due to increased headcount focused on new product development. This increase in headcount includes those employees added through acquisitions over the year. In the three months ended June 30, 2021, sales and marketing expenses increased $2.4 million, or 21%, as compared with the same period in 2020. This increase was driven by increases to marketing spend as we see higher levels of customer interaction since the outbreak of the Covid-19 pandemic, as well as increases in personnel costs as we invest for growth in strategic markets. In the three months ended June 30, 2021, general and administrative expenses increased $0.3 million, or 2%, as compared with the same period in 2020. This increase was due primarily to increased legal and other expenses related to our long-term debt amendments and business acquisition related activities. In the three months ended June 30, 2021, restructuring expenses decreased $0.8 million, or 75%, as compared with the same period in 2020. The decrease was the result of one-time workforce reductions in the prior year. Other Income (Expense) Three Months Ended June 30, (dollars in thousands) 2021 % of revenue 2020 % of revenue $ Change % Change Other income (expense) $ (198) 0 $ (385) (1) $ 187 49 Interest expense (3,886) (4) (6,437) 9 2,551 (40) The increase in other income (expense), net during the three months ended June 30, 2021 compared with the same period in 2020 was related primarily to fluctuations in foreign currency exchange rates. In the three months ended June 30, 2021, interest expense decreased $2.6 million, or 40%, as compared with the same period in 2020 due to a lower principal balance. Income Taxes Three Months Ended June 30, (dollars in thousands) 2021 % of revenue 2020 % of revenue $ Change % Change Income tax provision $ 13 — $ 419 1 $ (406) (97) 19 Table of Contents The income tax provision for the three months ended June 30, 2021 and 2020 is primarily influenced by foreign and state income taxes. Due to our history of net losses in the United States, 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. 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 disruptions in our supply chain and a 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. We had cash and cash equivalents of $19.1 million as of June 30, 2021, compared to $27.4 million as of March 31, 2021. These amounts exclude, as of both dates, $5.0 million in restricted cash that we are required to maintain under the Credit Agreements (as defined below), and $0.5 million of short-term restricted cash. Our outstanding long-term debt amounted to $81.3 million as of June 30, 2021, net of $8.8 million in unamortized debt issuance costs and $11.9 million in current portion of long-term debt, and $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. Included in long-term debt as of June 30, 2021 is $10.0 million borrowed under the Paycheck Protection Program (“PPP Loan”) which was included in the Coronavirus Aid, Relief, and Economic Security (CARES) Act. In July 2021, we received notice from PNC Bank that the PPP Loan and related accrued interest was approved for forgiveness in full by the U.S. SBA. As of June 30, 2021, we had $20.4 million of borrowing availability on our Amended PNC Credit Facility (subject to change based on certain financial metrics). On August 5, 2021 (the “Closing Date”), the Company entered into a senior secured term loan of $100.0 million, million (the “Term Loan”). A portion of the proceeds were used to prepay all outstanding borrowings under the Senior Secured Term Loan. Borrowings under the Term Loan mature on August 5, 2026. Principal is payable at a rate per annum equal to (a) 2.5% of the original principal balance thereof during the first year following the Closing Date and (b) 5% of the original principal balance thereof thereafter. Principal and interest payments are payable on a quarterly basis. Loans under the Term Loan Credit Agreement designated as “Prime Rate Loans” will bear interest at a rate per annum equal to the greatest of (i) 1.75%, (ii) the Federal funds rate plus 0.50%, (iii) the LIBOR Rate based upon an interest period of 1 month plus 1.0%, and (iv) the “Prime Rate” last quoted by the Wall Street Journal, plus an applicable margin of 5.00%. Loans designated as “LIBOR Rate Loans” will bear interest at a rate per annum equal to the LIBOR Rate plus an applicable margin of 6.00%. The “LIBOR Rate” is subject to a floor of 0.75%. The Company can designate a loan as a Prime Rate Loan or LIBOR Rate Loan in its discretion. The Term Loan Credit Agreement contains certain customary covenants, including requirements to prepay the loans in an amount equal to (i) 100% of the net cash proceeds from certain asset dispositions, extraordinary receipts, debt issuances and equity issuances, subject to certain reinvestment rights and other exceptions and (ii) 75% of certain 20 Table of Contents excess cash flow of the Company and its subsidiaries, subject to certain exceptions, including reductions to the percentage of such excess cash flow that is required to prepay the loans to 50% and 0%, based on the Company’s applicable total net leverage ratio. Amounts outstanding under the Term Loan may become due and payable upon the occurrence of specified events, which among other things include (subject to certain exceptions and cure periods): (i) failure to pay principal, interest, or any fees when due; (ii) breach of any representation or warranty, covenant, or other agreement in the Term Loan and other related loan documents; (iii) the occurrence of a bankruptcy or insolvency proceeding with respect to the Company or certain of its subsidiaries; (iv) any “Event of Default” with respect to other indebtedness involving an aggregate amount of $3,000,000 or more; (v) any lien created by the Term Loan or any related security documents ceasing to be valid and perfected; (vi) the Term Loan Credit Agreement or any related security documents or guarantees ceasing to be legal, valid, and binding upon the parties thereto; or (vii) a change of control shall occur. The Term Loan contains financial covenants relating to minimum liquidity and total net leverage ratio. We are subject to various debt covenants under our Credit Agreements. Our failure to comply with our debt covenants could materially and adversely affect our financial condition and ability to service our obligations. For additional information about our debt, see the sections entitled “Risk Factors—Risks Related to Our Business Operations” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” in our Annual Report on Form 10-K for the fiscal year ended March 31, 2021. Cash Flows The following table summarizes our consolidated cash flows for the periods indicated. Three Months Ended June 30, (Dollars in thousands) 2021 2020 Cash provided by (used in): Operating activities $ (6,866) $ (8,987) Investing activities (1,150) (484) Financing activities (463) 26,329 Effect of exchange rate changes (14) (16) Net increase (decrease) in cash and cash equivalents and restricted cash $ (8,493) $ 16,842 Cash Used In Operating Activities Net cash used in operating activities was $6.9 million for the three months ended June 30, 2021. This use of cash is primarily attributable to changes in working capital of $10.0 million driven by an increase in manufacturing and service parts inventories of $4.4 million, an increase in accounts payable, accrued compensation, deferred revenue of $3.2 million, $4.9 million and $6.3 million, respectively, in addition to miscellaneous changes in other current and non-current assets and liabilities, partially offset by a reduction in accounts receivable of $15.2 million. The decrease in deferred revenue reflects the seasonal nature of service contract renewals which peak in the fourth fiscal quarter. Net cash used in operating activities was $9.0 million for the three months ended June 30, 2020. This use of cash is primarily attributable to the net loss adjusted for non-cash items of $4.0 million and changes in working capital of $4.9 million. Cash used related to working capital was driven by a decrease of $21.0 million in accounts receivable more than offset by the increase in manufacturing and service inventory of $3.2 million and decreases in accounts payable, deferred revenue and other assets and liabilities of $9.9 million, $8.2 million and $4.2 million, respectively. The decrease in deferred revenue reflects the seasonal nature of service contract renewals which peak in the fourth fiscal quarter. Cash Used in Investing Activities Net cash used in investing activities was $1.2 million in the three months ended June 30, 2021, which included approximately $1.0 million related to new ERP systems software. 21 Table of Contents Net cash used in investing activities was $0.5 million in the three months ended June 30, 2020, which was mostly flat compared to the same period in the prior year. Our capital expenditures in both periods consisted primarily of tooling purchases and leasehold improvements. Cash Provided by (Used In) Financing Activities Net cash used in financing activities was $0.5 million in the three months ended June 30, 2021 related to debt principal amortization payment. Net cash provided by financing activities was $26.3 million in the three months ended June 30, 2020 which included new 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 and the net pay-down of our Amended PNC Credit Facility. 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 litigation and potential costs related to our financial statement restatement activities and related legal costs. Off Balance Sheet Arrangements Except for the indemnification commitments described under “—Commitments and Contingencies” above, we do not currently have any other off-balance sheet arrangements and do not have any holdings in variable interest entities. Contractual Obligations We have contractual obligations and commercial commitments, some of which, such as purchase obligations, are not recognized as liabilities in our financial statements. There have not been any other material changes to the contractual obligations disclosed in our Annual Report on Form 10-K for the fiscal year ended March 31, 2021. Critical Accounting Estimates and Policies The preparation of our consolidated financial statements in accordance with generally accepted accounting principles 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 Quarterly Report on Form 10-Q. 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 certain 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. Our accounting policies that include estimates that require management’s subjective or complex judgments about the effects of matters that are inherently uncertain are summarized in our most recently filed Annual Report on Form 10-K for the fiscal year ended March 31, 2021 under the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Critical Accounting Policies.” For additional information on our significant accounting policies, see Note 1 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. 22 Table of Contents Recently Issued and Adopted Accounting Pronouncements See Note 1 to the notes to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q and in our most recently filed Annual Report on Form 10-K.