QUANTUM CORP /DE/ 10-Q

ITEM 2. 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 Quarterly Report and our Annual Report on Form 10-K for the year ended March 31, 2022. In particular, the disclosure contained in Part I, Item 1A in our Annual Report on form 10-K, 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. 14 Table of Contents 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; interest associated with our long term debt and income taxes. COVID-19 and Macroeconomic Conditions COVID-19 has caused a significant disruption to the global supply chain, which continues to have a negative impact on our business. Before the current disruptions in the global supply chain our historical backlog was very limited and typically represented less than 5% of quarterly revenues. However, in fiscal 2022 continuing into fiscal 2023, our backlog has grown significantly, which has been driven primarily by our receipt of large purchase orders and our inability to satisfy those orders within our typical shipping timeline due to supply chain constraints. For example, as of June 30, 2022, our backlog was $46.8 million and has increased to $67.2 million as of July 31, 2022. The changes in our backlog are a result of the timing of receipt of large purchase orders. We anticipate that supply chain constraints will remain challenging, limiting our ability to ship against all customer demand and recognize a meaningful portion of the current backlog. In addition, the instability of global economic conditions, inflationary risks, military actions and armed conflicts and associated increased international trade regulations are adding to the uncertainty of our business. These adverse conditions could result in reductions in sales of our products and subscriptions for our services, longer sales cycles, increased costs to manufacture our products and increased price competition. Also, certain of our customers and partners have been and others may become credit or cash constrained, making it difficult for them to fulfill their payment obligations to us or require us to extend their payment terms. Given the dynamic nature of these macroeconomic conditions, we cannot reasonably estimate their full impact on our ongoing business, results of operations and overall financial performance. We will continue to actively monitor the impact of COVID-19 and global economic conditions 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. Global supply chain disruptions and the higher inflationary environment remain unpredictable and our past results may not be indicative of future performance. See Part II, Item 1A, Risk Factors, of our most recent Annual Report on Form 10-K for information regarding the risks we face as a result of the COVID-19 pandemic and an uncertain global economy. . 15 Table of Contents RESULTS OF OPERATIONS Three Months Ended June 30, (in thousands) 2022 2021 Total revenue $ 97,074 $ 89,099 Total cost of revenue (1) 63,026 51,821 Gross profit 34,048 37,278 Operating expenses Research and development (1) 12,125 11,291 Sales and marketing (1) 15,962 13,952 General and administrative (1) 12,314 11,825 Restructuring charges 725 266 Total operating expenses 41,126 37,334 Loss from operations (7,078) (56) Other income (expense), net 751 (198) Interest expense (2,091) (3,886) Loss on debt extinguishment (1,392) — Net loss before income taxes (9,810) (4,140) Income tax provision 410 13 Net loss $ (10,220) $ (4,153) (1) Includes stock-based compensation as follows: Three Months Ended June 30, (in thousands) 2022 2021 Cost of revenue $ 310 $ 293 Research and development 1,158 1,532 Sales and marketing 451 500 General and administrative 1,150 876 Total $ 3,069 $ 3,201 Comparison of the Three Months Ended June 30, 2022 and 2021 Revenue Three Months Ended June 30, (dollars in thousands) 2022 % of revenue 2021 % of revenue $ Change % Change Product revenue Primary storage systems $ 15,558 16 $ 11,312 13 $ 4,246 38 Secondary storage systems 33,038 34 28,205 32 4,833 17 Devices and media 11,615 12 12,614 14 (999) (8) Total product revenue 60,211 62 52,131 59 8,080 15 Service and subscription 33,423 34 32,831 37 592 2 Royalty 3,440 4 4,137 5 (697) (17) Total revenue $ 97,074 100 $ 89,099 101 $ 7,975 9 Product revenue 16 Table of Contents In the three months ended June 30, 2022, product revenue increased $8.1 million, or 15%, as compared to the same period in 2021. Primary storage systems increased $4.2 million, or 38%, primarily driven from increased sales of our video surveillance solutions. Secondary storage systems increased $4.8 million, or 17%, driven by higher demand in hyperscale use cases. Service revenue We offer a broad range of services including product maintenance, implementation, and training as well as software subscriptions. 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 and subscription revenue increased 2% in the three months ended June 30, 2022 compared to the same period in 2021 driven partially by growing sales of our recurring software subscription offerings as well as service revenue associated with newly acquired businesses. Royalty revenue We receive royalties from third parties that license our LTO media patents through our membership in the LTO consortium. Royalty revenue decreased $0.7 million, or 17%, in the three months ended June 30, 2022 compared to the same period in 2021 due to decreased market volume of older generation LTO media. Gross Profit and Margin Three Months Ended June 30, (dollars in thousands) 2022 Gross margin % 2021 Gross margin % $ Change Basis point change Product $ 12,290 20.4 $ 13,390 25.7 $ (1,100) (530) Service and subscription 18,318 54.8 19,751 60.2 (1,433) (540) Royalty 3,440 100.0 4,137 100.0 (697) — Gross profit $ 34,048 35.1 $ 37,278 41.8 $ (3,230) (670) Product Gross Margin Product gross margin decreased 530 basis points for the three months ended June 30, 2022, as compared with the same period in 2021. This decrease was due primarily to recent cost increases in materials across our global supply chain. We expect these cost increases to continue for the foreseeable future and are taking proactive measures to address the impact these cost increases could have on our business in the future. Service and Subscription Gross Margin Service and subscription gross margins decreased 540 basis points for the three months ended June 30, 2022, as compared with the same period in 2021. This was partially driven by cost pressures as a result of certain constraints in the global supply chain. Royalty Gross Margin Royalties do not have significant related cost of sales. 17 Table of Contents Operating expenses Three Months Ended June 30, (dollars in thousands) 2022 % of revenue 2021 % of revenue $ Change % Change Research and development $ 12,125 12.5 $ 11,291 12.7 $ 834 7 Sales and marketing 15,962 16.4 13,952 15.7 2,010 14 General and administrative 12,314 12.7 11,825 13.3 489 4 Restructuring charges 725 0.7 266 0.3 459 173 Total operating expenses $ 41,126 42.4 $ 37,334 41.9 $ 3,792 10 In the three months ended June 30, 2022, research and development expense increased $0.8 million, or 7%, as compared with the same period in 2021. This increase was primarily driven by an increase in personnel costs due to increased headcount from acquisitions. In the three months ended June 30, 2022, sales and marketing expenses increased $2.0 million, or 14%, as compared with the same period in 2021. This increase was driven by increased headcount as we invest in strategic areas to accelerate growth. This increase in headcount includes those employees added through acquisitions over the year. Both marketing expense and travel expense have also increased over the prior year as COVID-19 restrictions ease. In the three months ended June 30, 2022, general and administrative expenses increased $0.5 million, or 4%, as compared with the same period in 2021. This increase was largely driven by increased intangible amortization from recent acquisitions. In the three months ended June 30, 2022, restructuring expenses increased $0.5 million, or 173%, as compared with the same period in 2021. The increase was the result of cost reduction initiatives. Other Income (Expense) Three Months Ended June 30, (dollars in thousands) 2022 % of revenue 2021 % of revenue $ Change % Change Other income (expense) $ 751 1 $ (198) — $ 949 479 The decrease in other income (expense), net during the three months ended June 30, 2022 compared with the same period in 2021 was related primarily to fluctuations in foreign currency exchange rates. Interest expense Three Months Ended June 30, (dollars in thousands) 2022 % of revenue 2021 % of revenue $ Change % Change Interest expense (2,091) 2 (3,886) 4 1,795 46 In the three months ended June 30, 2022, interest expense decreased $1.8 million, or 46%, as compared with the same period in 2021 due to a lower principal balance and a lower effective interest rate on our Term Loan. 18 Table of Contents Loss on debt extinguishment Three Months Ended June 30, (dollars in thousands) 2022 % of revenue 2021 % of revenue $ Change % Change Loss on debt extinguishment (1,392) 1 — — (1,392) n/a In the three months ended June 30, 2022, loss on debt extinguishment of $1.4 million was related to prepayment of our Term Loan. Income Taxes Three Months Ended June 30, (dollars in thousands) 2022 % of revenue 2021 % of revenue $ Change % Change Income tax provision $ 410 — $ 13 — $ 397 3,054 The income tax provision for the three months ended June 30, 2022 and 2021 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. 19 Table of Contents 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 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 and substantial financial market volatility which have adversely affected both the U.S. and the global economy. We have experienced negative impacts on sales due to global supply chain constraints, inflationary concerns and overall uncertainty in the macroeconomic environment which has resulted in a significant increase in our sales backlog compared to our historical levels. The extent of the impacts 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 and market instability to continue to have a significant impact on our liquidity and capital resources. We had cash and cash equivalents of $26.5 million as of June 30, 2022, which consisted primarily of bank deposits and money market accounts. As of June 30, 2022 we had $11.8 million available to borrow under the PNC Credit Facility. We are subject to various debt covenants under our debt agreements including a net leverage covenant and a $25 million minimum liquidity covenant . Our failure to comply with our debt covenants could materially and adversely affect our financial condition and ability to service our obligations. On April 25, 2022, we amended the covenant levels for our financial covenants under our term debt and PNC Credit Facility. We believe we were in compliance with all covenants under our debt agreements as of the date of filing of this Quarterly Report on Form 10-Q. 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, 2022. Cash Flows The following table summarizes our consolidated cash flows for the periods indicated. Three Months Ended June 30, (in thousands) 2022 2021 Cash provided by (used in): Operating activities $ (18,346) $ (6,866) Investing activities (5,036) (1,150) Financing activities 44,643 (463) Effect of exchange rate changes 29 (14) Net increase (decrease) in cash and cash equivalents and restricted cash $ 21,290 $ (8,493) Cash Used In Operating Activities Net cash used in operating activities was $18.3 million for the three months ended June 30, 2022. This use of cash was primarily attributable to changes in working capital of $15.6 million driven by a decrease in deferred revenue of $13.6 million. The decrease in deferred revenue reflects the seasonal nature of service contract renewals. 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, 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. Cash Used in Investing Activities 20 Table of Contents Net cash used in investing activities was $5.0 million in the three months ended June 30, 2022, which was primarily attributable to capital expenditures of $3.0 million and a $2.0 million deferred business acquisition payment. 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 capital expenditures. Cash Provided by Financing Activities Net cash provided by financing activities was $44.6 million in the three months ended June 30, 2022, which was related primarily to $66.3 million of cash received from the Rights Offering of 30 million shares of our common stock offset by a $20 million prepayment of our term debt and a term debt principal amortization payment of $0.6 million Net cash used in financing activities was $0.5 million in the three months ended June 30, 2021 related to a term debt principal amortization payment. 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. 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, 2022. 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, 2022 under the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Critical Accounting Estimates and 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. 21 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.