Item 2. Management’s Discussion and Analysis
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
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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 interest associated with our long-term debt and income taxes.
Macroeconomic Conditions
We continue to actively monitor, evaluate and respond to the current uncertain macro environment, including the impact of higher interest rates, inflation, lingering supply chain challenges, and a stronger U.S. dollar. During the quarter we continued to experience longer sales cycle for opportunities with our enterprise as well as commercial customers.
The macro environment remains unpredictable and our past results may not be indicative of future performance.
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RESULTS OF OPERATIONS
Three Months Ended December 31, Nine Months Ended December 31,
(in thousands) 2022 2021 2022 2021
Total revenue $ 111,196 $ 95,344 $ 307,407 $ 277,623
Total cost of revenue (1)
70,907 60,134 205,239 166,746
Gross profit 40,289 35,210 102,168 110,877
Operating expenses
Research and development (1)
11,254 14,607 33,925 38,287
Sales and marketing (1)
16,339 16,714 47,894 46,128
General and administrative (1)
10,969 10,538 35,223 33,830
Restructuring charges (41) 576 1,605 850
Total operating expenses 38,521 42,435 118,647 119,095
Income (loss) from operations 1,768 (7,225) (16,479) (8,218)
Other income (expense), net (544) (150) 2,638 (223)
Interest expense (2,701) (2,431) (7,537) (9,387)
Loss on debt extinguishment — — (1,392) (4,960)
Net loss before income taxes (1,477) (9,806) (22,770) (22,788)
Income tax provision 693 1,254 1,564 1,678
Net loss $ (2,170) $ (11,060) $ (24,334) $ (24,466)
(1) Includes stock-based compensation as follows:
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Three Months Ended December 31, Nine Months Ended December 31,
(in thousands) 2022 2021 2022 2021
Cost of revenue $ (11) $ 208 $ 621 $ 799
Research and development 1,251 1,935 2,508 4,798
Sales and marketing 579 655 1,803 1,768
General and administrative 1,162 1,509 3,408 3,215
Total $ 2,981 $ 4,307 $ 8,340 $ 10,580
Comparison of the Three Months Ended December 31, 2022 and 2021
Revenue
Three Months Ended December 31,
(dollars in thousands) 2022 % of
revenue 2021 % of
revenue $ Change % Change
Product revenue
Primary storage systems $ 13,974 13 $ 13,791 14 $ 183 1
Secondary storage systems 50,722 44 30,630 32 20,092 66
Devices and media 10,724 10 14,101 15 (3,377) (24)
Total product revenue 75,420 67 58,522 61 16,898 29
Service and subscription 32,950 30 33,162 35 (212) (1)
Royalty 2,826 3 3,660 4 (834) (23)
Total revenue $ 111,196 100 $ 95,344 100 $ 15,852 17
Product revenue
In the three months ended December 31, 2022, product revenue increased $16.9 million, or 29%, as compared to the same period in 2021. Primary storage systems increased $0.2 million, or 1%, remaining relatively flat to the same period in 2021. Secondary storage systems increased $20.1 million, or 66%, 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 decreased 1% in the three months ended December 31, 2022 compared to the same period in 2021, partially driven by lower overall legacy service revenues offset by higher subscription revenue.
Royalty revenue
We receive royalties from third parties that license our LTO media patents through our membership in the LTO consortium. Royalty revenue decreased $0.8 million, or 23%, in the three months ended December 31, 2022 compared to the same period in 2021 due to decreased market volume of older generation LTO media.
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Gross Profit and Margin
Three Months Ended December 31,
(dollars in thousands) 2022 Gross
margin % 2021 Gross
margin % $ Change Basis point change
Product $ 16,892 22.4 $ 13,404 22.9 $ 3,488 (50)
Service and subscription 20,571 62.4 18,146 54.7 2,425 770
Royalty 2,826 100.0 3,660 100.0 (834) —
Gross profit $ 40,289 36.2 $ 35,210 36.9 $ 5,079 (70)
Product Gross Margin
Product gross margin decreased to 22.4% or by 50 basis points for the three months ended December 31, 2022, as compared with the same period in 2021. This decrease was primarily due to a less favorable mix of revenues, weighted towards our lower margin product lines.
Service and Subscription Gross Margin
Service and subscription gross margins increased 770 basis points for the three months ended December 31, 2022, as compared with the same period in 2021. This increase was primarily driven by lower overhead costs across our support and repair functions.
Royalty Gross Margin
Royalties do not have significant related cost of sales.
Operating expenses
Three Months Ended December 31,
(dollars in thousands) 2022 % of
revenue 2021 % of
revenue $ Change % Change
Research and development $ 11,254 10.1 $ 14,607 15.3 $ (3,353) (23)
Sales and marketing 16,339 14.7 16,714 17.5 (375) (2)
General and administrative 10,969 9.9 10,538 11.1 431 4
Restructuring charges (41) — 576 0.6 (617) (107)
Total operating expenses $ 38,521 34.6 $ 42,435 44.5 $ (3,914) (9)
In the three months ended December 31, 2022, research and development expense decreased $3.4 million, or 23%, as compared with the same period in 2021. This decrease was primarily driven by cost reduction measures to consolidate acquired businesses.
In the three months ended December 31, 2022, sales and marketing expenses decreased $0.4 million, or 2%, as compared with the same period in 2021. Marketing program expense decreased slightly as we shifted investment to earlier in the year.
In the three months ended December 31, 2022, general and administrative expenses increased $0.4 million, or 4%, as compared with the same period in 2021. This increase was largely driven by project cost in our facilities and IT organizations.
In the three months ended December 31, 2022, restructuring expenses decreased $0.6 million as compared with the same period in 2021. The decrease was the result of cost reduction initiatives in the prior year.
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Other Income (Expense)
Three Months Ended December 31,
(dollars in thousands) 2022 % of
revenue 2021 % of
revenue $ Change % Change
Other income (expense) $ (544) 0 $ (150) — $ (394) (263)
The change in other income (expense), net during the three months ended December 31, 2022 compared with the same period in 2021 was related primarily to fluctuations in foreign currency exchange rates and the sale of certain intangible assets during the nine months ended December 31, 2022.
Interest expense
Three Months Ended December 31,
(dollars in thousands) 2022 % of
revenue 2021 % of
revenue $ Change % Change
Interest expense (2,701) 2 (2,431) 3 (270) (11)
In the three months ended December 31, 2022, interest expense increased $0.3 million, or 11%, as compared with the same period in 2021 due to a higher effective interest rate on our Term Loan.
Loss on debt extinguishment
Three Months Ended December 31,
(dollars in thousands) 2022 % of
revenue 2021 % of
revenue $ Change % Change
Loss on debt extinguishment — — — — — n/a
There were no debt extinguishments in the three months ended December 31, 2022 and 2021.
Income Taxes
Three Months Ended December 31,
(dollars in thousands) 2022 % of
revenue 2021 % of
revenue $ Change % Change
Income tax provision $ 693 1 $ 1,254 — $ (561) (45)
The income tax provision for the three months ended December 31, 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.
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Comparison of the Nine Months Ended December 31, 2022 and 2021
Revenue
Nine Months Ended December 31,
(dollars in thousands) 2022 % of
revenue 2021 % of
revenue $ Change % Change
Product revenue
Primary storage systems $ 39,375 13 $ 41,787 15 $ (2,412) (6)
Secondary storage systems 127,852 43 85,093 31 42,759 50
Devices and media 31,370 9 38,428 14 (7,058) (18)
Total product revenue 198,597 65 165,308 60 33,289 20
Service and subscription 99,066 32 100,352 36 (1,286) (1)
Royalty 9,744 3 11,963 4 (2,219) (19)
Total revenue $ 307,407 100 $ 277,623 100 $ 29,784 11
Product revenue
In the nine months ended December 31, 2022, product revenue increased $33.3 million, or 20%, as compared to the same period in 2021. Primary storage systems decreased $2.4 million, or 6%, primarily driven from a reduced number of large purchases from install base customers. Secondary storage systems increased $42.8 million, or 50%, 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 decreased 1% in the nine months ended December 31, 2022 compared to the same period in 2021 partially driven by lower overall legacy service revenues offset by higher subscription revenue.
Royalty revenue
We receive royalties from third parties that license our LTO media patents through our membership in the LTO consortium. Royalty revenue decreased $2.2 million, or 19%, in the nine months ended December 31, 2022 compared to the same period in 2021 due to decreased market volume of older generation LTO media.
Gross Profit and Margin
Nine Months Ended December 31,
(dollars in thousands) 2022 Gross
margin % 2021 Gross
margin % $ Change Basis point change
Product $ 35,587 17.9 $ 40,326 24.4 $ (4,739) (650)
Service and subscription 56,837 57.4 58,588 58.4 (1,751) (100)
Royalty 9,744 100.0 11,963 100.0 (2,219) —
Gross profit $ 102,168 33.2 $ 110,877 39.9 $ (8,709) (670)
Product Gross Margin
Product gross margin decreased to 17.9% or by 650 basis points for the nine months ended December 31, 2022, as compared with the same period in 2021. This decrease was due primarily to a $6.9 million extraordinary inventory reserve provision recorded during the nine months ended December 31, 2022. Due to longer purchasing lead times and other factors caused by the global supply chain disruptions occurring since the beginning of the COVID-19
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pandemic, certain inventory has become obsolete due to next generation products being released and legacy products being discontinued. In addition, following our integration of several past acquisitions, certain legacy products were discontinued and replaced with updated product offerings rendering the related inventory obsolete. We do not believe that the magnitude of this inventory provision is indicative of our ongoing operations and is not expected to be repeated in the near term. Excluding this non-recurring adjustment, product gross margin has declined approximately 300 basis points for the nine months ended December 31, 2022, as compared to the same period in 2021 primarily due to a less favorable mix of revenues weighted towards our lower margin product lines of business and a reduction in royalty partially offset by improvements in pricing and lower supply chain costs.
Service and Subscription Gross Margin
Service and subscription gross margins decreased 100 basis points for the nine months ended December 31, 2022, as compared with the same period in 2021. This was partially driven by lower overall service revenues, and 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.
Operating expenses
Nine Months Ended December 31,
(dollars in thousands) 2022 % of
revenue 2021 % of
revenue $ Change % Change
Research and development $ 33,925 11.0 $ 38,287 13.8 $ (4,362) (11)
Sales and marketing 47,894 15.6 46,128 16.6 1,766 4
General and administrative 35,223 11.5 33,830 12.2 1,393 4
Restructuring charges 1,605 0.5 850 0.3 755 89
Total operating expenses $ 118,647 38.6 $ 119,095 42.9 $ (448) —
In the nine months ended December 31, 2022, research and development expense decreased $4.4 million, or 11%, as compared with the same period in 2021. This decrease was primarily driven by cost reduction measures to consolidate acquired businesses.
In the nine months ended December 31, 2022, sales and marketing expenses increased $1.8 million, or 4%, as compared with the same period in 2021. Both marketing expense and travel expense have increased over the prior year as COVID-19 restrictions ease.
In the nine months ended December 31, 2022, general and administrative expenses increased $1.4 million, or 4%, as compared with the same period in 2021. This increase was largely driven by increased intangible amortization from business acquisitions.
In the nine months ended December 31, 2022, restructuring expenses increased $0.8 million, or 89%, as compared with the same period in 2021. The increase was the result of cost reduction initiatives.
Other Income (Expense)
Nine Months Ended December 31,
(dollars in thousands) 2022 % of
revenue 2021 % of
revenue $ Change % Change
Other income (expense) $ 2,638 1 $ (223) — $ 2,861 1,283
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The change in other income (expense), net during the nine months ended December 31, 2022 compared with the same period in 2021 was related primarily to fluctuations in foreign currency exchange rates and the sale of certain intangible assets during the nine months ended December 31, 2022.
Interest expense
Nine Months Ended December 31,
(dollars in thousands) 2022 % of
revenue 2021 % of
revenue $ Change % Change
Interest expense (7,537) 2 (9,387) 3 1,850 20
In the nine months ended December 31, 2022, interest expense decreased $1.9 million, or 20%, as compared with the same period in 2021 due to a lower principal balance and a lower effective interest rate on our Term Loan.
Loss on debt extinguishment
Nine Months Ended December 31,
(dollars in thousands) 2022 % of
revenue 2021 % of
revenue $ Change % Change
Loss on debt extinguishment (1,392) — (4,960) 2 3,568 n/a
In the nine months ended December 31, 2022, the change in loss on debt extinguishment of $3.6 million was related to prepayments of our long term debt.
Income Taxes
Nine Months Ended December 31,
(dollars in thousands) 2022 % of
revenue 2021 % of
revenue $ Change % Change
Income tax provision $ 1,564 1 $ 1,678 1 $ (114) (7)
The income tax provision for the nine months ended December 31, 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.
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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 depends, in part, on how long the negative trends in customer demand and supply chain levels 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 $26.0 million as of December 31, 2022, which consisted primarily of bank deposits and money market accounts. As of December 31, 2022 we had $5.7 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 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.
Nine Months Ended December 31,
(in thousands) 2022 2021
Cash provided by (used in):
Operating activities $ (19,596) $ (26,681)
Investing activities (12,644) (11,779)
Financing activities 52,973 9,646
Effect of exchange rate changes 21 12
Net increase (decrease) in cash and cash equivalents and restricted cash $ 20,754 $ (28,802)
Cash Used In Operating Activities
Net cash used in operating activities was $19.6 million for the nine months ended December 31, 2022. This use of cash was primarily attributed to cash used due related to manufacturing and service part inventories of $12.0 million and a decrease in deferred revenue of $14.4 million offset by an increase $7.2 million in accounts payable.
Net cash used in operating activities was $26.7 million for the nine months ended December 31, 2021. This use of cash was primarily attributable to changes in working capital of $24.3 million driven by increases in manufacturing and service part inventories of $13.0 million, a decrease in deferred revenue of $8.6 million and a net change in other assets and liabilities of $12.2 million which includes an increase in prepaid inventory of approximately $5.5 million in order to secure manufacturing materials. These were partially offset by a decrease in accounts receivable of $7.0 million and a $5.4 million increase in accounts payable.
Cash Used in Investing Activities
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Net cash used in investing activities was $12.6 million in the nine months ended December 31, 2022, which was primarily attributable to capital expenditures of $10.6 million and a $2.0 million deferred business acquisition payment.
Net cash used in investing activities was $11.8 million in the nine months ended December 31, 2021, which was primarily attributable to cash paid for our acquisition of our video surveillance business of $7.8 million and capital expenditures of $4.0 million.
Cash Provided by Financing Activities
Net cash provided by financing activities was $53.0 million for the nine months ended December 31, 2022, which was related primarily to $66.7 million of net cash received from the Rights Offering of 30 million shares of our common stock and borrowings on our credit facility of $9.6 million offset by a $20.0 million prepayment of our term debt and term debt principal amortization payments and amendment fees totaling $3.3 million.
Net cash provided by financing activities was $9.6 million in the nine months ended December 31, 2021, which was related primarily to borrowings under our credit facility and proceeds from the new Term Loan offset by the repayment in full of the Senior Secured Term Loan.
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
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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—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.
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.
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