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 compares the change in the consolidated financial statements for fiscal years 2023 and 2022 and 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. For comparisons of fiscal years 2022 and 2021, see our Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, , Item 7 of our Annual Report on Form 10-K for the fiscal year ended March 31, 2022, filed with the SEC on June 8, 2022, and incorporated herein by reference.
The following discussion contains forward-looking statements, such as statements regarding 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 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.
RESULTS OF OPERATIONS
Year Ended March 31,
(in thousands) 2023 2022
Total revenue $ 412,752 $ 372,827
Total cost of revenue (1)
278,813 225,792
Gross profit 133,939 147,035
Operating expenses
Research and development (1)
44,555 51,812
Sales and marketing (1)
66,034 62,957
General and administrative (1)
47,752 45,256
Restructuring charges 1,605 850
Total operating expenses 159,946 160,875
Loss from operations (26,007) (13,840)
Other income (expense), net 1,956 (251)
Interest expense (10,560) (11,888)
Loss on debt extinguishment, net (1,392) (4,960)
Net loss before income taxes (36,003) (30,939)
Income tax provision 1,940 1,341
Net loss $ (37,943) $ (32,280)
(1) Includes stock-based compensation as follows:
28
Table of Contents
Year Ended March 31,
(in thousands) 2023 2022
Cost of revenue $ 929 $ 1,112
Research and development 2,997 5,843
Sales and marketing 2,397 2,516
General and administrative 4,427 4,358
Total $ 10,750 $ 13,829
Comparison of the Years Ended March 31, 2023 and 2022
Revenue
Year Ended March 31,
(in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Product revenue $ 266,537 65 % $ 223,761 60 % $ 42,776 19 %
Service and subscription revenue 132,510 32 % 133,689 36 % (1,179) (1) %
Royalty revenue 13,705 3 % 15,377 4 % (1,672) (11) %
Total revenue $ 412,752 100 % $ 372,827 100 % $ 39,925 11 %
Product Revenue
In fiscal 2023, product revenue increased $42.8 million, or 19%, as compared to fiscal 2022. The primary driver of the increase was demand from our large hyperscale customers, as well as continued strong demand globally for data protection and archive solutions. Outside of the Tape and Hyperscale business, our remaining Secondary and Primary storage systems are also offer as a subscription. We anticipate the product revenue portion of our Primary and Secondary storage systems to decrease as we continue to transition to subscription-based offerings. The Devices and media also decreased partially driven by lower volume of LTO® media sales.
Service and Subscription Revenue
Service and subscription revenue decreased $1.2 million, or 1%, in fiscal 2023 compared to fiscal 2022. This decrease was due in part to certain long-lived products reaching their end-of-service-life, partially offset by new support bookings and the transition towards subscription-based licensing.
Royalty Revenue
We receive royalties from third parties that license our LTO® media patents through our membership in the LTO® consortium. Royalty revenue decreased $1.7 million, or 11%, in fiscal 2023, as compared to fiscal 2022, related to lower overall unit shipments.
Gross Profit and Margin
Year Ended March 31,
(in thousands) 2023 Gross
margin % 2022 Gross
margin % $ Change Basis point change
Product gross profit $ 46,506 17.4 % $ 53,981 24.1 % $ (7,475) (670)
Service and subscription gross profit 73,728 55.6 % 77,677 58.1 % (3,949) (250)
Royalty gross profit 13,705 100.0 % 15,377 100.0 % (1,672) —
Gross profit $ 133,939 32.5 % $ 147,035 39.4 % $ (13,096) (690)
29
Table of Contents
Product Gross Margin
Product gross margin decreased 670 basis points for fiscal 2023, as compared to fiscal 2022. This decrease was due primarily to a $9.8 million inventory provision recorded during fiscal 2023. Due to longer purchasing lead times and other factors caused by the global supply chain disruptions occurring since the beginning of the COVID-19 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 370 basis points for fiscal 2023, as compared to fiscal 2022 primarily due to the continuation of pricing pressure on materials cost and freight, as global supply chain constraints disrupted normal procurement channels. Our product mix was also more heavily weighted to lower margin solutions.
Service and subscription Gross Margin
Service and subscription gross margin decreased 250 basis points for fiscal 2023, as compared to fiscal 2022. This decrease was due partially to increased costs for freight and repair on replacement parts in addition to additional inventory write downs required for service parts caused by the transition of certain service logistics activities to a third party provider.
Royalty Gross Margin
Royalties do not have significant related cost of sales.
Operating expenses
Year Ended March 31,
(in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Research and development $ 44,555 11 % $ 51,812 14 % $ (7,257) (14) %
Sales and marketing 66,034 16 % 62,957 17 % 3,077 5 %
General and administrative 47,752 12 % 45,256 12 % 2,496 6 %
Restructuring charges 1,605 — % 850 — % 755 89 %
Total operating expenses $ 159,946 39 % $ 160,875 43 % $ (929) (1) %
In fiscal 2023, research and development expense decreased $7.3 million, or 14%, as compared with fiscal 2022. This decrease was the result of one-time acquisition-related costs that occurred in the prior year, as well as the overall consolidation of those acquisitions.
In fiscal 2023, sales and marketing expenses increased $3.1 million, or 5%, as compared with fiscal 2022. This increase was partially driven by increased investment in sales resources in key strategic markets, as well as the resumption of large trade shows and other events that are a key driver of our marketing activities.
In fiscal 2023, general and administrative expenses increased $2.5 million, or 6%, as compared with fiscal 2022. This increase was driven primarily by transition costs as we complete large projects in our IT and facilities infrastructure.
In fiscal 2023, restructuring expenses increased $0.8 million, or 89%, as compared with fiscal 2022. This increase is driven by corporate restructuring activities as we consolidated our physical footprint and operations in certain markets.
Other expense, net
Year Ended March 31,
(in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Other income (expense), net $ 1,956 1 % $ (251) 0 % $ (2,207) (879) %
30
Table of Contents
In fiscal 2023, other income (expense), net increased $2.2 million or 879%, compared to fiscal 2022. The increase was primarily related to differences in foreign currency gains and losses during each period, as well as the sale of IP licenses.
Interest expense
Year Ended March 31,
(in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Interest expense (10,560) (3) % (11,888) (3) % (1,328) (11) %
In fiscal 2023, interest expense decreased $1.3 million, or 11%, as compared to fiscal 2022. This decrease was primarily due to a lower principal balance on our Term Loan.
Loss on debt extinguishment, net
Year Ended March 31,
(in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Loss on debt extinguishment, net (1,392) — % (4,960) (1) % (3,568) (72) %
In fiscal 2023, loss on debt extinguishment, net was related to prepayment of our long-term debt.
Income tax provision
Year Ended March 31,
(in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Income tax provision $ 1,940 1 % $ 1,341 — % $ 599 45 %
Our income tax provision is primarily influenced by foreign and state income taxes. In fiscal 2023, the income tax provision increased $0.6 million or 45%, compared to fiscal 2022, related primarily to higher current foreign taxes as a result of an increase in foreign taxable 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 credit facility with PNC Bank, National Association (as amended from time to time, the “PNC Credit Facility”) pursuant to the Amended Restated Revolving Credit and Security Agreement dated December 27, 2018. 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.
31
Table of Contents
We had cash and cash equivalents of $26.0 million as of March 31, 2023, which excludes $0.2 million. of short-term restricted cash as of March 31, 2023. Our total outstanding Term Loan debt was $74.7 million, and we had $20.0 million available to borrow under the PNC Credit Facility as of March 31, 2023.
We generated negative cash flows from operations of approximately $4.9 million and $33.7 million for the fiscal years ended March 31, 2023 and 2022, respectively, and generated net losses of approximately $37.9 million and $32.3 million for the fiscal years ended March 31, 2023 and 2022, respectively. We have funded operations through the sale of common stock, term debt borrowings and revolving credit facility borrowings described in Note 5: Debt .
On June 1, 2023, the Company entered into amendments to the Term Loan and the PNC Credit Facility. The amendments, among other things, (a) amended the total net leverage ratio financial covenant commencing with the fiscal quarter ended June 30, 2023; (b) amended the minimum liquidity financial covenant to decrease the minimum liquidity to $15 million; and (c) amended the “EBITDA” definition to increase the add-back cap on non-recurring items including restructuring charges during the fiscal years ended March 31, 2024 and 2025. The Term Loan amendment also provided an advance of $15 million in additional Term Loan borrowings. With the additional term debt borrowings, in addition to the amendments to the credit agreements, we forecasted that operating performance, cash, current working capital and borrowings available under the PNC Credit Facility will provide us with sufficient capital to fund operations for at least one year from the financial statement issuance date. If required, there is no assurance that we would be able to obtain sufficient additional funds when needed or that such funds, if available, would be obtainable on terms satisfactory to us.
Our outstanding long-term debt amounted to $83.1 million as of March 31, 2023, net of $3.3 million in unamortized debt issuance costs and $5.0 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. We believe we were in compliance with all covenants under our debt agreements as of the date of filing of this Annual Report on Form 10-K. 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) 2023 2022
Cash provided by (used in):
Operating activities (4,894) (33,728)
Investing activities (15,601) (14,124)
Financing activities 41,165 20,157
Effect of exchange rate changes 12 51
Net change in cash, cash equivalents, and restricted cash $ 20,682 $ (27,644)
Net Cash Used in Operating Activities
Net cash used in operating activities was $4.9 million for the year ended March 31, 2023, primarily attributable to cash provided by operating activities excluding changes in assets and liabilities of $1.5 million offset by cash used associated with working capital changes of $6.4 million including cash used related to manufacturing and service inventories of $5.3 million.
Net cash used in operating activities was $33.7 million for the year ended March 31, 2022, primarily attributable to $30.5 million of changes in assets and liabilities due primarily to working capital requirements due to higher manufacturing and service inventories.
32
Table of Contents
Net Cash Used in Investing Activities
Net cash used in investing activities was $15.6 million for the year ended March 31, 2023, primarily attributable to $12.6 million of capital expenditures and $3.0 million of cash paid related to the deferred purchase price for a prior business acquisition.
Net cash used in investing activities was $14.1 million for the year ended March 31, 2022, primarily attributable to $7.8 million of business acquisitions and $6.3 million of capital expenditures.
Net Cash Provided by Financing Activities
Net cash provided by financing activities was $41.2 million for the year ended March 31, 2023 due primarily to $66.2 million of net cash received from the Rights Offering of 30 million shares of our common stock offset in part 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 $20.2 million for the year ended March 31, 2022, primarily related 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 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, 2023 (in thousands):
Payments Due by Period
(in thousands) Total 1 year or less 1 – 3 Years 3 –5 Years More than
5 years
Debt obligations (1)
$ 140,407 $ 15,109 $ 108,548 $ 16,750 $ —
Future lease commitments (2)
22,993 2,700 3,989 3,042 13,262
Purchase obligations (3)
28,688 28,688 — — —
Total $ 192,088 $ 46,497 $ 112,537 $ 19,792 $ 13,262
(1) Consists of (i) principal and interest payments on our term loan based on the amount outstanding and interest rates in effect at March 31, 2023, and (ii) principal, interest, and unused commitment fees on our PNC Credit Facility based on the amount outstanding and rates in effect at March 31, 2023. Term loan debt matures on August 5, 2026.
(2) Represents aggregate future minimum lease payments under non-cancelable operating leases.
(3) Includes primarily non-cancelable inventory purchase commitments.
33
Table of Contents
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 generally accepted accounting principles in the United States of America (“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: (a) products, (b) service and subscription, and (c) royalties. Our performance obligations are satisfied at a point in time or over time as stand ready obligations. 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. Service and subscription revenue consists of customer support agreements, software subscriptions, installation, and consulting & training. Our software subscriptions include term licenses which are recognized as revenue when the license has been delivered to the customer and related customer support which is recognized ratably over the service period. Revenue from customer support agreements is recognized ratably over the contractual term of the agreement. Installation services are typically completed within a short period of time and revenue from these services are recognized at the point when installation is complete. A majority of our consulting and training revenue does not take significant time to complete therefore these obligations are satisfied upon completion of such services at a point in time. 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 Accounting Standards Codification (“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.
34
Table of Contents
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 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 9: 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. 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
35
Table of Contents
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.
Recently Issued and Adopted Accounting Pronouncements
For recently issued and adopted accounting pronouncements, see Note 1: Description of Business and Significant Accounting Policies , to our consolidated financial statements.