Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion gives effects to the restatement of our consolidated financial statements for the fiscal years ended March 31, 2023 and 2022, discussed in Note 14 to the consolidated financial statements of this Annual Report. 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. Our fiscal year ends on March 31 of each calendar year. "Fiscal 2024" in this Annual Report refers to the fiscal year ended March 31, 2024.
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.
Restatement
The accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations gives effect to the restatement adjustments made to the previously reported consolidated financial statements for the fiscal years ended March 31, 2022 and March 31, 2023. For additional information and a detailed discussion of the restatement, see Note 14: Restatement of Previously Issued Financial Statements in the Notes to our consolidated financial statements included in this Annual Report under the caption Item 8. Financial Statements and Supplementary Data . Restatement adjustments have also been made to the previously reported consolidated financial statements for the quarterly periods ended June 30, 2022 and June 30, 2023 as well as the quarters ended September 30, 2022 and December 31, 2022. For additional information related to the quarterly restatement, see Note 15: Quarterly Financial Summary (Unaudited) in the Notes to our consolidated financial statements included in this Annual Report on Form 10-K under the caption Item 8. Financial Statements and Supplementary Data .
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RESULTS OF OPERATIONS
Year Ended March 31,
(in thousands) 2024 2023 2022
Restated Restated
Total revenue $ 311,600 $ 422,077 $ 383,432
Total cost of revenue (1)
186,711 278,813 225,792
Gross profit 124,889 143,264 157,640
Operating expenses
Sales and marketing (1) 60,893 66,034 62,957
General and administrative (1) 51,547 47,752 45,256
Research and development (1) 38,046 44,555 51,812
Restructuring charges 3,280 1,605 850
Total operating expenses 153,766 159,946 160,875
Loss from operations (28,877) (16,682) (3,235)
Other income (expense), net (1,746) 1,956 (251)
Interest expense (15,089) (10,560) (11,888)
Change in fair value of warrant liability 5,137 10,250 60,030
Loss on debt extinguishment, net — (1,392) (4,960)
Net income (loss) before income taxes (40,575) (16,428) 39,696
Income tax provision 711 1,940 1,341
Net income (loss) $ (41,286) $ (18,368) $ 38,355
(1) Includes stock-based compensation as follows:
Year Ended March 31,
(in thousands) 2024 2023 2022
Cost of revenue $ 774 $ 929 $ 1,112
Research and development 1,091 2,997 5,843
Sales and marketing 669 2,397 2,516
General and administrative 2,187 4,427 4,358
Total $ 4,721 $ 10,750 $ 13,829
Comparison of the Years Ended March 31, 2024 and 2023 (restated)
Revenue
Year Ended March 31,
(in thousands) 2024 % of
revenue 2023 % of
revenue $ Change % Change
Restated
Product revenue $ 174,879 56 % $ 274,854 65 % $ (99,975) (36) %
Service and subscription revenue 126,590 41 133,518 32 (6,928) (5) %
Royalty revenue 10,131 3 13,705 3 (3,574) (26) %
Total revenue $ 311,600 100 % $ 422,077 100 % $ (110,477) (26) %
Product Revenue
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In fiscal 2024, product revenue decreased $100.0 million, or 36%, as compared to fiscal 2023. The primary driver of the decrease was a $62.5 million decrease in demand from our large hyperscale customers, as well as more general decreases in the overall tape market with declines in media and devices revenue. Outside of the Tape and Hyperscale business, our remaining Secondary and Primary storage systems are also offered 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.
Service and Subscription Revenue
Service and subscription revenue decreased $6.9 million, or 5%, in fiscal 2024 compared to fiscal 2023. 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 linear-tape open media patents through our membership in the linear-tape open consortium. Royalty revenue decreased $3.6 million, or 26%, in fiscal 2024, as compared to fiscal 2023, related to lower overall unit shipments.
Gross Profit and Margin
Year Ended March 31,
(in thousands) 2024 Gross
margin % 2023 Gross
margin % $ Change Basis point change
Restated
Product gross profit $ 38,459 22.0 % $ 54,823 19.9 % $ (16,364) 210
Service and subscription gross profit 76,299 60.3 % 74,736 56.0 % 1,563 430
Royalty gross profit 10,131 100.0 % 13,705 100.0 % (3,574) —
Gross profit $ 124,889 40.1 % $ 143,264 33.9 % $ (18,375) 614
Gross profit and margin percentages are key metrics that management monitors to assess the performance on the business.
Product Gross Margin
Product gross margin increased 210 basis points for fiscal 2024, as compared to fiscal 2023. This increase 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 had 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 was not repeated in fiscal 2024.
The other primary driver of product gross margin improvement in fiscal 2024 was a revenue mix less weighted towards hyperscalers, media, and devices. These revenue lines typically carry a lower gross margin than sales of our other secondary and primary storage products.
Service and subscription Gross Margin
Service and subscription gross margin increased 430 basis points for fiscal 2024, as compared to fiscal 2023. This increase was due primarily to improved operational costs as we implemented strict cost controls and improved our organization design. It was also partially driven by service parts inventory write downs in fiscal 2023, 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.
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Operating expenses
Year Ended March 31,
(in thousands) 2024 % of
revenue 2023 % of
revenue $ Change % Change
Restated
Sales and marketing $ 60,893 20 % $ 66,034 16 % $ (5,141) (8) %
General and administrative 51,547 17 % 47,752 11 % 3,795 8 %
Research and development 38,046 12 % 44,555 11 % (6,509) (15) %
Restructuring charges 3,280 1 % 1,605 — % 1,675 104 %
Total operating expenses $ 153,766 49 % $ 159,946 38 % $ (6,180) (4) %
In fiscal 2024, sales and marketing expenses decreased $5.1 million, or 8%, as compared with fiscal 2023. This decrease was primarily driven by decreased commission expense on lower revenue.
In fiscal 2024, general and administrative expenses increased $3.8 million, or 8%, as compared with fiscal 2023 This increase was primarily driven by large non-recurring costs related to our re-evaluation of Topic 606, and other related projects.
In fiscal 2024, research and development expenses decreased $6.5 million, or 15%, as compared with fiscal 2023. This decrease was the result of the continued consolidation of acquisition costs, and efficiencies realized through improved organization design.
In fiscal 2024, restructuring expenses increased $1.7 million, or 104%, as compared with fiscal 2023. 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) 2024 % of
revenue 2023 % of
revenue $ Change % Change
Restated
Other income (expense), net $ (1,747) (1) % $ 1,956 1 % $ 3,703 (189) %
In fiscal 2024, other income (expense), net decrease of $3.7 million or 189%, compared to fiscal 2023. The decrease was primarily related to differences in foreign currency gains and losses during each period, as well as the non-recurring sale of $2.3 million IP licenses in fiscal 2023.
Interest expense
Year Ended March 31,
(in thousands) 2024 % of
revenue 2023 % of
revenue $ Change % Change
Restated
Interest expense $ 15,089 5 % $ 10,560 3 % 4,529 43 %
In fiscal 2024, interest expense increased $4.5 million, or 43%, as compared to fiscal 2023. This increase was primarily due to a higher principal balance on our Term Loan as well as a higher interest rate.
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Warrant liabilities
Year Ended March 31,
(in thousands) 2024 % of
revenue 2023 % of
revenue $ Change % Change
Restated
Change in fair value of warrant liabilities $ 5,137 2 % $ 10,250 2 % $ (5,113) (50) %
In fiscal 2024, the fair value of warrant liabilities decreased $5.1 million, or 50%, as compared to fiscal 2023. The decrease was primarily due to a lower average stock price in fiscal 2024.
Loss on debt extinguishment, net
Year Ended March 31,
(in thousands) 2024 % of
revenue 2023 % of
revenue $ Change % Change
Restated
Loss on debt extinguishment, net $ — — % $ (1,392) — % $ 1,392 100 %
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) 2024 % of
revenue 2023 % of
revenue $ Change % Change
Restated
Income tax provision $ 711 — % $ 1,940 1 % $ 1,229 63 %
Our income tax provision is primarily influenced by foreign and state income taxes. In fiscal 2024, the income tax provision decreased $1.2 million or 63%, compared to fiscal 2023, related primarily to lower current foreign taxes as a result of a decrease 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 judgment is required in assessing our ability to realize any future benefit from our net deferred tax assets. We intend to maintain this valuation allowance until sufficient positive evidence exists to support its reversal. Our income tax expense recorded in the future will be reduced to the extent that sufficient positive evidence materializes to support a reversal of, or decrease in, our valuation allowance.
Comparison of the Years Ended March 31, 2023 and 2022
Revenue
Year Ended March 31,
(in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Restated Restated
Product revenue $ 274,854 65 % $ 230,814 60 % $ 44,040 19 %
Service and subscription revenue 133,518 32 % 137,241 36 % (3,723) (3) %
Royalty revenue 13,705 3 % 15,377 4 % (1,672) (11) %
Total revenue $ 422,077 100 % $ 383,432 100 % $ 38,645 10 %
Product Revenue
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In fiscal 2023, product revenue increased $44.0 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 offered 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 linear-tape open media sales.
Service and Subscription Revenue
Service and subscription revenue decreased $3.7 million, or 3%, 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 linear-tape open media patents through our membership in the linear-tape open 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
Restated Restated
Product gross profit $ 54,823 19.9 % $ 61,034 26.4 % $ (6,211) (650)
Service and subscription gross profit 74,736 56.0 % 81,229 59.2 % (6,493) (320)
Royalty gross profit 13,705 100.0 % 15,377 100.0 % (1,672) —
Gross profit $ 143,264 33.9 % $ 157,640 41.1 % $ (14,376) (720)
Gross profit and margin percentages are key metrics that management monitors to assess the performance on the business.
Product Gross Margin
Product gross margin decreased 650 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 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 320 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.
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Operating expenses
Year Ended March 31,
(in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Restated Restated
Sales and marketing $ 66,034 16 % $ 62,957 16 % $ 3,077 5 %
General and administrative 47,752 11 % 45,256 12 % 2,496 6 %
Research and development 44,555 11 % 51,812 14 % (7,257) (14) %
Restructuring charges 1,605 — % 850 — % 755 89 %
Total operating expenses $ 159,946 38 % $ 160,875 42 % $ (929) (1) %
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, 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, 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
Restated Restated
Other income (expense), net $ 1,956 1 % $ (251) 0 % $ 2,207 879 %
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
Restated Restated
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.
Warrant liabilities
Year Ended March 31,
(in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Restated Restated
Change in fair value of warrant liabilities $ 10,250 2 % $ 60,030 16 % $ (49,780) (83) %
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In fiscal 2023, the fair value of warrant liabilities decreased $49.8 million, or 83%, as compared to fiscal 2022. This decrease was primarily due to a lower average stock price in fiscal 2023.
Loss on debt extinguishment, net
Year Ended March 31,
(in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Restated Restated
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
Restated Restated
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 judgment is required in assessing our ability to realize any future benefit from our net deferred tax assets. We intend to maintain this valuation allowance until sufficient positive evidence exists to support its reversal. Our income tax expense recorded in the future will be reduced to the extent that sufficient positive evidence materializes to support a reversal of, or decrease in, our valuation allowance.
Comparison of the Three Months Ended December 31, 2023 and 2022
Revenue
Three Months Ended December 31,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Product revenue $ 37,113 51 % $ 77,494 69 % $ (40,381) (52) %
Service and subscription 32,771 46 % 33,155 29 % (384) (1) %
Royalty 2,042 3 % 2,826 2 % (784) (28) %
Total revenue $ 71,926 100 % $ 113,475 100 % $ (41,549) (37) %
Product Revenue
In the three months ended December 31, 2023, product revenue decreased $40.4 million, or 52%, as compared to the same period in 2022. The primary driver of the decrease was lower demand from our large hyperscale customers, as well as declines in the linear-tape open media market impacting both media cartridge sales and associated linear-tape open royalties.
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Service Revenue
Service and subscription revenue decreased $0.4 million, or 1%, in the three months ended December 31, 2023 compared to the same period in 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 linear-tape open media patents through our membership in the linear-tape open consortium. Royalty revenue decreased $0.8 million, or 28%, in the three months ended December 31, 2023 compared to the same period in 2022 due to decreased market volume of older generation linear-tape open media.
Gross Profit and Margin
Three Months Ended December 31,
(dollars in thousands) 2023 Gross
margin % 2022 Gross
margin % $ Change Basis point change
Product $ 7,069 19.0 % $ 18,966 24.5 % $ (11,897) (550)
Service and subscription 20,070 61.2 % 20,776 62.7 % (706) (150)
Royalty 2,042 100.0 % 2,826 100.0 % (784) —
Gross profit $ 29,181 40.6 % $ 42,568 37.5 % $ (13,387) 310
Gross profit and margin percentages are key metrics that management monitors to assess the performance on the business.
Product Gross Margin
Product gross margin decreased to 19.0%, or by 550 basis points, for the three months ended December 31, 2023, as compared with the same period in 2022. The primary driver of the decrease was lower demand from our large hyperscale customers, as well as declines in the linear-tape open media market impacting both media cartridge sales and associated linear-tape open royalties.
Service and Subscription Gross Margin
Service and subscription gross margins decreased 150 basis points for the three months ended December 31, 2023, as compared with the same period in 2022. This decrease was primarily driven by lower service revenues on a similar service cost basis.
Royalty Gross Margin
Royalties do not have significant related cost of sales.
Operating Expenses
Three Months Ended December 31,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Sales and marketing $ 14,244 20 % $ 16,339 14 % $ (2,095) (13) %
General and administrative 11,893 17 % 10,969 10 % 924 8 %
Research and development 8,763 12 % 11,254 10 % (2,491) (22) %
Restructuring charges 497 1 % (41) — % 538 (1,312) %
Total operating expenses $ 35,397 49 % $ 38,521 34 % $ (3,124) (8) %
In the three months ended December 31, 2023, sales and marketing expenses decreased $2.1 million, or 13%, as compared with the same period in 2022. This decrease was primarily driven by the pivot of existing sales and marketing investment towards high-growth markets.
In the three months ended December 31, 2023, general and administrative expenses increased $0.9 million, or 8%, as compared with the same period in 2022. This increase was largely driven by higher project expense related to the re-evaluation of the Company's application of standalone selling price under Topic 606.
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In the three months ended December 31, 2023, research and development expenses decreased $2.5 million, or 22%, as compared with the same period in 2022. This decrease was primarily driven by cost reduction measures to streamline common development functions across business units, and further consolidate acquired businesses.
In the three months ended December 31, 2023, restructuring expenses increased $0.5 million as compared with the same period in 2022. The increase was the result of cost reduction initiatives.
Other Income (Expense)
Three Months Ended December 31,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Other income (expense) $ (1,419) (2) % $ (544) (—) % $ (875) (161) %
The change in other income (expense), net during the three months ended December 31, 2023 compared with the same period in 2022 was related primarily to fluctuations in foreign currency exchange rates during the three months ended December 31, 2023.
Interest Expense
Three Months Ended December 31,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Interest expense $ 3,937 5 % $ 2,701 2 % $ 1,236 46 %
In the three months ended December 31, 2023, interest expense increased $1.2 million, or 46%, as compared with the same period in 2022 due to a higher effective interest rate on our Term Loan.
Loss on Debt Extinguishment
There were no debt extinguishments in the three months ended December 31, 2023 and 2022.
Income Taxes
Three Months Ended December 31,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Income tax provision $ 510 1 % $ 693 1 % $ (183) (26) %
The income tax provision for the three months ended December 31, 2023 and 2022 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 judgment 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, 2023 and 2022
Revenue
Nine Months Ended December 31,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Product revenue $ 138,635 58 % $ 203,192 65 % $ (64,557) (32) %
Service and subscription 94,229 39 % 99,937 32 % (5,708) (6) %
Royalty 7,235 3 % 9,744 3 % (2,509) (26) %
Total revenue $ 240,099 100 % $ 312,873 100 % $ (72,774) (23) %
Product Revenue
In the nine months ended December 31, 2023, product revenue decreased $64.6 million, or 32%, as compared to the same period in 2022. The primary driver of the decrease was lower demand from our large hyperscale customers, as well as declines in the linear-tape open media market impacting both media cartridge sales and associated linear-tape open royalties.
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 $5.7 million or 6% in the nine months ended December 31, 2023 compared to the same period in 2022, partially driven by lower overall legacy service revenues offset by higher subscription revenue.
Royalty Revenue
We receive royalties from third parties that license our linear-tape open media patents through our membership in the linear-tape open consortium. Royalty revenue decreased $2.5 million, or 26%, in the nine months ended December 31, 2023 compared to the same period in 2022 due to decreased market volume of older generation linear-tape open media.
Gross Profit and Margin
Nine Months Ended December 31,
(dollars in thousands) 2023 Gross
margin % 2022 Gross
margin % $ Change Basis point change
Product $ 33,421 24.1 % $ 40,182 19.8 % $ (6,761) 430
Service and subscription 56,900 60.4 % 57,708 57.7 % (808) 270
Royalty 7,235 100.0 % 9,744 100.0 % (2,509) —
Gross profit $ 97,556 40.6 % $ 107,634 34.4 % $ (10,078) 620
Gross profit and margin percentages are key metrics that management monitors to assess the performance on the business.
Product Gross Margin
Product gross margin increased to 24.1% or by 430 basis points for the nine months ended December 31, 2023, as compared with the same period in 2022. This increase was primarily due to a more favorable mix of revenues, weighted towards our higher margin product lines, as well as improvements in our operational efficiency and logistics costs. In addition, the prior year period included a $6.9 million inventory reserve provision recorded during the nine months ended December 31, 2022.
Service and Subscription Gross Margin
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Service and subscription gross margin of 60.4% increased 270 basis points for the nine months ended December 31, 2023, as compared with the same period in 2022. 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
Nine Months Ended December 31,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Sales and marketing $ 45,800 19 % $ 47,894 15 % $ (2,094) (4) %
General and administrative 34,833 15 % 35,223 11 % (390) (1) %
Research and development 28,828 12 % 33,925 11 % (5,097) (15) %
Restructuring charges 3,164 1 % 1,605 1 % 1,559 97 %
Total operating expenses $ 112,625 47 % $ 118,647 38 % $ (6,022) (5) %
In the nine months ended December 31, 2023, sales and marketing expenses decreased $2.1 million, or 4% compared with the same period in 2022 as we pivoted existing sales and marketing investment towards high growth markets.
In the nine months ended December 31, 2023, general and administrative expenses decreased $0.4 million, or 1%, as compared with the same period in 2022. This decrease was largely driven by a reduced facilities footprint, as well as other cost reduction efforts across the business, offset by higher project expense related to the re-evaluation of the Company's application of standalone selling price under Topic 606.
In the nine months ended December 31, 2023, research and development expense decreased $5.1 million, or 15%, as compared with the same period in 2022. This decrease was primarily driven by cost reduction measures to streamline common development functions across business units, and further consolidate acquired businesses.
In the nine months ended December 31, 2023, restructuring expenses increased $1.6 million as compared with the same period in 2022. The increase was the result of cost reduction initiatives.
Other Income (Expense)
Nine Months Ended December 31,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Other income (expense) $ (2,049) (1) % $ 2,638 1 % $ (4,687) 178 %
The change in other income (expense), net during the nine months ended December 31, 2023 compared with the same period in 2022 was related primarily to fluctuations in foreign currency exchange rates during the nine months ended December 31, 2023.
Interest expense
Nine Months Ended December 31,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Interest expense $ 10,992 5 % $ 7,537 2 % $ 3,455 46 %
In the nine months ended December 31, 2023, interest expense increased $3.5 million, or 46%, as compared with the same period in 2022 due to a higher effective interest rate on our Term Loan.
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Loss on debt extinguishment
Nine Months Ended December 31,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Loss on debt extinguishment $ — — % $ (1,392) — % $ 1,392 100 %
In the nine months ended December 31, 2023, loss on debt extinguishment decreased $1.4 million as compared with the same period in 2022 due to a loss on debt extinguishment of $1.4 million for a prepayment of our Term Loan.
Income Taxes
Nine Months Ended December 31,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Income tax provision $ 1,573 1 % $ 1,564 — % $ 9 1 %
The income tax provision for the nine months ended December 31, 2023 and 2022 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 judgment is required in assessing our ability to realize any future benefit from our net deferred tax assets. We intend to maintain this valuation allowance until sufficient positive evidence exists to support its reversal. Our income tax expense recorded in the future will be reduced to the extent that sufficient positive evidence materializes to support a reversal of, or decrease in, our valuation allowance.
Comparison of the Three Months Ended September 30, 2023 and 2022
Revenue
Three Months Ended September 30,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Product revenue $ 42,947 57 % $ 64,110 64 % $ (21,163) (33) %
Service and subscription 30,505 40 % 32,977 33 % (2,472) (7) %
Royalty 2,228 3 % 3,478 3 % (1,250) (36) %
Total revenue $ 75,680 100 % $ 100,565 100 % $ (24,885) (25) %
Product Revenue
In the three months ended September 30, 2023, product revenue decreased $21.2 million, or 33%, as compared to the same period in 2022. The primary driver of the decrease was lower demand from our large hyperscale customers, as well as declines in the linear-tape open media market impacting both media cartridge sales and associated linear-tape open royalties.
Service and subscription revenue decreased $2.5 million, or 7%, in the three months ended September 30, 2023 compared to the same period in 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 linear-tape open media patents through our membership in the linear-tape open consortium. Royalty revenue decreased $1.3 million, or 36%, in the three months ended September 30, 2023 compared to the same period in 2022 due to decreased market volume of older generation linear-tape open media.
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Gross Profit and Margin
Three Months Ended September 30,
(dollars in thousands) 2023 Gross
margin % 2022 Gross
margin % $ Change Basis point change
Product $ 12,228 28.5 % $ 7,550 11.8 % $ 4,678 1,670
Service and subscription 18,279 59.9 % 18,231 55.3 % 48 460
Royalty 2,228 100.0 % 3,478 100.0 % (1,250) —
Gross profit $ 32,735 43.3 % $ 29,259 29.1 % $ 3,476 1,420
Gross profit and margin percentages are key metrics that management monitors to assess the performance on the business.
Product Gross Margin
Product gross margin increased to 28.5%, or by 1,670 basis points, for the three months ended September 30, 2023, as compared with the same period in 2022. This increase was primarily due to a more favorable mix of revenues, weighted towards our higher margin product lines, as well as improvements in our operational efficiency and logistics costs. In addition, the prior year period included a $6.9 million inventory reserve provision recorded during the three months ended September 30, 2022.
Service and Subscription Gross Margin
Service and subscription gross margins increased 460 basis points for the three months ended September 30, 2023, as compared with the same period in 2022. 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 September 30,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Sales and marketing $ 15,717 21 % $ 15,593 16 % $ 124 1 %
General and administrative 10,241 14 % 11,940 12 % (1,699) (14) %
Research and development 9,152 12 % 10,546 10 % (1,394) (13) %
Restructuring charges 1,338 2 % 921 1 % 417 45 %
Total operating expenses $ 36,448 48 % $ 39,000 39 % $ (2,552) (7) %
In the three months ended September 30, 2023, sales and marketing expense increased $0.1 million, or 1%, as compared with the same period in 2022. Overall costs remain relatively flat as we pivot existing sales and marketing investment towards high-growth markets.
In the three months ended September 30, 2023, general and administrative expenses decreased $1.7 million, or 14%, as compared with the same period in 2022. This decrease was largely driven by a reduced facilities footprint, as well as other cost reduction efforts across the business.
In the three months ended September 30, 2023, research and development expenses decreased $1.4 million, or 13%, as compared with the same period in 2022. This decrease was primarily driven by cost reduction measures to consolidate acquired businesses.
In the three months ended September 30, 2023, restructuring expenses increased $0.4 million as compared with the same period in 2022. The increase was the result of cost reduction initiatives.
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Other Income (Expense)
Three Months Ended September 30,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Other income (expense) $ 367 0 % $ 2,431 2 % $ (2,064) 85 %
The change in other income (expense), net during the three months ended September 30, 2023 compared with the same period in 2022 was related primarily to fluctuations in foreign currency exchange rates during the three months ended September 30, 2023.
Interest Expense
Three Months Ended September 30,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Interest expense $ 3,855 5 % $ 2,745 3 % $ 1,110 40 %
In the three months ended September 30, 2023, interest expense increased $1.1 million, or 40%, as compared with the same period in 2022 due to a higher effective interest rate on our Term Loan.
Loss on Debt Extinguishment
There were no debt extinguishments in the three months ended September 30, 2023 and 2022.
Income Taxes
Three Months Ended September 30,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Income tax provision $ 533 1 % $ 461 — % $ 72 16 %
The income tax provision for the three months ended September 30, 2023 and 2022 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 judgment is required in assessing our ability to realize any future benefit from our net deferred tax assets. We intend to maintain this valuation allowance until sufficient positive evidence exists to support its reversal. Our income tax expense recorded in the future will be reduced to the extent that sufficient positive evidence materializes to support a reversal of, or decrease in, our valuation allowance.
Comparison of the Six Months Ended September 30, 2023 and 2022
Revenue
Six Months Ended September 30,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Product revenue $ 101,522 60 % $ 125,698 64 % $ (24,176) (19) %
Service and subscription 61,458 37 % 66,782 33 % (5,324) (8) %
Royalty 5,194 3 % 6,918 3 % (1,724) (25) %
Total revenue $ 168,174 100 % $ 199,398 100 % $ (31,224) (16) %
Product Revenue
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In the six months ended September 30, 2023, product revenue decreased $24.2 million, or 19%, as compared to the same period in 2022. The primary driver of the decrease was lower demand from our large hyperscale customers, as well as declines in the linear-tape open media market impacting both media cartridge sales and associated linear-tape open royalties.
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 $5.3 million, or 8%, in the six months ended September 30, 2023 compared to the same period in 2022, partially driven by lower overall legacy service revenues offset by higher subscription revenue.
Royalty Revenue
We receive royalties from third parties that license our linear-tape open media patents through our membership in the linear-tape open consortium. Royalty revenue decreased $1.7 million, or 25%, in the six months ended September 30, 2023 compared to the same period in 2022 due to decreased market volume of older generation linear-tape open media.
Gross Profit and Margin
Six Months Ended September 30,
(dollars in thousands) 2023 Gross
margin % 2022 Gross
margin % $ Change Basis point change
Product $ 26,352 26.0 % $ 21,216 16.9 % $ 5,136 910
Service and subscription 36,830 59.9 % 36,932 55.3 % (102) 460
Royalty 5,194 100.0 % 6,918 100.0 % (1,724) —
Gross profit $ 68,376 40.7 % $ 65,066 32.6 % $ 3,310 810
Gross profit and margin percentages are key metrics that management monitors to assess the performance on the business.
Product Gross Margin
Product gross margin increased to 26.0%, or by 910 basis points, for the six months ended September 30, 2023, as compared with the same period in 2022. This increase was primarily due to a more favorable mix of revenues, weighted towards our higher margin product lines, as well as improvements in our operational efficiency and logistics costs. In addition, the prior year period included a $6.9 million inventory reserve provision recorded during the six months ended September 30, 2022.
Service and Subscription Gross Margin
Service and subscription gross margin of 59.9% increased 460 basis points for the six months ended September 30, 2023, as compared with the same period in 2022. 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.
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Operating expenses
Six Months Ended September 30,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Sales and marketing $ 31,557 19 % $ 31,555 16 % $ 2 — %
General and administrative 22,940 14 % 24,254 12 % (1,314) (5) %
Research and development 20,065 12 % 22,671 11 % (2,606) (11) %
Restructuring charges 2,667 2 % 1,646 1 % 1,021 62 %
Total operating expenses $ 77,229 46 % $ 80,126 40 % $ (2,897) (4) %
In the six months ended September 30, 2023, sales and marketing expense was flat compared with the same period in 2022 as we pivoted existing sales and marketing investment towards high-growth markets.
In the six months ended September 30, 2023, general and administrative expense decreased $1.3 million, or 5%, compared with the same period in 2022. This decrease was largely driven by a reduced facilities footprint, as well as other cost reduction efforts across the business.
In the six months ended September 30, 2023, research and development expenses decreased $2.6 million, or 11%, as compared with the same period in 2022. This decrease was primarily driven by cost reduction measures to consolidate acquired businesses.
In the six months ended September 30, 2023, restructuring expenses increased $1.0 million as compared with the same period in 2022. The increase was the result of cost reduction initiatives.
Other Income (Expense)
Six Months Ended September 30,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Other income (expense) $ (630) 0 % $ 3,182 2 % $ (3,812) 120 %
The change in other income (expense), net during the six months ended September 30, 2023 compared with the same period in 2022 was related primarily to fluctuations in foreign currency exchange rates during the three months ended September 30, 2023.
Interest expense
Six Months Ended September 30,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Interest expense $ 7,055 4 % $ 4,836 2 % $ 2,219 46 %
In the six months ended September 30, 2023, interest expense increased $2.2 million, or 46%, as compared with the same period in 2022 due to a higher effective interest rate on our Term Loan.
Loss on debt extinguishment
Six Months Ended September 30,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Loss on debt extinguishment $ — — % $ (1,392) (1) % $ 1,392 100 %
In the six months ended September 30, 2023, loss on debt extinguishment decreased $1.4 million as compared with the same period in 2022 due to a loss on debt extinguishment of $1.4 million for a prepayment of our Term Loan.
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Income Taxes
Six Months Ended September 30,
(dollars in thousands) 2023 % of
revenue 2022 % of
revenue $ Change % Change
Income tax provision $ 1,063 1 % $ 872 — % $ 191 22 %
The income tax provision for the six months ended September 30, 2023 and 2022 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 judgment 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.
We had cash and cash equivalents of $25.7 million as of March 31, 2024, which excludes $0.2 million of short-term restricted cash. Our total outstanding Term Loan debt was $87.9 million, and we had $27.3 million available to borrow under the PNC Credit Facility as of March 31, 2024.
We generated negative cash flows from operations of approximately $10.2 million and $4.9 million for the fiscal years ended March 31, 2024 and 2023, respectively, and generated net losses of approximately $41.3 million and $18.4 million for the fiscal years ended March 31, 2024 and 2023, respectively. We have funded operations through the sale of common stock, term debt borrowings and revolving credit facility borrowings described in Note 5: 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. On February 14, 2024, we entered into amendments to the Credit Agreements which waived testing of the total net leverage ratio financial covenant for the fiscal quarter ended December 31, 2023. On May 24, 2024, we entered into amendments to the Credit Agreements which, among other things, waives compliance with our net leverage covenant as of March 31, 2024, reduced the daily minimum liquidity below $15.0 million until June 16, 2023 and waived any default that might arise as a result of the restatement of certain of our historical financial statements. The Term Loan and PNC Credit Facility both mature on August 5, 2026 under the terms of the related agreements. As discussed in Note 1 : Description of Business and Significant Accounting Policies—Going Concern , we expect to be in violation of our net leverage covenant as of the June 30, 2024 testing date and the violation will cause the outstanding Term Loan and PNC Credit Facility outstanding balances to become due as an event of default. As a result, we have classified the Term Loan and PNC Credit Facility as current liabilities in the accompanying consolidated balance sheet. We are currently working to obtain additional covenant waivers or refinance the existing Term Debt and PNC Credit Facility. Additionally, we are evaluating strategies to obtain additional funding to provide additional liquidity, including potential asset sales. In the event we are unable to obtain an extension of the waiver, additional funding will be required to pay the amount due on the revolver and term loan. However, we may be unable to obtain an extension of the waiver, or obtain additional funding. As such, there can be no assurance that we will be able to obtain additional liquidity when needed or under acceptable terms, if at all.
See "Risks Related to our Indebtedness" section of Item 1A. Risk Factors.
Registration Rights Agreement
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We have entered into a registration rights agreement with the holders of warrants previously issued to certain lenders in December 2018, June 2020 and June 2023 (the "Registration Rights Agreement"). The Registration Rights Agreement grants certain registration rights for the shares of common stock issuable upon the exercise of the warrants, including (i) the ability of a holder to request that the Company file a Form S-1 registration statement with respect to at least 40% of the registrable securities held by such holder, (ii) the ability of a holder to request that the Company file a Form S-3 registration statement with respect to outstanding registrable securities if at any time the Company is eligible to use a Form S-3 registration statement, and (iii) customary piggyback registration rights, subject to certain customary limitations.
Cash Flows
The following table summarizes our consolidated cash flows for the periods indicated.
Year Ended March 31,
( in thousands) 2024 2023
Restated
Cash provided by (used in):
Operating activities $ (10,156) $ (4,894)
Investing activities (5,869) (15,601)
Financing activities 15,713 41,165
Effect of exchange rate changes (3) 12
Net change in cash, cash equivalents, and restricted cash $ (315) $ 20,682
Net Cash Used in Operating Activities
Net cash used in operating activities was $10.2 million for the year ended March 31, 2024, primarily attributable to lower revenue and timing of certain vendor payments.
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 Investing Activities
Net cash used in investing activities was $5.9 million for the year ended March 31, 2024, primarily attributable to the implementation costs of a new Enterprise Resource Planning system.
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 Provided by Financing Activities
Net cash provided by financing activities was $15.7 million for the year ended March 31, 2024 due primarily to borrowings under our Term Loan credit facility.
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.
Commitments and Contingencies
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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, 2024 (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)
$ 114,546 $ 114,546 $ — $ — $ —
Future lease commitments (2)
21,127 2,538 3,776 2,730 12,083
Purchase obligations (3)
32,400 32,400 — — —
Total $ 168,073 $ 149,484 $ 3,776 $ 2,730 $ 12,083
(1) Consists of principal on our Term Loan and PNC Credit Facility.
(2) Represents aggregate future minimum lease payments under non-cancelable operating leases.
(3) Includes primarily non-cancelable inventory purchase commitments.
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
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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 judgments 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 customer's 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 internal discounting practices, competitor pricing, competitor margins, performance obligations with similar customers and product groupings. Determining the observable inputs and applying them to our performance obligations requires significant judgment. We reassess standalone selling price determination periodically.
Product revenue may be impacted by a variety of price adjustments or other factors, including rebates, returns and stock rotation. We use the expected value method to estimate the net consideration expected to be returned by the customer. We use historical data and current trends to drive our estimates. We record a reduction to revenue to account for these items that may result in variable consideration. We initially measure a returned asset at the carrying amount of the inventory, less any expected costs to recover the goods including potential decreases in value of the returned goods.
Income Taxes
Deferred tax assets and liabilities are recognized based on temporary differences between the financial reporting and tax bases of assets and liabilities, measured at the enacted tax rates expected to apply to taxable income in the years in which those tax assets or liabilities are expected to be realized or settled. Based on the evaluation of available evidence, both positive and negative, we recognize future tax benefits, such as net operating loss carryforwards and tax credit carryforwards, to the extent that realizing these benefits is considered to be more likely than not.
A valuation allowance is provided if we believe it is more likely than not that all or some portion of the deferred tax asset will not be realized. An increase or decrease in the valuation allowance, if any, that results from a change in circumstances, and which causes a change in our judgment about the realizability of the related deferred tax asset, is included in the tax provision.
We recognize the financial statement effects of an uncertain income tax position when it is more likely than not, based on technical merits, that the position will be sustained upon examination. We reevaluate these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances and changes in tax law. We recognize penalties and tax-related interest expense as a component of income tax expense in our consolidated statements of operations. See Note 10: Income Taxes , to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Inventories
Manufacturing Inventories
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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 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.
Warrant Accounting
We account for warrants as either equity-classified or liability-classified instruments based on an assessment of the warrant’s specific terms and applicable authoritative guidance ASC 480, Distinguishing Liabilities from Equity (“Topic 480”) and ASC 815, Derivatives and Hedging (“Topic 815”) . The assessment considers whether the warrants are freestanding financial instruments pursuant to Topic 480, meet the definition of a liability pursuant to Topic 480, and whether the warrants meet all of the requirements for equity classification under Topic 815, including whether the warrants are indexed to the Company’s own shares of common stock and whether the warrant holders could potentially require “net cash settlement” in a circumstance outside of the Company’s control, among other conditions for equity classification. This assessment, which requires the use of professional judgment, is conducted at the time of warrant issuance and as of each subsequent quarterly period end date while the warrants are outstanding.
For issued or modified warrants that meet all of the criteria for equity classification, the warrants are required to be recorded as a component of additional paid-in capital at the time of issuance or modification. For issued or modified warrants that do not meet all the criteria for equity classification, the warrants are required to be recorded at their initial fair value on the date of issuance, and each balance sheet date thereafter. This liability is subject to re-measurement at each balance sheet date until exercised, and any change in fair value is recognized in the Company’s consolidated statement of operations.
Recently Issued and Adopted Accounting Pronouncements
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For recently issued and adopted accounting pronouncements, see Note 1: Description of Business and Significant Accounting Policies , to our consolidated financial statements.