QUANTUM CORP /DE/ - FORM 10-Q - November 7, 2014

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

––––––––––––––––
Form 10-Q
––––––––––––––––

x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
    
 
 
 
For the quarterly period ended September 30, 2014
 
OR
 
¨
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
 
 
For the transition period from _______ to _______
Commission File Number 1-13449
––––––––––––––––
QUANTUM CORPORATION
––––––––––––––––
Incorporated Pursuant to the Laws of the State of Delaware
IRS Employer Identification Number 94-2665054
224 Airport Parkway, Suite 300, San Jose, California 95110
(408) 944-4000
––––––––––––––––
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No ¨
Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No ¨
Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  ¨
Accelerated filer  x
Non-accelerated filer  ¨
Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨  No x
As of the close of business on October 31, 2014, there were 255,495,188 shares of Quantum Corporation’s common stock issued and outstanding.


QUANTUM CORPORATION
INDEX




PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS


QUANTUM CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
(Unaudited)
 
September 30, 2014
 
March 31, 2014
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
105,031

 
$
99,125

Restricted cash
2,685

 
2,760

Accounts receivable, net of allowance for doubtful accounts of $232 and $88, respectively
92,882

 
101,605

Manufacturing inventories
36,200

 
34,815

Service parts inventories
24,627

 
25,629

Other current assets
10,382

 
10,161

Total current assets
271,807

 
274,095

Long-term assets:
 
 
 
Property and equipment, less accumulated depreciation
16,261

 
17,574

Intangible assets, less accumulated amortization
1,051

 
3,911

Goodwill
55,613

 
55,613

Other long-term assets
9,451

 
10,605

Total long-term assets
82,376

 
87,703

       
$
354,183

 
$
361,798

Liabilities and Stockholders’ Deficit
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
42,157

 
$
41,792

Accrued warranty
5,290

 
6,116

Deferred revenue, current
88,088

 
98,098

Accrued restructuring charges, current
3,424

 
4,345

Accrued compensation
26,873

 
25,036

Other accrued liabilities
18,941

 
15,168

Total current liabilities
184,773

 
190,555

Long-term liabilities:
 
 
 
Deferred revenue, long-term
38,197

 
40,054

Accrued restructuring charges, long-term
3,577

 
4,023

Convertible subordinated debt
203,735

 
203,735

Other long-term liabilities
10,103

 
10,831

Total long-term liabilities
255,612

 
258,643

Stockholders' deficit:
 
 
 
Common stock, $0.01 par value; 1,000,000 shares authorized; 255,479 and 250,410
 
 
 
 shares issued and outstanding at September 30, 2014 and March 31, 2014, respectively
2,555

 
2,504

Capital in excess of par
448,579

 
443,547

Accumulated deficit
(543,147
)
 
(540,071
)
Accumulated other comprehensive income
5,811

 
6,620

Total stockholders’ deficit
(86,202
)
 
(87,400
)
 
$
354,183

 
$
361,798


See accompanying Notes to Condensed Consolidated Financial Statements.

1

QUANTUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
September 30, 2014
 
September 30, 2013
 
September 30, 2014
 
September 30, 2013
Product revenue
$
85,216

 
$
84,756

 
$
165,410

 
$
170,605

Service revenue
39,157

 
36,194

 
77,657

 
72,686

Royalty revenue
10,733

 
10,529

 
20,167

 
36,037

Total revenue
135,106


131,479


263,234


279,328

Cost of product revenue
55,593

 
57,882

 
110,501

 
116,665

Cost of service revenue
17,584

 
17,116

 
35,278

 
36,347

Restructuring charges related to cost of revenue
—

 
89

 
—

 
89

Total cost of revenue
73,177


75,087


145,779


153,101

Gross margin
61,929

 
56,392

 
117,455

 
126,227

Operating expenses:
 
 
 
 
 
 
 
Research and development
15,157

 
16,359

 
29,711

 
33,053

Sales and marketing
28,218

 
29,995

 
55,923

 
60,153

General and administrative
14,085

 
14,795

 
28,456

 
29,484

Restructuring charges
624

 
208

 
1,489

 
2,767

Total operating expenses
58,084

 
61,357

 
115,579

 
125,457

Gain on sale of assets
—

 
—

 
462

 
—

Income (loss) from operations
3,845

 
(4,965
)
 
2,338

 
770

Other income and expense
215

 
46

 
90

 
421

Interest expense
(2,456
)
 
(2,440
)
 
(4,900
)
 
(4,879
)
Income (loss) before income taxes
1,604

 
(7,359
)
 
(2,472
)
 
(3,688
)
Income tax provision
356

 
534

 
604

 
924

Net income (loss)
$
1,248

 
$
(7,893
)
 
$
(3,076
)
 
$
(4,612
)
 
 
 
 
 
 
 
 
Basic and diluted net income (loss) per share
$
0.00

 
$
(0.03
)
 
$
(0.01
)
 
$
(0.02
)
Weighted average shares:
 
 
 
 
 
 
 
Basic
254,760

 
247,074

 
252,724

 
246,569

Diluted
257,579

 
247,074

 
252,724

 
246,569


See accompanying Notes to Condensed Consolidated Financial Statements.

2

QUANTUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
September 30, 2014
 
September 30, 2013
 
September 30, 2014
 
September 30, 2013
Net income (loss)
$
1,248

 
$
(7,893
)
 
$
(3,076
)
 
$
(4,612
)
     Other comprehensive income (loss), net of taxes:
 
 
 
 
 
 
 
           Foreign currency translation adjustments
(1,101
)
 
464

 
(1,092
)
 
395

           Net unrealized gain (loss) on revaluation of
long-term intercompany balances
225

 
(98
)
 
283

 
(162
)
      Total other comprehensive income (loss)
(876
)
 
366

 
(809
)
 
233

                      Total comprehensive income (loss)
$
372

 
$
(7,527
)
 
$
(3,885
)
 
$
(4,379
)

See accompanying Notes to Condensed Consolidated Financial Statements.


3

QUANTUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Six Months Ended
 
September 30, 2014
 
September 30, 2013
Cash flows from operating activities:
 
 
 
Net loss
$
(3,076
)
 
$
(4,612
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation
4,272

 
5,671

Amortization of intangible assets
3,377

 
4,449

Amortization of debt issuance costs
829

 
816

Service parts lower of cost or market adjustment
2,007

 
6,659

Gain on sale of assets
(462
)
 
—

Deferred income taxes
(50
)
 
59

Share-based compensation
5,737

 
6,847

Other non-cash
(302
)
 
—

Changes in assets and liabilities, net of effect of acquisition:
 
 
 
Accounts receivable
8,723

 
10,520

Manufacturing inventories
(3,213
)
 
185

Service parts inventories
(687
)
 
1,688

Accounts payable
390

 
(14,245
)
Accrued warranty
(826
)
 
(1,031
)
Deferred revenue
(11,867
)
 
(6,449
)
Accrued restructuring charges
(1,393
)
 
359

Accrued compensation
2,151

 
(5,195
)
Other assets and liabilities
2,941

 
2,507

Net cash provided by operating activities
8,551

 
8,228

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(1,912
)
 
(3,226
)
Proceeds from sale of assets
462

 
—

Change in restricted cash
(69
)
 
(117
)
Purchases of other investments
—

 
(534
)
Return of principal from other investments
104

 
—

Payment for business acquisition, net of cash acquired
(517
)
 
—

Net cash used in investing activities
(1,932
)
 
(3,877
)
Cash flows from financing activities:
 
 
 
Payment of taxes due upon vesting of restricted stock
(2,187
)
 
(1,770
)
Proceeds from issuance of common stock
1,533

 
2,247

Net cash provided by (used in) financing activities
(654
)
 
477

Effect of exchange rate changes on cash and cash equivalents
(59
)
 
25

Net increase in cash and cash equivalents
5,906

 
4,853

Cash and cash equivalents at beginning of period
99,125

 
68,976

Cash and cash equivalents at end of period
$
105,031

 
$
73,829

Supplemental disclosure of cash flow information:
 
 
 
Purchases of property and equipment included in accounts payable
$
237

 
$
758

See accompanying Notes to Condensed Consolidated Financial Statements.

4

QUANTUM CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1: BASIS OF PRESENTATION
Quantum Corporation (“Quantum”, the “Company”, “us” or “we”), founded in 1980, is a leading expert in scale-out storage, archive and data protection, providing solutions for capturing, sharing and preserving digital assets over the entire data lifecycle. Our customers, ranging from small businesses to major enterprises, trust us to address their most demanding data workflow challenges. We provide solutions for storing and protecting information in physical, virtual and cloud environments that are designed to help customers Be Certain™ they have an end-to-end storage foundation to maximize the value of their data by making it accessible whenever and wherever needed, retaining it indefinitely and reducing total cost and complexity. We work closely with a broad network of distributors, value-added resellers (“VARs”), direct marketing resellers (“DMRs”), original equipment manufacturers (“OEMs”) and other suppliers to meet customers’ evolving needs. Our stock is traded on the New York Stock Exchange under the symbol QTM.
The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of Quantum and our wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated. The interim financial statements reflect all adjustments, consisting of normal recurring adjustments that, in the opinion of management, are necessary for a fair statement of the results for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year. The Condensed Consolidated Balance Sheet as of March 31, 2014 has been derived from the audited financial statements at that date, but it does not include all disclosures required by accounting principles generally accepted in the United States for complete financial statements. The accompanying financial statements should be read in conjunction with the audited Consolidated Financial Statements for the fiscal year ended March 31, 2014 included in our Annual Report on Form 10-K, as filed with the Securities and Exchange Commission on June 6, 2014.
Recently Adopted Accounting Pronouncements
In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (“ASU 2013-11”). ASU 2013-11 requires an entity to present an unrecognized tax benefit as a reduction of a deferred tax asset for a net operating loss (“NOL”) carryforward, or similar tax loss or tax credit carryforward, rather than as a liability when (1) the uncertain tax position would reduce the NOL or other carryforward under the tax law of the applicable jurisdiction and (2) the entity intends to use the deferred tax asset for that purpose. ASU 2013-11 does not require new recurring disclosures. ASU 2013-11 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. We adopted ASU 2013-11 prospectively in the first quarter of fiscal 2015. Adoption did not impact our statements of financial position or results of operations.
Recent Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 requires entities to recognize revenue through the application of a five-step model, which includes identification of the contract, identification of the performance obligations, determination of the transaction price, allocation of the transaction price to the performance obligations and recognition of revenue as the entity satisfies the performance obligations. ASU 2014-09 will become effective for us beginning April 1, 2017, or fiscal 2018. We are currently evaluating the guidance to determine the potential impact on our financial condition, results of operations, cash flows and financial statement disclosures.

In June 2014, the FASB issued ASU No. 2014-12, Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (“ASU 2014-12”). ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period is treated as a performance condition. ASU 2014-12 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015. We plan to adopt ASU 2014-12 prospectively in the first quarter of fiscal 2017 and do not anticipate adoption will impact our statements of financial position or results of operations.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements – Going Concern (Topic 205-40): Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 requires that management assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. ASU 2014-15 is effective for annual periods ending after December 15, 2016, and for annual periods and interim periods thereafter. We plan to adopt ASU 2014-15 as of the end of our fiscal year ending March 31, 2017 and do not anticipate adoption will impact our statements of financial position or results of operations.

5

NOTE 2: REVISION OF PRIOR PERIOD FINANCIAL STATEMENTS
During the fourth quarter of fiscal 2014, we identified an error related to certain allowances recorded for estimated future price adjustments with a cumulative $0.7 million overstatement of revenue and accounts receivable at April 1, 2013. Revenue for the second quarter and first six months of fiscal 2014 was understated by less than $0.1 million and overstated by $0.1 million, respectively, as a result of this error. We also identified an error related to straight-line rent expense that had accumulated since fiscal 2006, resulting in a $2.1 million cumulative overstatement of rent expense and total other accrued liabilities and other long-term liabilities at April 1, 2013. General and administrative expense was overstated by less than $0.1 million for both the second quarter and first six months of fiscal 2014.
In the fourth quarter of fiscal 2014, we evaluated these errors in accordance with the Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 99 and determined that the cumulative impact of the errors was not material to our results of operations, financial position or cash flows in our previously issued financial statements and therefore, amendments of previously filed reports are not required. However, if the entire correction of the errors had been recorded during the fourth quarter of fiscal 2014, the impact would have been significant to the Consolidated Statement of Operations for the quarter ended March 31, 2014. As a result, we revised our prior period financial statements in accordance with the SEC's Staff Accounting Bulletin No. 108.
We believe the revisions are not material to the Condensed Consolidated Statements of Operations, Condensed Consolidated Statements of Comprehensive Income (Loss) or Condensed Consolidated Statements of Cash Flows for the second quarter or first six months ended September 30, 2013.
NOTE 3: ACQUISITION
On July 29, 2014, we acquired a majority of the assets of Symform, Inc., a Washington corporation, for cash of approximately $0.5 million. The assets, consisting primarily of Symform technology, were recorded as purchased technology and are expected to enhance our cloud software capabilities and service offerings for data protection and scale-out storage. This acquisition was recorded as a business combination and the effect was not material to our financial position, results of operations or cash flows.

NOTE 4: FAIR VALUE
Our assets measured and recorded at fair value on a recurring basis consist of money market funds, which are included in cash and cash equivalents in our Condensed Consolidated Balance Sheets, and are valued using quoted market prices (level 1 fair value measurements) at the respective balance sheet dates (in thousands):
 
As of
 
September 30, 2014
 
March 31, 2014
Money market funds
$
74,703

 
$
93,077


We did not record impairments to any non-financial assets in the second quarter or first six months of fiscal 2015 or 2014. We do not have any non-financial liabilities measured and recorded at fair value on a non-recurring basis.
Our financial liabilities were comprised primarily of convertible subordinated debt at September 30, 2014 and March 31, 2014. The carrying value and fair value based on quoted market prices in less active markets (level 2 fair value measurement) were as follows (in thousands):
 
As of
 
September 30, 2014
 
March 31, 2014
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
Convertible subordinated debt
$
203,735

 
$
204,298

 
$
203,735

 
$
203,820






6


NOTE 5: INVENTORIES
Manufacturing inventories and service parts inventories consisted of the following (in thousands):
 
As of
 
September 30, 2014

March 31, 2014
Manufacturing inventories:
 
 
 
Finished goods
$
22,346

 
$
18,069

Work in process
88

 
1,056

Materials and purchased parts
13,766

 
15,690

 
$
36,200

 
$
34,815

 
As of
 
September 30, 2014
 
March 31, 2014
Service parts inventories:
 
 
 
Finished goods
$
16,761

 
$
17,926

Component parts
7,866

 
7,703

 
$
24,627

 
$
25,629


NOTE 6: INTANGIBLE ASSETS AND GOODWILL
We evaluate our amortizable and indefinite-lived intangible assets (“long-lived assets”) for impairment whenever indicators of impairment exist. We concluded the carrying amount of our long-lived assets was recoverable and there was no impairment in the second quarter or first six months of fiscal 2015 or 2014. The following provides a summary of the carrying value of intangible assets (in thousands):
 
As of
 
September 30, 2014
 
March 31, 2014
 
Gross
Amount
 
Accumulated
Amortization
 
Net
Amount
 
Gross
Amount
 
Accumulated
Amortization
 
Net
Amount
Purchased technology
$
179,992

 
$
(178,941
)
 
$
1,051

 
$
179,475

 
$
(178,348
)
 
$
1,127

Trademarks
3,900

 
(3,900
)
 
—

 
3,900

 
(3,900
)
 
—

Customer lists
76,019

 
(76,019
)
 
—

 
76,019

 
(73,235
)
 
2,784

 
$
259,911

 
$
(258,860
)
 
$
1,051

 
$
259,394

 
$
(255,483
)
 
$
3,911


We evaluate goodwill for impairment annually during the fourth quarter of our fiscal year, or more frequently when indicators of impairment are present. There were no changes to goodwill balances during the second quarter or first six months of fiscal 2015. The following table provides a summary of the goodwill balance at both September 30, 2014 and March 31, 2014 (in thousands):
 
Goodwill
 
Accumulated
Impairment Losses
 
Net Amount
Balance
$
394,613

 
$
(339,000
)
 
$
55,613







7


NOTE 7: ACCRUED WARRANTY
The quarterly changes in the accrued warranty balance were (in thousands):
 
Three Months Ended
 
Six Months Ended
 
September 30, 2014
 
September 30, 2013
 
September 30, 2014
 
September 30, 2013
Beginning balance
$
5,898

 
$
7,015

 
$
6,116

 
$
7,520

Additional warranties issued
1,519

 
1,787

 
3,247

 
3,929

Adjustments for warranties issued in prior
fiscal years
(243
)
 
(22
)
 
140

 
(82
)
Settlements
(1,884
)
 
(2,291
)
 
(4,213
)
 
(4,878
)
Ending balance
$
5,290

 
$
6,489

 
$
5,290

 
$
6,489


We warrant our products against certain defects for one to three years. A provision for estimated future costs and estimated returns for credit relating to warranty is recorded when products are shipped and revenue recognized. Our estimate of future costs to satisfy warranty obligations is primarily based on historical trends and, if believed to be significantly different from historical trends, estimates of future failure rates and future costs of repair. Future costs of repair include materials consumed in the repair, labor and overhead amounts necessary to perform the repair. If we determine in a future period, that either actual failure rates or actual costs of repair were to differ from our estimates, we record the impact of those differences in that future period.
NOTE 8: LONG-TERM DEBT
On April 24, 2014, our credit agreement with Wells Fargo (as amended, the “WF credit agreement”) was amended to allow us to use proceeds from the credit agreement to repay our convertible subordinated notes so long as we have a fixed charge coverage ratio of 1.5 and liquidity of $25 million. The amendment also impacted the available line, maturity date and certain covenants and compliance obligations, which are reflected below.
Under the WF credit agreement, we have the ability to borrow the lesser of $75 million or the amount of the monthly borrowing base under a senior secured revolving credit facility. The WF credit agreement matures March 29, 2017 so long as an amount sufficient to repay the $133.7 million of 3.50% convertible subordinated notes due November 15, 2015 is available for borrowing under the WF credit agreement or is deposited in an escrow account prior to August 16, 2015. Otherwise, the WF credit agreement matures on August 16, 2015. Quarterly, we are required to pay a 0.375% commitment fee on undrawn amounts under the revolving credit facility.
The WF credit agreement contains customary covenants, including cross-default provisions, as well as financial covenants. Average liquidity must exceed $15.0 million each month. The fixed charge coverage ratio is required to be greater than 1.2 for the 12 month period ending on the last day of any month in which the covenant is applicable. This covenant is applicable only in months in which borrowings exceed $5.0 million at any time during the month. To avoid triggering mandatory field audits and Wells Fargo controlling our cash receipts, we must maintain liquidity of at least $20.0 million at all times. The fixed charge coverage ratio, average liquidity and liquidity are defined in the WF credit agreement and/or amendments. Certain schedules in the compliance certificate must be filed monthly if borrowings exceed $5.0 million; otherwise they are to be filed quarterly.
We have letters of credit totaling $1.0 million, reducing the maximum amount available to borrow by this amount at September 30, 2014. As of September 30, 2014, and during the second quarter and first six months of fiscal 2015, we were in compliance with all covenants and had no outstanding balance on the line of credit.






8

NOTE 9: RESTRUCTURING CHARGES
The types of restructuring expense for the three and six months ended September 30, 2014 and September 30, 2013 were (in thousands):
 
Three Months Ended
 
Six Months Ended
 
September 30, 2014
 
September 30, 2013
 
September 30, 2014
 
September 30, 2013
Severance and benefits
$
(20
)
 
$
108

 
$
105

 
$
2,591

Facilities
647

 
12

 
1,374

 
88

Other
(3
)
 
177

 
10

 
177

Total
$
624

 
$
297

 
$
1,489

 
$
2,856


In the second quarter and first six months of fiscal 2015, restructuring charges were primarily due to facilities costs as a result of further consolidating our facilities in the U.S. The restructuring charges in the second quarter and first six months of fiscal 2014 were primarily the result of efforts to consolidate manufacturing and service activities with contract manufacturers that were initiated the first quarter of fiscal 2014.
Accrued Restructuring
The following tables show the activity and the estimated timing of future payouts for accrued restructuring (in thousands):
 
Three Months Ended September 30, 2014
 
Severance
and Benefits
 
Facilities
 
Other
 
Total
Balance as of June 30, 2014
$
498

 
$
6,915

 
$
53

 
$
7,466

Restructuring costs
53

 
647

 
—

 
700

Restructuring charge reversal
(73
)
 
—

 
(3
)
 
(76
)
Cash payments
(230
)
 
(852
)
 
(50
)
 
(1,132
)
Other non-cash
—

 
43

 
—

 
43

Balance as of September 30, 2014
$
248

 
$
6,753

 
$
—

 
$
7,001

 
Six Months Ended September 30, 2014
 
Severance
and Benefits
 
Facilities
 
Other
 
Total
Balance as of March 31, 2014
$
1,574

 
$
6,724

 
$
70

 
$
8,368

Restructuring costs
319

 
1,374

 
13

 
1,706

Restructuring charge reversal
(214
)
 
—

 
(3
)
 
(217
)
Cash payments
(1,431
)
 
(1,647
)
 
(80
)
 
(3,158
)
Other non-cash
—

 
302

 
—

 
302

Balance as of September 30, 2014
$
248

 
$
6,753

 
$
—

 
$
7,001

 
As of September 30, 2014
 
Severance and
Benefits
 
Facilities
 
Total
Estimated timing of future payouts:
 
 
 
 
 
Next twelve months
$
99

 
$
3,325

 
$
3,424

October 2015 through February 2021
149

 
3,428

 
3,577

 
$
248

 
$
6,753

 
$
7,001


We anticipate $0.1 million of severance and benefits will be paid by the end of fiscal 2015 and the remaining $0.1 million of severance and benefits will be paid by the end of fiscal 2016. Facility restructuring accruals will be paid in accordance with the respective facility lease terms.


9

NOTE 10: STOCK INCENTIVE PLANS AND SHARE-BASED COMPENSATION
Share-Based Compensation
The following table summarizes share-based compensation (in thousands):
 
Three Months Ended
 
Six Months Ended
 
September 30, 2014
 
September 30, 2013
 
September 30, 2014
 
September 30, 2013
Share-based compensation:
 
 
 
 
 
 
 
Cost of revenue
$
333

 
$
523

 
$
747

 
$
1,051

Research and development
603

 
908

 
1,383

 
1,776

Sales and marketing
887

 
1,080

 
1,797

 
2,154

General and administrative
846

 
980

 
1,810

 
1,866

 
$
2,669

 
$
3,491

 
$
5,737

 
$
6,847

Share-based compensation by type of award:
 
 
 
 
 
 
 
Stock options
$
154

 
$
208

 
$
311

 
$
440

Restricted stock
2,315

 
2,968

 
5,013

 
5,706

Stock purchase plan
200

 
315

 
413

 
701

 
$
2,669

 
$
3,491

 
$
5,737

 
$
6,847

Stock Incentive Plans - Grants and Fair Value
Stock Options
No stock options were granted during the second quarter or first six months of fiscal 2015 or 2014. The Black-Scholes option pricing model is used to estimate the fair value of stock options.
Restricted Stock
The fair value of restricted stock units (“RSUs”) granted is the intrinsic value as of the respective grant date since the RSUs are granted at no cost to the employee. The weighted-average grant date fair value of RSUs granted during the second quarter and first six months of fiscal 2015 was $1.25. The weighted-average grant date fair values of RSUs granted during the second quarter and first six months of fiscal 2014 were $1.41 and $1.40, respectively.

During the second quarter of fiscal 2015, we granted 2.3 million RSUs with performance conditions (“performance RSUs”), and the total fair value of these RSUs at the grant date was $2.9 million. Performance RSUs will become eligible for vesting based on Quantum achieving certain revenue and operating income targets through the end of fiscal 2015. Share-based compensation expense for performance RSUs is recognized when it is probable that the performance conditions will be achieved. As of September 30, 2014, the amount of share-based compensation expense recognized for the performance RSUs was immaterial.
Stock Purchase Plan
Under the Stock Purchase Plan, rights to purchase shares are typically granted during the second and fourth quarter of each fiscal year. The value of rights to purchase shares granted in the second quarter and first six months of fiscal 2015 and fiscal 2014, respectively, was estimated at the date of the grant using the Black-Scholes option pricing model. The weighted-average grant date fair values and the assumptions used in calculating fair values for the three and six month periods ended September 30, 2014 and 2013 were as follows:
 
Three and Six Months Ended
 
September 30, 2014
 
September 30, 2013
Option life (in years)
0.5

 
0.5

Risk-free interest rate
0.06
%
 
0.07
%
Stock price volatility
32.19
%
 
47.65
%
Weighted-average grant date fair value
$
0.30

 
$
0.47


10

Stock Incentive Plans - Activity
Stock Options
A summary of activity relating to our stock options follows (options and aggregate intrinsic value in thousands):

Options
 
Weighted-
Average
Exercise Price
 
Weighted-
Average
Remaining
Contractual Term
 
Aggregate
Intrinsic Value
Outstanding as of March 31, 2014
7,997

 
$
1.78

 
 
 
 
Exercised
(155
)
 
0.86

 
 
 
 
Forfeited
(99
)
 
2.13

 
 
 
 
Expired
(1,761
)
 
2.69

 
 
 
 
Outstanding as of September 30, 2014
5,982

 
$
1.52

 
2.07
 
$
704

Vested and expected to vest at September 30, 2014
5,977

 
$
1.52

 
2.06
 
$
704

Exercisable as of September 30, 2014
5,792

 
$
1.49

 
2.02
 
$
704


Restricted Stock
A summary of activity relating to our restricted stock follows (shares in thousands):
 
Shares
 
Weighted-Average
Grant Date
Fair Value
Nonvested at March 31, 2014
12,108

 
$
1.80

Granted
9,519

 
1.25

Vested
(5,284
)
 
2.21

Forfeited
(462
)
 
1.52

Nonvested at September 30, 2014
15,881

 
$
1.34


NOTE 11: INCOME TAXES
Income tax provisions for the second quarter and first six months of fiscal 2015 were $0.4 million and $0.6 million, respectively, and were $0.5 million and $0.9 million for the second quarter and first six months of fiscal 2014, respectively. Income tax provisions for each of these periods reflect expenses for foreign income taxes and state taxes. We have provided a full valuation allowance against our U.S. net deferred tax assets due to our history of net losses, difficulty in predicting future results and our conclusion that we cannot rely on projections of future taxable income to realize the deferred tax assets. Significant management judgment is required in determining our deferred tax assets and liabilities and valuation allowances for purposes of 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 a reversal or decrease in this allowance. Future income tax expense will be reduced to the extent that we have sufficient positive evidence to support a reversal of, or decrease in, our valuation allowance.








11

NOTE 12: NET INCOME (LOSS) PER SHARE
The following is the computation of basic and diluted net income (loss) per share (in thousands, except per share data):
 
Three Months Ended
 
Six Months Ended
 
September 30, 2014
 
September 30, 2013
 
September 30, 2014
 
September 30, 2013
Net income (loss)
$
1,248

 
$
(7,893
)
 
$
(3,076
)
 
$
(4,612
)
Divided by
 
 
 
 
 
 
 
Weighted average shares:
 
 
 
 
 
 
 
Basic
254,760

 
247,074

 
252,724

 
246,569

Dilutive shares from stock plans
2,819

 
—

 
—

 
—

Diluted
257,579

 
247,074

 
252,724

 
246,569

Basic and diluted net income (loss) per share
$
0.00

 
$
(0.03
)
 
$
(0.01
)
 
$
(0.02
)

The computations of diluted net income (loss) per share for the periods presented exclude the following because the effect would have been anti-dilutive:
•
For all periods presented, 42.5 million weighted average shares related to our 4.50% convertible subordinated notes were excluded. At September 30, 2014 and 2013, 30.9 million and 31.2 million, respectively, weighted average shares of 3.50% convertible subordinated notes were excluded.
•
For the second quarter and first six months of fiscal 2015, options to purchase 2.3 million and 7.0 million weighted average shares, respectively, were excluded. For the second quarter and first six months of fiscal 2014, options to purchase 13.9 million and 14.9 million weighted average shares, respectively, were excluded.
•
Unvested RSUs of 0.2 million and 12.0 million weighted average shares for the second quarter and first six months of fiscal 2015, respectively, were excluded. Unvested RSUs of 10.9 million and 10.4 million weighted average shares for the second quarter and first six months of fiscal 2014, respectively, were excluded.
NOTE 13: LEGAL PROCEEDINGS
On February 18, 2014, Crossroads Systems, Inc. (“Crossroads”) filed a patent infringement lawsuit against Quantum in the U.S. District Court for the Western District of Texas, alleging infringement of U.S. Patents 6,425,035 and 7,934,041. An amended complaint filed on April 15, 2014 also alleged infringement of U.S. patent 7,051,147. Crossroads asserts that we have incorporated Crossroads' patented technology into our StorNext QX and Q-Series lines of disk array products, and into our Scalar libraries. Crossroads seeks unspecified monetary damages and injunctive relief. Crossroads has already dismissed all claims of infringement with respect to the StorNext QX and Q-Series products. We do not believe it is reasonably possible that we will pay material damages related to this lawsuit.
On September 23, 2014, we filed a lawsuit against Crossroads in the U.S. District Court for the Northern District of California alleging patent infringement of our patent 6,766,412 by Crossroad’s StrongBox VSeries Library Solution product. We are seeking injunctive relief and the recovery of monetary damages.

12

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENT
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements in this report usually contain the words “will,” “estimate,” “anticipate,” “expect,” “believe,” “project” or similar expressions and variations or negatives of these words. All such forward-looking statements including, but not limited to: (1) our goals for future operating performance including increasing revenue, having operating profit and generating cash from operations; (2) our expectation that we will continue to derive a substantial portion of our revenue from products based on tape technology; (3) our belief that our existing cash and capital resources will be sufficient to meet all currently planned expenditures, debt service and sustain our operations for at least the next 12 months; (4) our expectations regarding our ongoing efforts to control our cost structure; (5) our expectations regarding the outcome of any litigation in which we are involved and (6) our business goals, objectives, key focuses, opportunities and prospects are inherently uncertain as they are based on management’s expectations and assumptions concerning future events, and they are subject to numerous known and unknown risks and uncertainties. Readers are cautioned not to place undue reliance on these forward-looking statements, about which we speak only as of the date hereof. As a result, our actual results may differ materially from the forward-looking statements contained herein. Factors that could cause actual results to differ materially from those described herein include, but are not limited to: (1) the amount of orders received in future periods; (2) our ability to timely ship our products; (3) uncertainty regarding information technology spending and the corresponding uncertainty in the demand for our products and services; (4) our ability to maintain supplier relationships; (5) general economic, political and fiscal conditions in the U.S. and internationally; (6) our ability to successfully introduce new products; (7) our ability to capitalize on market demand; (8) our ability to achieve anticipated gross margin levels and (9) those factors discussed under “Risk Factors” in Part II, Item 1A. Our forward-looking statements are not guarantees of future performance. We disclaim any obligation to update information in any forward-looking statement.
OVERVIEW
We believe our combination of expertise, innovation and platform independence enables us to solve data protection and scale-out storage challenges more easily, cost-effectively and securely than competitive offerings. We earn our revenue from the sale of products, systems and services through an array of channel partners and our sales force. Our products are sold under both the Quantum brand name and the names of various OEM customers. Our scale-out storage solutions include StorNext® software, StorNext appliances, StorNext Pro™ Solutions and Lattus™ extended online storage systems and are designed to help customers manage large unstructured data sets in an information workflow, encompassing high-performance ingest, real-time collaboration, scalable processing, intelligent protection and high-value monetization. Our data protection solutions include DXi® deduplication backup systems and Scalar® automated tape libraries that optimize backup and recovery, simplify management and lower cost. Our vmPRO™ virtual server backup and disaster recovery offerings protect virtual environments while minimizing the impact on servers and storage. In addition, we also offer software for cloud backup and disaster recovery of physical and virtual servers. We have a full range of services and the global scale and scope to support our worldwide customer base.
Our goal for fiscal 2015 is to profitably grow total revenue in our core business to improve operating results and shareholder value. We have undertaken several initiatives to achieve this goal, which include leveraging our market position in tape automation; penetrating growing markets where we are well positioned from a technology and go-to-market perspective with our DXi, StorNext and Lattus product lines; leveraging our large customer install base across our product portfolio to achieve efficiency and scale; focusing on vertical markets where we are strong; expanding our product portfolio; and continuing to pursue go-to-market partnerships that would drive incremental revenue and profit.

13

During the first half of fiscal 2015, our focus on providing an increasingly broad range of scale-out storage solutions and expanding our footprint in the vertical market of media and entertainment helped us achieve record quarterly revenue for scale-out storage products and services. We have created specific product combinations in our StorNext Pro Solutions as well as dedicated sales and marketing resources for this vertical market. We also believe there is opportunity for growth in other vertical markets and use cases where customers can benefit from our workflow-optimized solutions, including oil and gas, government intelligence, corporate video and cybersecurity. In addition, we leveraged our install base of data center customers to sell scale-out storage solutions to manage growing media files and large content workflows for these customers. We also introduced the DXi6900, which incorporates StorNext 5 technology and is optimized for modern data protection workflows. We are pursuing strategic partnerships and have announced new joint solutions with a partner targeted for sporting event media and entertainment customers and with a strategic partner that enables customers to more easily investigate and combat cyber-attacks. In addition, in October we announced a joint solution with a partner that is designed to optimize workflows for the oil and gas industry. We believe these strategic partnership joint solutions for specific use cases can contribute incremental revenue in fiscal 2015.
In July we acquired Symform, Inc.'s cloud storage services platform and development team, gaining technology and expertise we plan to leverage in future scale-out storage and data protection offerings.
We believe our current cash, balance sheet resources and line of credit availability are sufficient to pay off the $133.7 million of 3.50% convertible subordinated notes due November 15, 2015, operate the business and fund additional growth opportunities.
Results
We had total revenue of $135.1 million in the second quarter of fiscal 2015, a $3.6 million increase from the second quarter of fiscal 2014, primarily due to increases in scale-out storage solutions and service revenue, partially offset by decreased revenue from tape automation systems and media. Product and service revenue increased despite a decrease in sales to the U.S. federal government, which were lower than expected. Our branded product and service revenue increased 7% from the second quarter of fiscal 2014 due to increased scale-out storage solutions revenue offset by decreased tape automation and media revenue. Revenue from branded scale-out storage solutions increased compared to the prior year in all geographies - APAC, EMEA and North America. Our continued focus on our branded business is reflected in a greater proportion of non-royalty revenue from branded business, at 86% in the second quarter of fiscal 2015, compared to 83% in the second quarter of fiscal 2014.
Our gross margin percentage increased 290 basis points from the second quarter of fiscal 2014 to 45.8% as a result of higher revenue and the improvements we have made in our business model over the past year, including moving to an outsourced manufacturing model.
Operating expenses decreased $3.3 million, or 5% from the second quarter of fiscal 2014, primarily from cost controls and spending reductions implemented over the past year. The largest spending decrease compared to the second quarter of fiscal 2014 was for compensation and benefits as a result of reduced staffing to right-size our workforce. Intangible amortization expense also decreased significantly due to certain intangibles becoming fully amortized during the second quarter of fiscal 2015.
Our operating results improved $8.8 million, from a $5.0 million loss from operations in the second quarter of fiscal 2014 to $3.8 million of income from operations in the second quarter of fiscal 2015. We generated $8.6 million in cash from operations during the first six months of fiscal 2015 compared to $8.2 million in the first six months of fiscal 2014. We ended the quarter with $107.7 million in cash, cash equivalents and restricted cash, the highest quarter-end balance in over four years.

14

RESULTS OF OPERATIONS
Revenue
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2014
 
% of
revenue
 
September 30, 2013
 
% of
revenue
 
Change
 
% Change
Product revenue
$
85,216

 
63.1
%
 
$
84,756

 
64.5
%
 
$
460

 
0.5
 %
Service revenue
39,157

 
29.0
%
 
36,194

 
27.5
%
 
2,963

 
8.2
 %
Royalty revenue
10,733

 
7.9
%
 
10,529

 
8.0
%
 
204

 
1.9
 %
Total revenue
$
135,106

 
100.0
%
 
$
131,479

 
100.0
%
 
$
3,627

 
2.8
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended
 
 
 
 
(Dollars in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2014
 
% of
revenue
 
September 30, 2013
 
% of
revenue
 
Change
 
% Change
Product revenue
$
165,410

 
62.8
%
 
$
170,605

 
61.1
%
 
$
(5,195
)
 
(3.0
)%
Service revenue
77,657

 
29.5
%
 
72,686

 
26.0
%
 
4,971

 
6.8
 %
Royalty revenue
20,167

 
7.7
%
 
36,037

 
12.9
%
 
(15,870
)
 
(44.0
)%
Total revenue
$
263,234

 
100.0
%
 
$
279,328

 
100.0
%
 
$
(16,094
)
 
(5.8
)%

Total revenue increased from the second quarter of fiscal 2014 primarily due to increases in scale-out storage solutions and service revenue, partially offset by decreased revenue from media and OEM tape automation systems. Total revenue decreased from the first six months of fiscal 2014 primarily due to a decline in royalty and tape automation systems revenue, partially offset by an increase in sales of scale-out storage solutions. The decrease in royalty revenue was primarily due to a $15.0 million royalty received in connection with an intellectual property agreement in the prior year.
We believe the changes in our product and service revenue are driven by the changing storage environment, including increased market demand for scale-out storage solutions and reduced demand for tape products. Revenue from branded data protection products and services decreased $2.9 million, or 3%, from the second quarter of fiscal 2014 and $7.4 million, or 4%, from the first six months of fiscal 2014, largely due to decreases in media and tape automation systems revenue. Data protection products include our tape automation systems, disk backup systems and devices and media offerings. Revenue from branded scale-out storage solutions and services increased $9.5 million, or 59%, from the second quarter of fiscal 2014 and $14.6 million, or 51%, from the first six months of fiscal 2014 largely due to increased sales of our StorNext appliances. Scale-out storage solutions include StorNext software, StorNext appliances, StorNext Pro Solutions and Lattus extended online storage solutions. In addition, OEM product and service revenue, which primarily comprises tape automation systems, decreased $3.2 million and $7.4 million from the second quarter and first six months of fiscal 2014, respectively.
Product Revenue
Total product revenue, which includes sales of our hardware and software products sold through both our Quantum branded and OEM channels, increased $0.5 million in the second quarter of fiscal 2015 and decreased $5.2 million in the first six months of fiscal 2015 compared to the prior year periods. The increase in product revenue for the second quarter of fiscal 2015 was primarily due to increased sales of both scale-out storage solutions and disk backup systems, partially offset by decreases in revenue from media and OEM tape automation systems. The decrease in product revenue for the first six months of fiscal 2015 was primarily due to lower tape automation systems and media sales, partially offset by an increase in revenue from scale-out storage solutions. Revenue from sales of branded products increased 6% and 2%, respectively, and sales of products to our OEM customers decreased 18% and 20%, respectively, in the second quarter and first six months of fiscal 2015 compared to the prior year periods.

15

 
Three Months Ended
 
 
 
 
(Dollars in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2014
 
% of revenue
 
September 30, 2013
 
% of revenue
 
Change
 
% Change
Tape automation systems
$
37,857

 
28.0
%
 
$
41,570

 
31.6
%
 
$
(3,713
)
 
(8.9
)%
Disk backup systems*
12,860

 
9.5
%
 
11,734

 
8.9
%
 
1,126

 
9.6
 %
Devices and media
12,993

 
9.6
%
 
16,762

 
12.7
%
 
(3,769
)
 
(22.5
)%
Scale-out storage solutions*
21,506

 
16.0
%
 
14,690

 
11.3
%
 
6,816

 
46.4
 %
Total product revenue
$
85,216

 
63.1
%
 
$
84,756

 
64.5
%
 
$
460

 
0.5
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended
 
 
 
 
(Dollars in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2014
 
% of revenue
 
September 30, 2013
 
% of revenue
 
Change
 
% Change
Tape automation systems
$
75,763

 
28.8
%
 
$
86,235

 
30.9
%
 
$
(10,472
)
 
(12.1
)%
Disk backup systems*
22,671

 
8.6
%
 
23,230

 
8.3
%
 
(559
)
 
(2.4
)%
Devices and media
30,718

 
11.7
%
 
34,741

 
12.4
%
 
(4,023
)
 
(11.6
)%
Scale-out storage solutions*
36,258

 
13.7
%
 
26,399

 
9.5
%
 
9,859

 
37.3
 %
Total product revenue
$
165,410

 
62.8
%
 
$
170,605

 
61.1
%
 
$
(5,195
)
 
(3.0
)%

*Revenue from disk backup systems and scale-out storage solutions was previously included in a caption entitled disk backup systems and software solutions. Previously reported amounts have been reclassified to conform to current period presentation.

Our branded tape automation business performed better in the second quarter and first six months of fiscal 2015 than our OEM tape automation systems business. Branded tape automation revenue declined 3%, or $0.7 million, and 6%, or $3.2 million, respectively, compared to OEM tape automation revenue decreases of 17%, or $3.0 million, and 21%, or $7.3 million, respectively, in the second quarter and first six months of fiscal 2015 compared to the prior year periods. The OEM decreases during both the second quarter and first six months of fiscal 2015 were primarily due to a decline in revenue from enterprise and midrange systems, with both product categories experiencing similar decreases during the second quarter of fiscal 2015 and midrange systems declining approximately twice as much as enterprise systems during the first six months of fiscal 2015. Within our branded tape automation business, the decline in the second quarter of fiscal 2015 was primarily due to a decrease in sales of enterprise systems, and the decline in the first six months of fiscal 2015 was primarily due to a decrease in sales of midrange systems.
The increase in disk backup systems revenue during the second quarter of fiscal 2015 was primarily attributed to our branded business, with a $1.8 million increase in revenue from entry-level systems and a $0.9 million increase in revenue from midrange systems, including the recently-introduced DXi 6900, partially offset by a $1.3 million decrease in enterprise systems revenue. The DXi 6900 scales to higher storage capacities than previous midrange systems, which contributed to the decrease in enterprise systems revenue. The decrease in disk backup systems revenue during the first six months of fiscal 2015 was primarily due to a 16% decrease in midrange systems revenue, offset by increased sales of entry-level systems, which more than doubled compared to the prior year, driven by the introduction of the DXi 4700. During both the second quarter and first six months of fiscal 2015, we experienced an increase in large disk backup systems orders over $200,000.
Product revenue from devices, which includes tape drives and removable hard drives, and non-royalty media sales decreased during the second quarter and first six months of fiscal 2015 primarily due to lower media sales.
Our scale-out storage solutions revenue increased during both the second quarter and first six months of fiscal 2015 primarily due to increased sales of StorNext appliances. During these two periods, revenue from Lattus extended online storage and StorNext Pro Solutions products also increased, partially offset by decreases in StorNext standalone software revenue. During both the second quarter and first six months of fiscal 2015, we experienced an increase in large scale-out storage solutions orders over $200,000.
Service Revenue
Service revenue is primarily comprised of hardware service contracts, which are typically purchased by our customers to extend the warranty or to provide faster service response time, or both. Service revenue increased from the second quarter and first six months of fiscal 2014 primarily due to increased revenue from branded service contracts for our StorNext appliances.

16

Royalty Revenue
Royalty revenue was relatively flat compared to the second quarter of fiscal 2014. It decreased from the first six months of fiscal 2014 primarily due to the $15.0 million royalty received in connection with an intellectual property agreement in the prior year.
Gross Margin
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
September 30, 2014
 
Gross
margin %
 
September 30, 2013
 
Gross
margin %
 
Change
 
Basis
point
change
Product gross margin
$
29,623

 
34.8
%
 
$
26,874

 
31.7
%
 
$
2,749

 
310

Service gross margin
21,573

 
55.1
%
 
19,078

 
52.7
%
 
2,495

 
240

Royalty gross margin
10,733

 
100.0
%
 
10,529

 
100.0
%
 
204

 
—

Gross margin
$
61,929

 
45.8
%
 
$
56,392

*
42.9
%
*
$
5,537

 
290

 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended
 
 
 
 
(Dollars in thousands)
September 30, 2014
 
Gross
margin %
 
September 30, 2013
 
Gross
margin %
 
Change
 
Basis
point
change
Product gross margin
$
54,909

 
33.2
%
 
$
53,940

 
31.6
%
 
$
969

 
160

Service gross margin
42,379

 
54.6
%
 
36,339

 
50.0
%
 
6,040

 
460

Royalty gross margin
20,167

 
100.0
%
 
36,037

 
100.0
%
 
(15,870
)
 
—

Gross margin
$
117,455

 
44.6
%
 
$
126,227

*
45.2
%
*
$
(8,772
)
 
(60
)

* The second quarter and first six months of fiscal 2014 includes $0.1 million of restructuring charges related to cost of revenue.

The increase in gross margin percentage for the second quarter of fiscal 2015 was primarily due to increases in both product and service gross margin rates. The decrease in gross margin percentage for the first six months of fiscal 2015 was primarily due to the decrease in royalty revenue attributable to the $15.0 million royalty received in connection with an intellectual property agreement in the prior year. Partially offsetting this decrease were increases in both product and service gross margin rates.
Product Margin
Product gross margins increased 310 and 160 basis points, respectively, during the second quarter and first six months of fiscal 2015, despite relatively flat product revenue during the second quarter of fiscal 2015 and $5.2 million less product revenue during the first six months of fiscal 2015 compared to the prior year periods. These increases in product gross margin rates were primarily due to shifting to an outsourced manufacturing model during the second half of fiscal 2014. Outsourcing our manufacturing has created a more variable cost model, reducing costs during the first half of fiscal 2015 that were relatively fixed during the first half of fiscal 2014 when we manufactured the majority of our products in our facilities. Notable cost decreases from the second quarter and first six months of fiscal 2014 as a result of implementing outsourced manufacturing include compensation and benefits and facility expenses.
Service Margin
Service gross margin dollars increased 13% and 240 basis points compared to the second quarter of fiscal 2014 on an 8% increase in service revenue. For the first six months of fiscal 2015, service gross margin dollars increased 17% and 460 basis points on a 7% increase in service revenue. The increases in service gross margin rates were primarily due to reduced costs as a result of continued improvements to our service delivery model, including outsourcing geographies with lower service and repair volumes and improving utilization of our service team and service parts inventories. In addition, our service activities continue to reflect a larger proportion of branded products under contract, which have relatively higher margins than margins for OEM repair services.

17

Royalty Margin
Royalties typically do not have related cost of sales and have a 100% gross margin percentage. Therefore, royalty gross margin dollars vary directly with royalty revenue. Royalty revenue and gross margin dollars were relatively flat in the second quarter of fiscal 2015. The decrease in royalty gross margin dollars in the first six months of fiscal 2015 was primarily due to the non-recurring $15.0 million royalty received in the first quarter of fiscal 2014.
Research and Development Expenses
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
September 30, 2014
 
% of
revenue
 
September 30, 2013
 
% of
revenue
 
Change
 
%
Change
Research and development
$
15,157

 
11.2
%
 
$
16,359

 
12.4
%
 
$
(1,202
)
 
(7.3
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended
 
 
 
 
(Dollars in thousands)
September 30, 2014
 
% of
revenue
 
September 30, 2013
 
% of
revenue
 
Change
 
%
Change
Research and development
$
29,711

 
11.3
%
 
$
33,053

 
11.8
%
 
$
(3,342
)
 
(10.1
)%
The decrease in research and development expense in the second quarter and first six months of fiscal 2015 compared to the second quarter and first six months of fiscal 2014 was primarily due to cost reductions that resulted in a $1.2 million and $3.1 million decrease, respectively, in compensation and benefits from lower staffing levels.
Sales and Marketing Expenses
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
September 30, 2014
 
% of
revenue
 
September 30, 2013
 
% of
revenue
 
Change
 
%
Change
Sales and marketing
$
28,218

 
20.9
%
 
$
29,995

 
22.8
%
 
$
(1,777
)
 
(5.9
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended
 
 
 
 
(Dollars in thousands)
September 30, 2014
 
% of
revenue
 
September 30, 2013
 
% of
revenue
 
Change
 
%
Change
Sales and marketing
$
55,923

 
21.2
%
 
$
60,153

 
21.5
%
 
$
(4,230
)
 
(7.0
)%
The decrease in sales and marketing expense in the second quarter and first six months of fiscal 2015 compared to the second quarter and first six months of fiscal 2014 was primarily due to a $0.7 million and $2.6 million, respectively, decrease in compensation and benefits from decreased staffing levels and a $0.9 million decrease in both periods in intangible amortization expense due to certain intangibles becoming fully amortized during fiscal 2015. Additionally, spending reductions in the second quarter and first six months of fiscal 2015 compared to the second quarter and first six months of fiscal 2014 resulted in a $0.5 million and $1.2 million, respectively, decrease in marketing and advertising expense and a $0.4 million and $0.5 million, respectively, decrease in travel expense. These decreases in the second quarter and first six months of fiscal 2015 compared to the second quarter and first six months of fiscal 2014 were offset by a $1.0 million and $1.4 million, respectively, increase in commission expense as we achieved growth in branded revenue.
General and Administrative Expenses
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
September 30, 2014
 
% of
revenue
 
September 30, 2013
 
% of
revenue
 
Change
 
%
Change
General and administrative
$
14,085

 
10.4
%
 
$
14,795

 
11.3
%
 
$
(710
)
 
(4.8
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended
 
 
 
 
(Dollars in thousands)
September 30, 2014
 
% of
revenue
 
September 30, 2013
 
% of
revenue
 
Change
 
%
Change
General and administrative
$
28,456

 
10.8
%
 
$
29,484

 
10.6
%
 
$
(1,028
)
 
(3.5
)%


18

The decrease in general and administrative expense for the second quarter and first six months of fiscal 2015 compared to the second quarter and first six months of fiscal 2014 was primarily due to a $0.7 million refund received for IT purchases. Additionally, we had a $0.5 million and $1.2 million, respectively, decrease in facility-related expenses largely from vacating portions of various facilities in the second quarter and first six months of fiscal 2015. These decreases were partially offset by $0.7 million and $0.8 million of costs related to activities and inquiries of Starboard Value LP incurred during the second quarter and first six months of fiscal 2015, respectively. For further information regarding Starboard Value LP, refer to Item 1A. "Risk Factors."
Restructuring Charges
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
September 30, 2014
 
% of
revenue
 
September 30, 2013
 
% of
revenue
 
Change
 
%
Change
Restructuring charges related to cost of revenue
$
—

 
—
%
 
$
89

 
0.1
%
 
$
(89
)
 
(100.0
)%
Restructuring charges in operating expenses
624

 
0.5
%
 
208

 
0.2
%
 
416

 
200.0
 %
 
$
624

 
0.5
%
 
$
297

 
0.2
%
 
$
327

 
110.1
 %
 
Six Months Ended
 
 
 
 
(Dollars in thousands)
September 30, 2014
 
% of
revenue
 
September 30, 2013
 
% of
revenue
 
Change
 
%
Change
Restructuring charges related to cost of revenue
$
—

 
—
%
 
$
89

 
—
%
 
$
(89
)
 
(100.0
)%
Restructuring charges in operating expenses
1,489

 
0.6
%
 
2,767

 
1.0
%
 
(1,278
)
 
(46.2
)%
 
$
1,489

 
0.6
%

$
2,856

 
1.0
%
 
$
(1,367
)
 
(47.9
)%
Restructuring charges in the second quarter and the first six months of fiscal 2015 were primarily due to facilities costs as a result of further consolidating our facilities in the U.S. Restructuring charges in the second quarter and the first six months of fiscal 2014 were primarily due to severance and benefits costs as a result of deciding to outsource our manufacturing operations and consolidate production and service activities. For further information regarding restructuring charges, refer to Note 9 "Restructuring Charges."
Gain on Sale of Assets
 
Six Months Ended
 
 
 
 
(Dollars in thousands)
September 30, 2014
 
% of
revenue
 
September 30, 2013
 
% of
revenue
 
Change
 
%
Change
Gain on sale of assets
$
462

 
0.2
%
 
$
—

 
—
%
 
$
462

 
n/a
The gain on sale of assets was primarily due to the sale of IP addresses in the first six months of fiscal 2015.
Other Income and Expense
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
September 30, 2014
 
% of
revenue
 
September 30, 2013
 
% of
revenue
 
Change
 
%
Change
Other income and expense
$
215

 
0.2
%
 
$
46

 
—
%
 
$
169

 
367.4
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended
 
 
 
 
(Dollars in thousands)
September 30, 2014
 
% of
revenue
 
September 30, 2013
 
% of
revenue
 
Change
 
%
Change
Other income and expense
$
90

 
—
%
 
$
421

 
0.2
%
 
$
(331
)
 
(78.6
)%
Other income in the second quarter of fiscal 2015 was primarily due to net foreign exchange gains, which were largely due to strengthening of the U.S. dollar against the Australian dollar and the Swiss franc. Other income in the first six months of fiscal 2014 was primarily due to net foreign exchange gains, which were largely due to strengthening of the U.S. dollar against the Australian dollar.

19

Income Taxes
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
September 30, 2014
 
% of
pre-tax income
 
September 30, 2013
 
% of
pre-tax loss
 
Change
 
%
Change
Income tax provision
$
356

 
22.2
 %
 
$
534

 
(7.3
)%
 
$
(178
)
 
(33.3
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended
 
 
 
 
(Dollars in thousands)
September 30, 2014
 
% of
pre-tax loss
 
September 30, 2013
 
% of
pre-tax loss
 
Change
 
%
Change
Income tax provision
$
604

 
(24.4
)%
 
$
924

 
(25.1
)%
 
$
(320
)
 
(34.6
)%
The income tax provision for both the second quarter and first six months of fiscal 2015 and fiscal 2014 reflects expenses for foreign income taxes and state taxes. We have provided a full valuation allowance against our U.S. net deferred tax assets due to our history of net losses, difficulty in predicting future results and our conclusion that we cannot rely on projections of future taxable income to realize the deferred tax assets.
Significant management judgment is required in determining our deferred tax assets and liabilities and valuation allowances for purposes of 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 a reversal or decrease in this allowance. Future income tax expense will be reduced to the extent that we have sufficient positive evidence to support a reversal of, or decrease in, our valuation allowance.
Amortization of Intangible Assets
The following table details intangible asset amortization expense within our Condensed Consolidated Statements of Operations (dollars in thousands):
 
Three Months Ended
 
 
 
 
 
September 30, 2014
 
September 30, 2013
 
Change
 
% Change
Cost of revenue
$
215

 
$
368

 
$
(153
)
 
(41.6
)%
Sales and marketing
928

 
1,857

 
(929
)
 
(50
)%
 
$
1,143

 
$
2,225

 
$
(1,082
)
 
(48.6
)%
 
 
 
 
 
 
 
 
 
Six Months Ended
 
 
 
 
 
September 30, 2014
 
September 30, 2013
 
Change
 
% Change
Cost of revenue
$
593

 
$
736

 
$
(143
)
 
(19.4
)%
Sales and marketing
2,784

 
3,713

 
(929
)
 
(25
)%
 
$
3,377

 
$
4,449

 
$
(1,072
)
 
(24.1
)%

The decrease in intangible amortization in the second quarter and first six months of fiscal 2015 compared to the second quarter and first six months of fiscal 2014 was primarily due to certain intangibles becoming fully amortized during the second quarter of fiscal 2015. For further information regarding amortizable intangible assets, refer to Note 6 “Intangible Assets and Goodwill.”

20

Share-based Compensation
The following table summarizes share-based compensation expense within our Condensed Consolidated Statements of Operations (dollars in thousands):
 
Three Months Ended
 
 
 
 
 
September 30, 2014
 
September 30, 2013
 
Change
 
% Change
Cost of revenue
$
333

 
$
523

 
$
(190
)
 
(36.3
)%
Research and development
603

 
908

 
(305
)
 
(33.6
)%
Sales and marketing
887

 
1,080

 
(193
)
 
(17.9
)%
General and administrative
846

 
980

 
(134
)
 
(13.7
)%
 
$
2,669

 
$
3,491

 
$
(822
)
 
(23.5
)%
 
 
 
 
 
 
 
 
 
Six Months Ended
 
 
 
 
 
September 30, 2014
 
September 30, 2013
 
Change
 
% Change
Cost of revenue
$
747

 
$
1,051

 
$
(304
)
 
(28.9
)%
Research and development
1,383

 
1,776

 
(393
)
 
(22.1
)%
Sales and marketing
1,797

 
2,154

 
(357
)
 
(16.6
)%
General and administrative
1,810

 
1,866

 
(56
)
 
(3.0
)%
 
$
5,737

 
$
6,847

 
$
(1,110
)
 
(16.2
)%
The decrease in share-based compensation expense in the second quarter and first six months of fiscal 2015 compared to the second quarter and first six months of fiscal 2014 was primarily due to a $0.7 million decrease in expense related to a decrease in the fair value of restricted stock units.
LIQUIDITY AND CAPITAL RESOURCES
Following is a summary of cash flows from operating, investing and financing activities (in thousands):
 
Six Months Ended
 
September 30, 2014
 
September 30, 2013
Net loss
$
(3,076
)
 
$
(4,612
)
Net cash provided by operating activities
8,551

 
8,228

Net cash used in investing activities
(1,932
)
 
(3,877
)
Net cash provided by (used in) financing activities
(654
)
 
477

Six Months Ended September 30, 2014
The $11.6 million difference between net loss and net cash provided by operating activities during the six months ended September 30, 2014 was primarily due to $15.4 million in non-cash items, the largest of which were share-based compensation, depreciation, amortization and service parts lower of cost or market adjustment. In addition, we had an $8.7 million decrease in accounts receivable, which was offset by an $11.9 million decrease in deferred revenue. The decrease in accounts receivable was primarily due to decreased service contract invoicing in the second quarter of fiscal 2015 compared to the fourth quarter of fiscal 2014. The decrease in deferred revenue was largely due to a typical seasonal decline in service contract volumes. The majority of our service contracts renew in our third and fourth fiscal quarters.
Cash used in investing activities reflects $1.9 million of property and equipment purchases and $0.5 million of cash paid for our acquisition of Symform, Inc. Equipment purchases were primarily for engineering equipment for product development and permanent demo units.

21

Six Months Ended September 30, 2013
The $12.8 million difference between reported net loss and net cash provided by operating activities during the six months ended September 30, 2013 was primarily due to $24.5 million in non-cash items, the largest of which were share-based compensation, service parts lower of cost or market adjustment, depreciation and amortization. In addition, we had a $10.5 million decrease in accounts receivable primarily due to decreased sales in the second quarter of fiscal 2014 compared to the fourth quarter of fiscal 2013. These were partially offset by cash uses from a $14.2 million decrease in accounts payable and a $6.4 million decrease in deferred revenue. Accounts payable decreased due to reduced purchases in addition to the timing of payments. The decrease in deferred revenue was largely due to a typical seasonal decline in service contract volumes.
Cash used in investing activities for the six months ended September 30, 2013 was primarily due to $3.2 million of property and equipment purchases and $0.5 million used to purchase other investments. Equipment purchases were primarily for engineering equipment to support product development activities, IT equipment and software, largely related to an ERP system upgrade, and permanent demo units. Other investments were from investments we made in private technology companies with products or features complementary to Quantum products.
Capital Resources and Financial Condition

We continue to focus on improving our operating performance, including efforts to increase revenue and to continue to control costs in order to improve margins, return to consistent profitability and generate positive cash flows from operating activities. We believe that our existing cash and capital resources will be sufficient to meet all currently planned expenditures, debt service and contractual obligations and to sustain operations for at least the next 12 months. This belief is dependent upon our ability to achieve gross margin projections and to control operating expenses in order to provide positive cash flow from operating activities. Although we recorded facility restructuring charges in the second quarter and first six months of fiscal 2015, payments for the accrued facility restructuring will be made monthly in accordance with the lease agreements, which continue through February 2021. As a result, the facility restructuring is not expected to change our cash requirements. Our cash outlay for these lease payments could be reduced in the future if we are able to sublease facilities. Should any of the above assumptions prove incorrect, either in combination or individually, it would likely have a material negative effect on our cash balances and capital resources.

The following is a description of our existing capital resources including outstanding balances, funds available to borrow and primary repayment terms including interest rates.
We have $203.7 million of convertible subordinated debt outstanding in addition to a line of credit under a Wells Fargo credit agreement, inclusive of amendments (“WF credit agreement”). The $203.7 million of convertible subordinated debt comprises $133.7 million of 3.50% convertible subordinated notes due November 15, 2015 (“3.50% notes”) and $70 million of 4.50% convertible subordinated notes due November 15, 2017 (“4.50% notes”). Both the 3.50% notes and the 4.50% notes require semi-annual interest payments and have no early call provisions. Interest payments related to the 3.50% notes and 4.50% notes are paid on May 15 and November 15 of each year. We paid $2.3 million of interest on the 3.50% notes and $1.6 million of interest on the 4.50% notes in the first six months of fiscal 2015.
Under the WF credit agreement, we have the ability to borrow the lesser of $75 million or the amount of the monthly borrowing base under a senior secured revolving credit facility. The WF credit agreement matures March 29, 2017 so long as an amount sufficient to repay the 3.50% notes is available for borrowing under the WF credit agreement or is deposited in an escrow account prior to August 16, 2015. Otherwise, the WF credit agreement matures on August 16, 2015. Quarterly, we are required to pay a 0.375% commitment fee on undrawn amounts under the revolving credit facility. There is a blanket lien on all of our assets under the WF credit agreement in addition to certain financial and reporting covenants. We have letters of credit totaling $1.0 million, reducing the maximum amount available to borrow by this amount at September 30, 2014. As of September 30, 2014, and during the second quarter and first six months of fiscal 2015, we were in compliance with all covenants and had no outstanding balance on the line of credit.
Generation of positive cash flow from operating activities has historically been, and will continue to be, an important source of cash to fund operating needs and meet our current and long-term obligations. We anticipate the combination of our current cash balance and availability on the line of credit provides us with the ability to repay the 3.50% notes while maintaining sufficient cash to fund operating needs and other obligations. In addition, we plan to generate cash from operating activities in the future, which would provide us with additional operational flexibility.

22

We have taken many actions in recent years to respond to market conditions and improve our operating results. We cannot provide assurance that the actions we have taken in the past or any actions we may take in the future will ensure a consistent, sustainable and sufficient level of net income and positive cash flow from operating activities to fund, sustain or grow our business. Certain events that are beyond our control, including prevailing economic, competitive and industry conditions, as well as various legal and other disputes, may prevent us from achieving these financial objectives. Any inability to achieve consistent and sustainable net income and cash flow could result in:
(i)    Restrictions on our ability to manage or fund our existing operations, which could result in a material and adverse effect on our future results of operations and financial condition.
(ii)    Unwillingness on the part of the lenders to do any of the following:
•
Provide a waiver or amendment for any covenant violations we may experience in future periods, thereby triggering a default under, or termination of, the revolving credit line, or
•
Approve any amendments to the credit agreement we may seek to obtain in the future.
    
Any lack of renewal, waiver, or amendment, if needed, could result in the revolving credit line becoming unavailable to us and any amounts outstanding becoming immediately due and payable.
(iii)    Further impairment of our financial flexibility, which could require us to raise additional funding in the capital markets sooner than we otherwise would, and on terms less favorable to us, if available at all.
Any of the above mentioned items, individually or in combination, could have a material and adverse effect on our results of operations, available cash and cash flows, financial condition, access to capital and liquidity.