QUANTUM CORP /DE/ - FORM 10-Q - February 3, 2017

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EX-32.2 - EXHIBIT 32.2 - QUANTUM CORP /DE/exhibit322q317.htm
EX-32.1 - EXHIBIT 32.1 - QUANTUM CORP /DE/exhibit321q317.htm
EX-31.2 - EXHIBIT 31.2 - QUANTUM CORP /DE/exhibit312q317.htm
EX-31.1 - EXHIBIT 31.1 - QUANTUM CORP /DE/exhibit311q317.htm

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 December 31, 2016
 
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
––––––––––––––––
Delaware
(State or other jurisdiction of incorporation or organization)
94-2665054
(I.R.S. Employer Identification No.)
224 Airport Parkway, Suite 550, San Jose, California
(Address of principal executive offices)

95110
(Zip Code)

(408) 944-4000
(Registrant’s telephone number, including area code)
––––––––––––––––
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 January 27, 2017, there were 271,322,956 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)
 
December 31, 2016
 
March 31, 2016
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
22,595

 
$
33,870

Restricted cash
2,686

 
2,788

Accounts receivable, net of allowance for doubtful accounts of $19 and $22, respectively
107,477

 
105,959

Manufacturing inventories
30,964

 
40,614

Service parts inventories
19,967

 
21,407

Other current assets
8,933

 
8,007

Total current assets
192,622

 
212,645

Long-term assets:
 
 
 
Property and equipment, less accumulated depreciation
11,591

 
12,939

Intangible assets, less accumulated amortization
312

 
451

Restricted cash, long-term
20,000

 
—

Other long-term assets
5,136

 
4,565

Total long-term assets
37,039

 
17,955

       
$
229,661

 
$
230,600

Liabilities and Stockholders’ Deficit
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
49,272

 
$
46,136

Accrued warranty
3,287

 
3,430

Deferred revenue, current
80,733

 
88,919

Accrued restructuring charges, current
1,305

 
1,621

Long-term debt, current
—

 
3,000

Convertible subordinated debt, current
64,219

 
—

Accrued compensation
21,338

 
22,744

Other accrued liabilities
11,707

 
13,806

Total current liabilities
231,861

 
179,656

Long-term liabilities:
 
 
 
Deferred revenue, long-term
34,340

 
35,427

Accrued restructuring charges, long-term
570

 
1,116

Long-term debt
72,239

 
62,709

Convertible subordinated debt, long-term
—

 
69,253

Other long-term liabilities
7,205

 
8,324

Total long-term liabilities
114,354

 
176,829

Stockholders' deficit:
 
 
 
Common stock, $0.01 par value; 1,000,000 shares authorized; 271,188 and 266,209 shares issued and outstanding at December 31, 2016 and March 31, 2016, respectively
2,712

 
2,662

Capital in excess of par
469,602

 
464,549

Accumulated deficit
(591,382
)
 
(596,940
)
Accumulated other comprehensive income
2,514

 
3,844

Total stockholders’ deficit
(116,554
)
 
(125,885
)
 
$
229,661

 
$
230,600

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
 
Nine Months Ended
 
December 31, 2016
 
December 31, 2015
 
December 31, 2016
 
December 31, 2015
Product revenue
$
86,510

 
$
79,672

 
$
246,911

 
$
213,448

Service revenue
36,445

 
37,099

 
108,883

 
112,285

Royalty revenue
10,529

 
11,277

 
28,716

 
30,196

Total revenue
133,484


128,048


384,510


355,929

Cost of product revenue
63,324

 
56,323

 
177,808

 
156,656

Cost of service revenue
15,158

 
15,550

 
45,328

 
50,524

Total cost of revenue
78,482


71,873


223,136


207,180

Gross margin
55,002

 
56,175

 
161,374

 
148,749

Operating expenses:
 
 
 
 
 
 
 
Research and development
10,579

 
11,148

 
33,038

 
37,841

Sales and marketing
25,145

 
28,212

 
77,658

 
83,860

General and administrative
12,130

 
13,488

 
37,662

 
41,610

Restructuring charges (benefits)
(105
)
 
1,895

 
1,962

 
2,540

Total operating expenses
47,749

 
54,743

 
150,320

 
165,851

Income (loss) from operations
7,253

 
1,432

 
11,054


(17,102
)
Other income (expense)
519

 
(22
)
 
685

 
406

Interest expense
(2,423
)
 
(1,406
)
 
(5,416
)
 
(5,304
)
Loss on debt extinguishment, net
(48
)
 
(394
)
 
(48
)
 
(394
)
Income (loss) before income taxes
5,301

 
(390
)
 
6,275

 
(22,394
)
Income tax provision
295

 
431

 
717

 
1,117

Net income (loss)
$
5,006

 
$
(821
)
 
$
5,558

 
$
(23,511
)
 
 
 
 
 
 
 
 
Basic and diluted net income (loss) per share
$
0.02

 
$
(0.00
)
 
$
0.02

 
$
(0.09
)
 
 
 


 
 
 
 
Weighted average shares:
 
 
 
 
 
 
 
Basic
271,186

 
264,003

 
269,329

 
261,849

Diluted
274,443

 
264,003

 
271,473

 
261,849


See accompanying Notes to Condensed Consolidated Financial Statements.

2

QUANTUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
December 31, 2016
 
December 31, 2015
 
December 31, 2016
 
December 31, 2015
Net income (loss)
$
5,006

 
$
(821
)
 
$
5,558

 
$
(23,511
)
     Other comprehensive loss, net of taxes:
 
 
 
 
 
 
 
           Foreign currency translation adjustments
(1,442
)
 
(244
)
 
(1,575
)
 
(143
)
           Net unrealized gain (loss) on revaluation of
long-term intercompany balances
260

 
(124
)
 
245

 
(3
)
      Total other comprehensive loss
(1,182
)
 
(368
)
 
(1,330
)
 
(146
)
                      Total comprehensive income (loss)
$
3,824

 
$
(1,189
)
 
$
4,228

 
$
(23,657
)

See accompanying Notes to Condensed Consolidated Financial Statements.


3

QUANTUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Nine Months Ended
 
December 31, 2016
 
December 31, 2015
Cash flows from operating activities:
 
 
 
Net income (loss)
$
5,558

 
$
(23,511
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
Depreciation
4,035

 
4,945

Amortization of intangible assets
139

 
233

Amortization and write-off of debt issuance costs
916

 
894

Service parts lower of cost or market adjustment
3,950

 
4,640

Deferred income taxes
(16
)
 
(1
)
Share-based compensation
5,124

 
7,339

Changes in assets and liabilities:
 
 
 
Accounts receivable
(1,518
)
 
22,890

Manufacturing inventories
7,248

 
13,503

Service parts inventories
(1,298
)
 
(547
)
Accounts payable
3,377

 
(12,708
)
Accrued warranty
(143
)
 
(797
)
Deferred revenue
(9,273
)
 
(14,833
)
Accrued restructuring charges
(862
)
 
(2,258
)
Accrued compensation
(1,105
)
 
(10,711
)
Other assets and liabilities
(5,663
)
 
(4,992
)
Net cash provided by (used in) operating activities
10,469

 
(15,914
)
Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(1,736
)
 
(2,800
)
Change in restricted cash
(19,996
)
 
(142
)
Net cash used in investing activities
(21,732
)
 
(2,942
)
Cash flows from financing activities:
 
 
 
Borrowings of long-term debt, net
92,581

 
68,920

Repayments of long-term debt
(87,209
)
 
—

Repayments of convertible subordinated debt
(5,296
)
 
(83,735
)
Payment of taxes due upon vesting of restricted stock
(679
)
 
(3,112
)
Proceeds from issuance of common stock
658

 
1,772

Net cash provided by (used in) financing activities
55

 
(16,155
)
Effect of exchange rate changes on cash and cash equivalents
(67
)
 
(18
)
Net decrease in cash and cash equivalents
(11,275
)
 
(35,029
)
Cash and cash equivalents at beginning of period
33,870

 
67,948

Cash and cash equivalents at end of period
$
22,595

 
$
32,919

Supplemental disclosure of cash flow information:
 
 
 
Purchases of property and equipment included in accounts payable
$
149

 
$
430

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 and reincorporated in Delaware in 1987, is a leading expert in scale-out storage, archive and data protection, providing solutions for capturing, sharing, managing and preserving digital assets over the entire data lifecycle. Our customers, ranging from small businesses to large/multi-national enterprises, trust us to address their most demanding data workflow challenges. Our end-to-end tiered storage solutions enable users 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, 2016 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, 2016 included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission (“SEC”) on June 3, 2016, as amended by Amendment No. 1 to Form 10-K, filed with the SEC on July 27, 2016 (together, the “Form 10-K”).
Recently Adopted Accounting Pronouncements
In April 2015, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement (“ASU 2015-05”). ASU 2015-05 requires that customers apply the same criteria as vendors to determine whether a cloud computing arrangement (“CCA”) contains a software license or is solely a service contract. Under ASU 2015-05, fees paid by a customer in a CCA will be within the scope of internal-use software guidance if both of the following criteria are met: 1) the customer has the contractual right to take possession of the software at any time without significant penalty and 2) it is feasible for the customer to run the software on its own hardware (or to contract with another party to host the software). ASU 2015-05 may be applied prospectively to all agreements entered into or materially modified after the adoption date or retrospectively. We adopted ASU 2015-05 prospectively in the first quarter of fiscal 2017 and adoption did not impact our statements of financial condition, results of operations, cash flows or financial statement disclosures.
Recent Accounting Pronouncements
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. We evaluated our forecasted earnings, cash flows and liquidity to evaluate any potential situations, including payment of our convertible notes upon maturity, that would trigger additional assessment and reporting under this standard. Based upon such evaluation, we do not anticipate adoption will impact our statements of financial condition, results of operations, cash flows or financial statement disclosures.

In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330) (“ASU 2015-11”). ASU 2015-11 requires that an entity measure all inventory at the lower of cost and net realizable value, except for inventory that is measured using last-in, first-out (LIFO) or the retail inventory method. ASU 2015-11 will become effective for us beginning April 1, 2017, or fiscal 2018. Prospective application is required. As we currently adjust the carrying value of our inventory to the lower-of-cost or market, we do not anticipate adoption will have a material impact on our statements of financial condition, results of operations, cash flows or financial statement disclosures.

5

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Topic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). ASU 2016-01 addresses certain aspects of recognition, measurement, presentation and disclosures of financial instruments. ASU 2016-01 will become effective for us beginning April 1, 2018, or fiscal 2019. We must apply the provisions using a cumulative-effect adjustment to the balance sheet at the beginning of the year of adoption, or April 1, 2018. We are currently assessing what financial instruments are being impacted and the extent of the potential impact on our statements of financial condition, results of operations, cash flows and financial statement disclosures.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842)(“ASU 2016-02”). ASU 2016-02 provides a new comprehensive model for lease accounting. Under ASU 2016-02, lessees and lessors should apply a “right-of-use” model in accounting for all leases and eliminate the concept of operating leases and off-balance sheet leases. ASU 2016-02 will become effective for us beginning April 1, 2019, or fiscal 2020. ASU 2016-02 requires a modified retrospective transition approach with certain practical expedients available. We are currently putting in place the process for analyzing our current leases to evaluate the impact on our statements of financial condition, results of operations, cash flows and financial statement disclosures.

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. ASU 2016-09 will become effective for us beginning April 1, 2017, or fiscal 2018. Transition requirements vary based upon certain facts and circumstances, which we are in the process of evaluating to determine our approach. We are currently evaluating our existing share-based payments awards and the structure of future compensation plans to determine the potential impact on our statements of financial condition, results of operations, cash flows and financial statement disclosures.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Receipts and Cash Payments (“ASU 2016-15”). ASU 2016-15 provides guidance on the following eight specific cash flow issues: 1) debt prepayment or debt extinguishment costs, 2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing, 3) contingent consideration payments made after a business combination, 4) proceeds from the settlement of insurance claims, 5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies, 6) distributions received from equity method investees, 7) beneficial interests in securitization transactions and 8) separately identifiable cash flows and application of the predominance principle. ASU 2016-15 transition requires the use of the retrospective method for all periods presented. We have evaluated the types of transactions impacted by ASU 2016-15 and at this time, anticipate only having immaterial debt extinguishment costs that are impacted and therefore, we do not anticipate adoption will have a material impact on our statements of cash flows.

In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory (“ASU 2016-16”). ASU 2016-16 requires that an entity recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 will become effective for us beginning April 1, 2018, or fiscal 2019. ASU 2016-16 requires the modified retrospective transition approach with a cumulative-effect adjustment to retained earnings at the beginning of the period of adoption. We currently do not have any material intra-entity transfers of assets and therefore we do not anticipate that adoption will have a material impact on our statements of financial condition, results of operations, cash flows or financial statement disclosures.

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”). ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. ASU 2016-18 will become effective for us beginning April 1, 2018, or fiscal 2019. ASU 2016-18 is required to be applied retrospectively. Upon the adoption, amounts described as restricted cash will be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts shown on the statements of cash flows.

The FASB issued the following accounting standard updates related to its revenue convergence project:

•
ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”) in May 2014. 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.

6

•
ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) (“ASU 2016-08”) in March 2016. ASU 2016-08 does not change the core principle of revenue recognition in Topic 606 but clarifies the implementation guidance on principal versus agent considerations.
•
ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing (“ASU 2016-10”) in April 2016. ASU 2016-10 does not change the core principle of revenue recognition in Topic 606 but clarifies the implementation guidance on identifying performance obligations and the licensing implementation guidance, while retaining the related principles for those areas.
•
ASU No. 2016-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting (SEC Update) (“ASU 2016-11”) in May 2016. ASU 2016-11 rescinds SEC paragraphs pursuant to two SEC Staff Announcements at the March 3, 2016 EITF meeting. The SEC Staff is rescinding SEC Staff Observer comments that are codified in Topic 605 and Topic 932, effective upon adoption of Topic 606.
•
ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients in May 2016. ASU 2016-12 does not change the core principle of revenue recognition in Topic 606 but clarifies the implementation guidance on a few narrow areas and adds some practical expedients to the guidance.

These ASUs will become effective for us beginning April 1, 2018, or fiscal 2019. ASU 2014-09 and the related ASUs allow for either a retrospective or a modified retrospective transition approach. We plan to use a modified retrospective approach upon the adoption of Topic 606. We have initiated an assessment of the potential changes in our revenue recognition accounting policies for the new revenue standards, including our accounting for related commissions and extended product warranty costs. We are currently evaluating the impact of these changes as well as the impact of our rebate programs (“variable consideration”) and establishing the standalone selling price for each performance obligation which will help us to assess the overall impact of the adoption of Topic 606 on our financial condition, results of operations, cash flows and financial statement disclosures.

NOTE 2: REVISION OF PRIOR PERIOD FINANCIAL STATEMENTS

In connection with the preparation of our condensed consolidated financial statements for the quarter ended December 31, 2016, we identified an error related to the manner in which we had previously recognized costs for certain third party maintenance contracts. Specifically, we had historically expensed such costs in the period the contracts were entered into rather than expensing them ratably over the contract period. In accordance with Staff Accounting Bulletin (“SAB”) No. 99, Materiality, and SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, we evaluated the error and determined that the related impact was not material to our results of operations or financial position for any prior annual or interim period, but that correcting the $1.6 million cumulative impact of the error would be material to our results of operations for the three month period ended December 31, 2016. Accordingly, we have corrected these errors for all prior periods presented by revising the condensed consolidated financial statements. Periods not presented herein will be revised, as applicable, in future filings. We also corrected the timing of a previously recorded immaterial out-of-period adjustment and reflected the adjustment in the period in which it originated in the revised prior period financial statements. 
Consolidated Balance Sheets
 
As of March 31,
 
2016
 
As Reported
 
Adjustment
 
As Revised
Other current assets
$
6,953

 
$
1,054

 
$
8,007

Total current assets
211,591

 
1,054

 
212,645

Total assets
229,546

 
1,054

 
230,600

Accumulated deficit
(597,994
)
 
1,054

 
(596,940
)
Total stockholders’ deficit
$
(126,939
)
 
$
1,054

 
$
(125,885
)


7

Consolidated Statements of operations
 
Three Months Ended
 
Nine Months Ended
 
December 31, 2015
 
December 31, 2015
 
As Reported
 
Adjustment
 
As Revised
 
As Reported
 
Adjustment
 
As Revised
Cost of product revenue
$
56,323

 
$
—

 
$
56,323

 
$
156,360

 
$
296

 
$
156,656

Cost of service revenue
15,028

 
522

 
15,550

 
49,590

 
934

 
50,524

Total cost of revenue
71,351

 
522

 
71,873

 
205,950

 
1,230

 
207,180

Gross margin
56,697

 
(522
)
 
56,175

 
149,979

 
(1,230
)
 
148,749

Income (loss) from operations
1,954

 
(522
)
 
1,432

 
(15,872
)
 
(1,230
)
 
(17,102
)
Income (loss) before income taxes
132

 
(522
)
 
(390
)
 
(21,164
)
 
(1,230
)
 
(22,394
)
Net income (loss)
$
(299
)
 
$
(522
)
 
$
(821
)
 
$
(22,281
)
 
$
(1,230
)
 
$
(23,511
)

The revisions did not impact previously reported basic or diluted earnings per share and had no impact on our previously reported cash flows.
There were no income tax impacts related to the error as the Company has full valuation allowances against its net deferred tax assets in the related jurisdictions and was not subject to income taxes payable in the related periods.
NOTE 3: 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
 
December 31, 2016
 
March 31, 2016
Money market funds
$
—

 
$
1,640

We did not record impairments to any non-financial assets in the third quarter or first nine months of fiscal 2017 or fiscal 2016. 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 and long-term debt at December 31, 2016 and March 31, 2016. The carrying value and fair value of our convertible subordinated debt and long-term debt were as follows (in thousands):
 
As of
 
December 31, 2016
 
March 31, 2016
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
Convertible subordinated debt (1)
$
64,219

 
$
61,999

 
$
69,253

 
$
51,686

 
 
 
 
 
 
 
 
Long-term debt: (2)
 
 
 
 
 
 
 
Credit agreement with Wells Fargo
—

 
—

 
65,709

 
65,741

Revolving credit agreement
24,219

 
25,998

 
—

 
—

Term loan agreement
48,020

 
50,001

 
—

 
—

Total long-term debt
$
72,239

 
$
75,999

 
$
65,709

 
$
65,741

 
 
 
 
 
 
(1) Fair value based on quoted market prices in less active markets (level 2).
 
(2) Fair value based on outstanding borrowings and market interest rates (level 2).

8

NOTE 4: INVENTORIES
Manufacturing inventories and service parts inventories consisted of the following (in thousands):
 
As of
 
December 31, 2016

March 31, 2016
Manufacturing inventories:
 
 
 
Finished goods
$
15,806

 
$
22,127

Work in process
801

 
665

Materials and purchased parts
14,357

 
17,822

 
$
30,964

 
$
40,614

 
As of
 
December 31, 2016
 
March 31, 2016
Service parts inventories:
 
 
 
Finished goods
$
15,583

 
$
16,381

Component parts
4,384

 
5,026

 
$
19,967

 
$
21,407

NOTE 5: INTANGIBLE ASSETS
We evaluate our amortizable 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 third quarter or first nine months of fiscal 2017 or fiscal 2016. The following provides a summary of the carrying value of our long-lived assets (in thousands):
 
As of
 
December 31, 2016
 
March 31, 2016
 
Gross
Amount
 
Accumulated
Amortization
 
Net
Amount
 
Gross
Amount
 
Accumulated
Amortization
 
Net
Amount
Purchased technology
$
178,292

 
$
(177,980
)
 
$
312

 
$
178,292

 
$
(177,841
)
 
$
451

Trademarks
3,900

 
(3,900
)
 
—

 
3,900

 
(3,900
)
 
—

Customer lists
64,701

 
(64,701
)
 
—

 
64,701

 
(64,701
)
 
—

 
$
246,893

 
$
(246,581
)
 
$
312

 
$
246,893

 
$
(246,442
)
 
$
451



9

NOTE 6: ACCRUED WARRANTY
The changes in the accrued warranty balance were (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
December 31, 2016
 
December 31, 2015
 
December 31, 2016
 
December 31, 2015
Beginning balance
$
3,371

 
$
3,473

 
$
3,430

 
$
4,219

Additional warranties issued
1,477

 
1,550

 
5,083

 
4,680

Adjustments for warranties issued in prior fiscal years
182

 
228

 
583

 
159

Settlements
(1,743
)
 
(1,829
)
 
(5,809
)
 
(5,636
)
Ending balance
$
3,287

 
$
3,422

 
$
3,287

 
$
3,422

We warrant our products against certain defects typically for one to three years. A provision for estimated future costs and estimated returns for repair or replacement relating to warranty is recorded when products are shipped and revenue is 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 7: DEBT
Our debt consisted of the following (in thousands):
 
As of
 
December 31, 2016
 
March 31, 2016
Convertible subordinated debt, current:
 
 
 
4.50% convertible subordinated notes
$
64,590

 
$
70,000

Unamortized debt issuance costs
(371
)
 
(747
)
Convertible subordinated debt, current, net of unamortized debt issuance costs
$
64,219

 
$
69,253

 
As of
 
December 31, 2016
 
March 31, 2016
Long-term debt, current:
 
 
 
Credit agreement with Wells Fargo
$
—

 
$
3,000

 
 
 
 
Long-term debt:
 
 
 
Credit agreement with Wells Fargo
$
—

 
$
62,709

Revolving credit agreement
26,000

 
—

Term loan agreement
50,000

 
—

Unamortized discount and debt issuance costs
(3,761
)
 
—

Long-term debt, net of unamortized discount and debt issuance costs
$
72,239

 
$
62,709

Long-term Debt
On October 21, 2016 (“closing date”), we refinanced our credit agreement with Wells Fargo (as amended, the “WF credit agreement”) through the use of proceeds obtained from our term loan and revolving credit facility (“credit facility”). The credit facility includes a revolving credit and security agreement entered into with PNC Bank, National Association (“revolving credit agreement”) and a term loan credit and security agreement entered into with TCW Asset Management Company LLC (“term loan agreement”). In connection with the refinance, we recorded a loss on debt extinguishment of $0.1 million comprised of unamortized debt issuance costs related to the WF credit agreement.

10

On the closing date, we borrowed $50.0 million under the term loan agreement and $26.0 million under the revolving credit agreement. These borrowings were used to i) pay $60.3 million of the outstanding balance on the WF credit agreement and accrued interest, ii) fund $10.0 million towards a portion of a $20.0 million restricted reserve requirement under the revolving credit agreement with the remaining portion of the requirement funded with cash on hand, iii) pay $4.7 million of transaction fees and other expenses and iv) pay a $1.0 million refundable deposit to Wells Fargo to hold during the transfer of our existing letters of credit to the new credit facility. Transaction fees and other expenses incurred under the credit facility included $3.1 million of debt issuance costs, $1.0 million of debt discount and $0.6 million of loan commitment fees. The $20.0 million restricted reserve requirement is presented as restricted cash, long-term within the Condensed Consolidated Balance Sheets as of December 31, 2016.
Revolving credit agreement

Under the revolving credit agreement, we have the ability to borrow the lesser of $80 million or the amount of the monthly borrowing base, which is reduced by $1.0 million of the outstanding letters of credit. Our borrowing base is established monthly based on certain working capital asset balances. The revolving credit agreement also includes an uncommitted accordion in an amount up to $20 million. The revolving credit agreement matures on October 21, 2021.
Of the $4.7 million of transaction fees and other expenses, as discussed above, $1.9 million of debt issuance costs and $0.6 million of loan commitment fees were attributable to the revolving credit agreement. During the third quarter of fiscal 2017, debt issuance costs related to our revolving credit agreement were recorded as a reduction of its carrying amount to the extent outstanding borrowings are greater than the related unamortized fees and are amortized to interest expense over the term of the related agreement using the effective interest method. Loan commitment fees paid related to future borrowing capacity were recorded as an asset and are amortized ratably over the term of the revolving credit agreement.
Borrowings under the revolving credit agreement bear interest at a rate per annum equal to, at our option, either (a) the greatest of (i) the base rate, (ii) the Federal funds rate plus 0.50% and (iii) the LIBOR rate based upon an interest period of 1 month plus 1.0%, plus an applicable margin of 1.50%, or (b) the LIBOR rate plus an applicable margin of 2.50%. The base rate is defined in the revolving credit agreement. Additionally, we are required to pay a 0.375% commitment fee on undrawn amounts under the revolving credit agreement on a quarterly basis, which is recorded as interest expense in the period incurred. As of December 31, 2016, we had a $26.0 million outstanding balance on the line of credit at an interest rate of 3.31%.
Term loan agreement

The term loan agreement provides for $50 million of a senior secured term loan drawn on the closing date and $20 million of a senior secured delay draw term loan (“DDTL”). Borrowings under the DDTL are restricted to only be used to redeem our 4.50% convertible subordinated notes due November 15, 2017 (“4.50% notes”) and are available through December 31, 2017. The term loan agreement matures on October 21, 2021. The amount outstanding under the term loan is to be repaid on a quarterly basis in an amount equal to 1.25% of the original principal amount beginning on March 31, 2018, with any remaining principal balance due on the maturity of the term loan.
Of the $4.7 million of transaction fees and other expenses, as discussed above, $1.2 million of debt issuance costs and $1.0 million of debt discount were attributable to the term loan agreement. These fees were recorded as a reduction to the carrying amount of outstanding borrowings under the term loan agreement and amortized to interest expense over the term of the borrowing using the effective interest method.
Borrowings under the term loan agreement bear interest at a rate per annum equal to, at our option, either (a) the greatest of (i) 3.00%, (ii) the Federal funds rate plus 0.50%, (iii) the LIBOR rate based upon an interest period of 1 month plus 1.0% and (iv) the “prime rate” last quoted by the Wall Street Journal, plus a margin ranging from 6.00% to 7.25% based on the applicable senior net leverage ratio, or (b) the LIBOR rate plus 7.00% to 8.25% based on the applicable senior net leverage ratio. The senior net leverage ratio is defined in the term loan agreement. As of December 31, 2016, our interest rate on the term loan was 8.50%.
The term loan agreement and the revolving credit agreement contain customary affirmative and negative covenants, events of default and financial covenants including fixed charge coverage ratio, senior net leverage ratio and total leverage ratio. Additionally, the revolving credit agreement includes minimum liquidity requirements. There is a blanket lien on all of our assets under the revolving credit agreement and term loan agreement. As of December 31, 2016, and during the first nine months of fiscal 2017, we were in compliance with all covenants.

11

Convertible Subordinated Debt

In November 2016, we entered into private transactions with note holders to purchase an aggregate principal amount of $5.4 million of the 4.50% notes for $5.3 million of cash. In connection with these transactions, we recorded a gain on debt extinguishment of $0.1 million, which included a write-off of unamortized debt issuance costs related to the purchased notes.
Debt Maturities
A summary of the scheduled maturities for our principal outstanding debt as of December 31, 2016 follows (in thousands):
 
Debt Maturity Due by Period
 
Less than One Year
 
One Year
 
Two Years
 
Three Years
 
Four Years
 
More than Five years
 
Total
4.50% convertible subordinated notes
$
64,590

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
64,590

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Long-term debt:
 
 
 
 
 
 
 
 
 
 
 
 
 
Revolving credit agreement
—

 
—

 
—

 
—

 
26,000

 
—

 
26,000

Term loan agreement
—

 
2,500

 
2,500

 
2,500

 
42,500

 
—

 
50,000

Total long-term debt
$
—

 
$
2,500

 
$
2,500

 
$
2,500

 
$
68,500

 
$
—

 
$
76,000

NOTE 8: RESTRUCTURING CHARGES
Fiscal 2017 April Restructuring Plan
In April 2016, we approved a plan (“Fiscal 2017 April Restructuring Plan”) to eliminate 29 positions in the U.S. and internationally to reduce investments in various functions of our business to improve operational efficiencies. The costs associated with these actions consist of restructuring charges related to severance and benefits. These actions were completed by the second quarter of fiscal 2017. We incurred and paid $1.5 million of restructuring charges under this plan.

Fiscal 2016 Restructuring Plan

In November 2015, we approved a plan (“Fiscal 2016 Restructuring Plan”) to eliminate approximately 65 positions in the U.S. and internationally, primarily in research and development and sales and marketing functions, in order to improve our cost structure and align spending with continuing operations plans. These actions were completed by the first quarter of fiscal 2017, with the majority having occurred by December 31, 2015. The costs associated with these actions consist of restructuring charges related to severance and benefits. We incurred and paid $2.0 million of restructuring charges under this plan.

Summary of Restructuring Expense
The types of restructuring expense for the three and nine months ended December 31, 2016 and December 31, 2015 were (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
December 31, 2016
 
December 31, 2015
 
December 31, 2016
 
December 31, 2015
Severance and benefits
$
(13
)
 
$
1,685

 
$
1,437

 
$
1,912

Facilities
(92
)
 
210

 
525

 
628

Total
$
(105
)
 
$
1,895

 
$
1,962

 
$
2,540


For the third quarter of fiscal 2017, restructuring benefits were primarily due to a change in estimate of sublease in one of our facilities in the U.S. For the first nine months of fiscal 2017, restructuring charges were primarily due to $1.5 million of severance and benefits costs incurred as a result of the Fiscal 2017 April Restructuring Plan. Additionally, we approved a plan to vacate certain leased space in the U.S. primarily used for administration and research and development in the first quarter of fiscal 2017 and recorded $0.2 million of restructuring charges related to facilities costs in the first nine months of fiscal 2017.


12

For the third quarter and first nine months of fiscal 2016, restructuring charges were largely due to $1.7 million of severance and benefits costs incurred as a result of the Fiscal 2016 Restructuring Plan. Additionally, for the first nine months of fiscal 2016, we incurred restructuring charges related to facilities costs as a result of further consolidating our facilities in the U.S. 

Accrued Restructuring

The following tables show the activity and the estimated timing of future payouts for accrued restructuring (in thousands):
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended December 31, 2015
 
Three Months Ended December 31, 2016
 
Severance
and Benefits
 
Facilities
 
Total
 
Severance
and Benefits
 
Facilities
 
Total
Beginning balance
$
257

 
$
2,572

 
$
2,829

 
$
140

 
$
2,378

 
$
2,518

Restructuring costs
1,690

 
210

 
1,900

 
—

 
(92
)
 
(92
)
Adjustment of prior estimates
(5
)
 
—

 
(5
)
 
(13
)
 
—

 
(13
)
Cash payments
(1,171
)
 
(1,022
)
 
(2,193
)
 
(1
)
 
(619
)
 
(620
)
Other non-cash
—

 
57

 
57

 
—

 
82

 
82

Ending balance
$
771

 
$
1,817

 
$
2,588

 
$
126

 
$
1,749

 
$
1,875

 
Nine Months Ended December 31, 2015
 
Nine Months Ended December 31, 2016
 
Severance and Benefits
 
Facilities
 
Total
 
Severance and Benefits
 
Facilities
 
Total
Beginning balance
$
189

 
$
4,657

 
$
4,846

 
$
354

 
$
2,383

 
$
2,737

Restructuring costs
1,913

 
604

 
2,517

 
1,489

 
388

 
1,877

Adjustment of prior estimates
(1
)
 
24

 
23

 
(52
)
 
137

 
85

Cash payments
(1,330
)
 
(3,568
)
 
(4,898
)
 
(1,665
)
 
(1,283
)
 
(2,948
)
Other non-cash
—

 
100

 
100

 
—

 
124

 
124

Ending balance
$
771

 
$
1,817

 
$
2,588

 
$
126

 
$
1,749

 
$
1,875

 
As of December 31, 2016
 
Severance and
Benefits
 
Facilities
 
Total
Estimated timing of future payouts:
 
 
 
 
 
Next twelve months
$
126

 
$
1,179

 
$
1,305

January 2018 through December 2021
—

 
570

 
570

 
$
126

 
$
1,749

 
$
1,875


Facility restructuring accruals will be paid in accordance with the respective facility lease terms, partially offset by the estimated sublease amounts to be received over the course of the facility lease terms.

13

NOTE 9: STOCK INCENTIVE PLANS AND SHARE-BASED COMPENSATION
Share-Based Compensation
The following table summarizes share-based compensation (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
December 31, 2016
 
December 31, 2015
 
December 31, 2016
 
December 31, 2015
Share-based compensation:
 
 
 
 
 
 
 
Cost of revenue
$
183

 
$
313

 
$
697

 
$
1,006

Research and development
284

 
488

 
1,020

 
1,529

Sales and marketing
542

 
658

 
1,760

 
2,367

General and administrative
467

 
780

 
1,647

 
2,437

 
$
1,476

 
$
2,239

 
$
5,124

 
$
7,339

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

 
$
—

 
$
—

 
$
2

Restricted stock units
1,437

 
1,955

 
4,784

 
6,552

Stock purchase plan
39

 
284

 
340

 
785

 
$
1,476

 
$
2,239

 
$
5,124

 
$
7,339

Stock Incentive Plans - Grants and Fair Value
Stock Options
No stock options were granted during the third quarter or first nine months of fiscal 2017 or fiscal 2016.
Restricted Stock Units
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 values of RSUs granted during the third quarter and first nine months of fiscal 2017 were $0.74 and $0.44, respectively. The weighted-average grant date fair values of RSUs granted during the third quarter and first nine months of fiscal 2016 were $0.82 and $1.64 per share, respectively.

During the first nine months of fiscal 2017, we granted 3.4 million RSUs with performance conditions (“2017 performance RSUs”), and the total fair value of 2017 performance RSUs at the grant date was $1.4 million at a weighted average grant date fair value per share of $0.43. The 2017 performance RSUs will become eligible for vesting based on Quantum achieving a certain revenue target through the end of fiscal 2017. Share-based compensation expense for the 2017 performance RSUs is recognized when it is probable that the performance conditions will be achieved. During the third quarter and first nine months of fiscal 2017, $0.1 million and $0.3 million of share-based compensation expense was recognized for the 2017 performance RSUs.
Employee Stock Purchase Plan
Under the Employee Stock Purchase Plan (“ESPP”), 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 first nine months of fiscal 2017 and fiscal 2016, respectively, was estimated at the date of 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 nine month periods ended December 31, 2016 and December 31, 2015 were as follows:
 
Nine Months Ended
 
December 31, 2016
 
December 31, 2015
Option life (in years)
0.5

 
0.5

Risk-free interest rate
0.40
%
 
0.09
%
Stock price volatility
81.88
%
 
64.61
%
Weighted-average grant date fair value per share
$
0.23

 
$
0.38


14

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, 2016
4,131

 
$
1.52

 
 
 
 
Forfeited
(303
)
 
1.03

 
 
 
 
Expired
(2,383
)
 
0.99

 
 
 
 
Outstanding as of December 31, 2016
1,445

 
$
2.50

 
1.20
 
$
2,107

Vested and expected to vest at December 31, 2016
1,445

 
$
2.50

 
1.20
 
$
2,107

Exercisable as of December 31, 2016
1,445

 
$
2.50

 
1.20
 
$
2,107

Restricted Stock Units
A summary of activity relating to our restricted stock units follows (shares in thousands):
 
Shares
 
Weighted-Average
Grant Date
Fair Value Per Share
Nonvested at March 31, 2016
11,109

 
$
1.39

Granted
8,312

 
0.44

Vested
(4,850
)
 
1.38

Forfeited
(875
)
 
1.40

Nonvested at December 31, 2016
13,696

 
$
0.81

NOTE 10: INCOME TAXES
Income tax provisions for the third quarter and first nine months of fiscal 2017 were $0.3 million and $0.7 million, respectively. Income tax provisions for the third quarter and first nine months of fiscal 2016 were $0.4 million and $1.1 million, 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.

15

NOTE 11: 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
 
Nine Months Ended
 
December 31, 2016
 
December 31, 2015
 
December 31, 2016
 
December 31, 2015
Numerator:
 
 
 
 
 
 
 
Net income (loss)
$
5,006

 
$
(821
)
 
$
5,558

 
$
(23,511
)
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Weighted average shares:
 
 
 
 
 
 
 
Basic
271,186

 
264,003

 
269,329

 
261,849

Dilutive shares from stock plans
3,257

 
—

 
2,144

 
—

Diluted
274,443

 
264,003

 
271,473

 
261,849

 
 
 
 
 
 
 
 
Basic and diluted net income (loss) per share
$
0.02

 
$
(0.00
)
 
$
0.02

 
$
(0.09
)

Dilutive and potentially dilutive common shares from the Stock Incentive Plans are determined by applying the treasury stock method to the assumed exercise of outstanding options and the assumed vesting of outstanding restricted stock units. The dilutive impact related to our convertible subordinated notes is determined by applying the if-converted method, which includes adding the related weighted average shares to the denominator and the related interest expense to net income.

The computations of diluted net income (loss) per share for the periods presented exclude the following because the effect would have been anti-dilutive (in millions):

 
Three Months Ended
 
Nine Months Ended
 
December 31, 2016
 
December 31, 2015
 
December 31, 2016
 
December 31, 2015
Weighted average shares excluded:
 
 
 
 
 
 
 
4.50% convertible subordinated notes
40.9

 
42.5

 
42.0

 
42.5

3.50% convertible subordinated notes
—

 
1.3

 
—

 
13.3

Stock options
1.4

 
4.4

 
2.3

 
4.6

Unvested restricted stock units
3.1

 
12.0

 
3.8

 
12.4

 
 
 
 
 
 
 
 
Interest expense excluded:
 
 
 
 
 
 
 
4.50% convertible subordinated notes
$
0.9

 
$
0.9

 
$
2.7

 
$
2.7

3.50% convertible subordinated notes
$
—

 
$
0.1

 
$
—

 
$
1.8

NOTE 12: COMMITMENTS AND CONTINGENCIES
Commitments to Purchase Inventory

We use contract manufacturers for our manufacturing operations. Under these arrangements, the contract manufacturer procures inventory to manufacture products based upon our forecast of customer demand. We have similar arrangements with certain other suppliers. We are responsible for the financial impact on the supplier or contract manufacturer of any reduction or product mix shift in the forecast relative to materials that the third party had already purchased under a prior forecast. Such a variance in forecasted demand could require a cash payment for inventory in excess of current customer demand or for costs of excess or obsolete inventory. As of December 31, 2016 and March 31, 2016, we issued non-cancelable commitments for $52.9 million and $42.2 million, respectively, to purchase inventory from our contract manufacturers and suppliers.


16

Legal Proceedings

Crossroads
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. In July and September of 2014, we filed for inter partes review of all three asserted Crossroads patents before the Patent Trial and Appeal Board and a review has been initiated for all claims. On June 16, 2015, the U.S. District Court, Western District of Texas stayed the Crossroads trial proceedings pending resolution of the inter partes review proceedings. On January 29, 2016, the Patent Trial and Appeal Board issued decisions on the inter partes reviews for U.S. patents 6,425,035 and 7,051,147, ordering all claims of both patents to be unpatentable. On March 17, 2016, the Patent Trial and Appeal Board issued a decision on the inter partes review for U.S. patent 7,934,041, ordering all claims to be unpatentable. On March 31, 2016, Crossroads filed Notices of Appeal in each of the inter partes review decisions. We believe the probability that this lawsuit will have a material adverse effect on our business, operating results or financial condition is remote.
Realtime Data
On July 22, 2016, Realtime Data LLC d/b/a IXO(“Realtime Data”) filed a patent infringement lawsuit against Quantum in the U.S. District Court for the Eastern District of Texas, alleging infringement of U.S. patents 7,161,506, 7,378,992, 7,415,530, 8,643,513, 9,054,728 and 9,116,908. Realtime Data asserts that we have incorporated Realtime Data’s patented technology into our deduplication products and services. Realtime Data seeks unspecified monetary damages and other relief that the Court deems appropriate. We believe the probability that this lawsuit will have a material adverse effect on our business, operating results or financial condition is remote.

17

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, strategy and expectations for future operating performance including increasing market share and shareholder value, continuing to add customers and increasing revenue and delivering on operating profit goals; (2) our expectations and beliefs regarding the storage market and the other markets in which we compete; (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
Quantum Corporation (“Quantum”, the “Company”, “us” or “we”), is a leading expert in scale-out storage, archive and data protection, providing solutions for capturing, sharing, managing and preserving digital assets over the entire data lifecycle. We believe our combination of expertise, innovation and platform independence enables us to solve scale-out storage and data protection 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 tiered storage includes appliances (which include XcellisTM, Lattus®, StorNext ProTM Solutions and StorNext® AEL), scale-out tiered storage related tape automations (which includes Scalar® automated tape libraries), scale-out tiered storage related media and scale-out tiered storage related disk storage (which includes QXSTM Hybrid). These products 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 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 2017 is to increase shareholder value by growing our scale-out storage revenue and investing to drive future growth in our scale-out business while also delivering on our operating profit goals. We continue to focus on building our momentum in three main broad categories of scale-out storage: media and entertainment, video surveillance and technical workflows with large unstructured data. Outside of our scale-out storage business, our strategy is to continue leveraging our technology leadership, our extensive customer base and our channel and technology partnerships to generate profits and cash from our offerings.

18

Results

We had total revenue of $133.5 million in the third quarter of fiscal 2017, a $5.4 million increase from the third quarter of fiscal 2016, primarily due to increased branded product revenue from media, scale-out tiered storage and disk backup systems, partially offset by decreased product revenue from OEM tape automation systems. Our focus on our branded business continues to be reflected in the proportion of non-royalty revenue from branded business, which was 94% in the third quarter of fiscal 2017 compared to 89% in the third quarter of fiscal 2016. Our branded product and service revenue increased by 11% from the third quarter of fiscal 2016.

Our gross margin percentage decreased by 270 basis points to 41.2% from the third quarter of fiscal 2016 primarily due to a shift in revenue mix from higher margin products to lower margin products.
Operating expenses decreased $7.0 million, or 13%, from the third quarter of fiscal 2016 primarily due to cost reduction actions we took in the second half of fiscal 2016 and the first half of fiscal 2017 (“cost reduction actions”). The largest spending decrease compared to the third quarter of fiscal 2016 was for compensation and benefits due to lower staffing levels. In addition, we had a decrease in restructuring charges primarily due to higher severance restructuring charges incurred in prior year from our Fiscal 2016 Restructuring Plan and a decrease in legal fees related to the Crossroads lawsuit. For further information, refer to Note 12 “Commitments and Contingencies” of the Notes to the Condensed Consolidated Financial Statements.
Our operating results improved by $5.8 million to $7.3 million of income from operations in the third quarter of fiscal 2017.
We generated $10.5 million in cash from operations in the first nine months of fiscal 2017 compared to $15.9 million of cash used in operations in the first nine months of fiscal 2016. We ended the quarter with $45.3 million in cash, cash equivalents and restricted cash.
RESULTS OF OPERATIONS
Revenue
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
December 31, 2016
 
% of
revenue
 
December 31, 2015
 
% of
revenue
 
Change
 
% Change
Product revenue
$
86,510

 
64.8
%
 
$
79,672

 
62.2
%
 
$
6,838

 
8.6
 %
Service revenue
36,445

 
27.3
%
 
37,099

 
29.0
%
 
(654
)
 
(1.8
)%
Royalty revenue
10,529

 
7.9
%
 
11,277

 
8.8
%
 
(748
)
 
(6.6
)%
Total revenue
$
133,484

 
100.0
%
 
$
128,048

 
100.0
%
 
$
5,436

 
4.2
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
 
 
 
 
(Dollars in thousands)
December 31, 2016
 
% of
revenue
 
December 31, 2015
 
% of
revenue
 
Change
 
% Change
Product revenue
$
246,911

 
64.2
%
 
$
213,448

 
60.0
%
 
$
33,463

 
15.7
 %
Service revenue
108,883

 
28.3
%
 
112,285

 
31.5
%
 
(3,402
)
 
(3.0
)%
Royalty revenue
28,716

 
7.5
%
 
30,196

 
8.5
%
 
(1,480
)
 
(4.9
)%
Total revenue
$
384,510

 
100.0
%
 
$
355,929

 
100.0
%
 
$
28,581

 
8.0
 %

We believe the changes in our product and service revenue continue to be driven by the changing storage environment, including increased market demand for scale-out tiered storage and changes in demand for data protection tape products. Revenue from branded scale-out tiered storage and services increased $4.1 million, or 12%, from the third quarter of fiscal 2016 and $24.0 million, or 26%, from the first nine months of fiscal 2016 due to increased sales of our scale-out storage related media. Revenue from branded data protection products and services increased $7.5 million, or 11%, from the third quarter of fiscal 2016 and $13.7 million, or 7% from the first nine months of fiscal 2016, primarily due to increased revenue in media and disk backup systems, which was partially offset by decreased revenue in tape automation systems. OEM product and service revenue, which primarily is comprised of data protection tape automation systems, decreased $5.4 million and $7.1 million from the third quarter and first nine months of fiscal 2016, respectively.

19

Product Revenue
Total product revenue, which includes sales of our hardware and software products sold through both our Quantum branded and OEM channels, increased $6.8 million and $33.5 million in the third quarter and first nine months of fiscal 2017, respectively, compared to the prior year periods. Revenue from sales of branded products increased 18% and 22% and revenue from sales of products to OEM customers decreased 41% and 19% in the third quarter and first nine months of fiscal 2017, respectively, compared to the prior year periods.
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
December 31, 2016
 
% of revenue
 
December 31, 2015
 
% of revenue
 
Change
 
% Change
Tape automation systems
$
23,882

 
17.9
%
 
$
28,304

 
22.1
%
 
$
(4,422
)
 
(15.6
)%
Disk backup systems
14,326

 
10.7
%
 
11,353

 
8.9
%
 
2,973

 
26.2
 %
Devices and media
15,463

 
11.6
%
 
10,210

 
8.0
%
 
5,253

 
51.4
 %
Scale-out tiered storage*
32,839

 
24.6
%
 
29,805

 
23.2
%
 
3,034

 
10.2
 %
Total product revenue
$
86,510

 
64.8
%
 
$
79,672

 
62.2
%
 
$
6,838

 
8.6
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
 
 
 
 
(Dollars in thousands)
December 31, 2016
 
% of revenue
 
December 31, 2015
 
% of revenue
 
Change
 
% Change
Tape automation systems
$
69,164

 
18.0
%
 
$
74,340

 
20.9
%
 
$
(5,176
)
 
(7.0
)%
Disk backup systems
37,832

 
9.8
%
 
29,921

 
8.4
%
 
7,911

 
26.4
 %
Devices and media
42,781

 
11.1
%
 
32,639

 
9.2
%
 
10,142

 
31.1
 %
Scale-out tiered storage*
97,134

 
25.3
%
 
76,548

 
21.5
%
 
20,586

 
26.9
 %
Total product revenue
$
246,911

 
64.2
%
 
$
213,448

 
60.0
%
 
$
33,463

 
15.7
 %
 
 
 
 
 
 
 
 
 
 
 
 
* Scale-out tiered storage was referred to as “scale-out storage solutions” in our previous filings.
 
 
 
 

Revenue from tape automation systems decreased in the third quarter and the first nine months of fiscal 2017 compared to the prior year periods due to decreases of $5.1 million and $5.6 million, respectively, in OEM tape automation systems, partially offset by increases of $0.7 million and $0.4 million, respectively, in branded tape automation systems.
Revenue from disk backup systems increased in the third quarter and the first nine months of fiscal 2017 compared to the prior year periods primarily due to increased sales of DXi 6900.
Product revenue from devices, which includes tape drives and removable hard drives, and non-royalty media sales increased during the third quarter and first nine months of fiscal 2017 compared to the prior year periods primarily due to higher sales of branded media.

Our scale-out tiered storage revenue increased during the third quarter and first nine months of fiscal 2017 compared to the prior year period primarily due to increased sales of scale-out storage automation.
Service Revenue
Service revenue is primarily comprised of hardware service contracts, which are typically purchased by our customers to extend the warranty, to provide faster service response time, or both. Service revenue decreased during the third quarter and first nine months of fiscal 2017 due to decreased service revenue from our data protection products, partially offset by increased revenue from branded service contracts for our scale-out tiered storage.
Royalty Revenue
Royalty revenue decreased during the third quarter and the first nine months of fiscal 2017 compared to the prior year periods primarily due to decreased media royalties from LTO generation 1 through 5, partially offset by increased media royalties from LTO 7.

20

Gross Margin
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
December 31, 2016
 
Gross
margin %
 
December 31, 2015
 
Gross
margin %
 
Change
 
Basis
point
change
Product gross margin
$
23,186

 
26.8
%
 
$
23,349

 
29.3
%
 
$
(163
)
 
(250
)
Service gross margin
21,287

 
58.4
%
 
21,549

 
58.1
%
 
(262
)
 
30

Royalty gross margin
10,529

 
100.0
%
 
11,277

 
100.0
%
 
(748
)
 
—

Gross margin
$
55,002

 
41.2
%
 
$
56,175

 
43.9
%
 
$
(1,173
)
 
(270
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
 
 
 
 
(Dollars in thousands)
December 31, 2016
 
Gross
margin %
 
December 31, 2015
 
Gross
margin %
 
Change
 
Basis
point
change
Product gross margin
$
69,103

 
28.0
%
 
$
56,792

 
26.6
%
 
$
12,311

 
140

Service gross margin
63,555

 
58.4
%
 
61,761

 
55.0
%
 
1,794

 
340

Royalty gross margin
28,716

 
100.0
%
 
30,196

 
100.0
%
 
(1,480
)
 
—

Gross margin
$
161,374

 
42.0
%
 
$
148,749

 
41.8
%
 
$
12,625

 
20

Product Margin
Product gross margin decreased 250 basis points during the third quarter of fiscal 2017 compared to the prior year period primarily due to a shift in revenue mix from higher margin products to lower margin products.
Product gross margin increased 140 basis points during the first nine months of fiscal 2017 compared to the prior year period primarily due to improved leverage on fixed costs from increased product revenue.
Service Margin
Service gross margin increased 30 basis points in the third quarter of fiscal 2017 compared to the prior year period primarily due to a decrease in third party maintenance expense.
Service gross margin increased 340 basis points in the first nine months of fiscal 2017 compared to the prior year period primarily due to the cost reduction actions described above, which resulted in a decrease in compensation and benefits from lower staffing levels and lower external repair expense.
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.
Research and Development Expenses
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
December 31, 2016
 
% of
revenue
 
December 31, 2015
 
% of
revenue
 
Change
 
%
Change
Research and development
$
10,579

 
7.9
%
 
$
11,148

 
8.7
%
 
$
(569
)
 
(5.1
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
 
 
 
 
(Dollars in thousands)
December 31, 2016
 
% of
revenue
 
December 31, 2015
 
% of
revenue
 
Change
 
%
Change
Research and development
$
33,038

 
8.6
%
 
$
37,841

 
10.6
%
 
$
(4,803
)
 
(12.7
)%
The decrease in research and development expense in the third quarter and first nine months of fiscal 2017 compared to the prior year periods was primarily due to the cost reduction actions described above.
The largest spending reduction in the third quarter of fiscal 2017 compared to the prior year period was a decrease of $0.4 million in compensation and benefits from lower staffing levels.

21

The largest spending reductions in the first nine months of fiscal 2017 compared to the prior year period were a decrease of $3.1 million in compensation and benefits from lower staffing levels, followed by decreases of $0.4 million in external service provider expense and $0.3 million in expensed equipment. Additionally, we had a $0.6 million decrease in depreciation expense in the first nine months of fiscal 2017 compared to the prior year period due to lower capital expenditures.
Sales and Marketing Expenses
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
December 31, 2016
 
% of
revenue
 
December 31, 2015
 
% of
revenue
 
Change
 
%
Change
Sales and marketing
$
25,145

 
18.8
%
 
$
28,212

 
22.0
%
 
$
(3,067
)
 
(10.9
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
 
 
 
 
(Dollars in thousands)
December 31, 2016
 
% of
revenue
 
December 31, 2015
 
% of
revenue
 
Change
 
%
Change
Sales and marketing
$
77,658

 
20.2
%
 
$
83,860

 
23.6
%
 
$
(6,202
)
 
(7.4
)%
The decrease in sales and marketing expense in the third quarter and first nine months of fiscal 2017 compared to the prior year periods was primarily due to the cost reduction actions described above.
The largest spending reductions in the third quarter of fiscal 2017 compared to the prior year period were a decrease of $2.0 million in compensation and benefits from lower staffing levels, followed by a $0.9 million decrease in advertising and marketing expense.
The largest spending reductions in the first nine months of fiscal 2017 compared to the prior year period were a decrease of $4.1 million in compensation and benefits from lower staffing levels, followed by decreases of $0.5 million in advertising and marketing expense, $0.4 million in travel expense, $0.4 million in sponsored employee activities and $0.4 million in external service provider expense.
General and Administrative Expenses
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
December 31, 2016
 
% of
revenue
 
December 31, 2015
 
% of
revenue
 
Change
 
%
Change
General and administrative
$
12,130

 
9.1
%
 
$
13,488

 
10.5
%
 
$
(1,358
)
 
(10.1
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
 
 
 
 
(Dollars in thousands)
December 31, 2016
 
% of
revenue
 
December 31, 2015
 
% of
revenue
 
Change
 
%
Change
General and administrative
$
37,662

 
9.8
%
 
$
41,610

 
11.7
%
 
$
(3,948
)
 
(9.5