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QUANTUM CORP /DE/ - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) 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-------------------------------------------------------------------------------- Table of Contents 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-------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS Revenue Three Months Ended (Dollars in thousands) % of % of September 30, 2014 revenue September 30, 2013 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) % of % of September 30, 2014 revenue September 30, 2013 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-------------------------------------------------------------------------------- Table of Contents 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-------------------------------------------------------------------------------- Table of Contents 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) Basis Gross Gross point September 30, 2014 margin % September 30, 2013 margin % Change 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) Basis Gross Gross point September 30, 2014 margin % September 30, 2013 margin % Change 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-------------------------------------------------------------------------------- Table of Contents 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) % of % of % September 30, 2014 revenue September 30, 2013 revenue Change Change Research and development $ 15,157 11.2 % $ 16,359 12.4 % $ (1,202 ) (7.3 )% Six Months Ended (Dollars in thousands) % of % of % September 30, 2014 revenue September 30, 2013 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) % of % of % September 30, 2014 revenue September 30, 2013 revenue Change Change Sales and marketing $ 28,218 20.9 % $ 29,995 22.8 % $ (1,777 ) (5.9 )% Six Months Ended (Dollars in thousands) % of % of % September 30, 2014 revenue September 30, 2013 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) % of % of % September 30, 2014 revenue September 30, 2013 revenue Change Change General and administrative $ 14,085 10.4 % $ 14,795 11.3 % $ (710 ) (4.8 )% Six Months Ended (Dollars in thousands) % of % of % September 30, 2014 revenue September 30, 2013 revenue Change Change General and administrative $ 28,456 10.8 % $ 29,484 10.6 % $ (1,028 ) (3.5 )% 18-------------------------------------------------------------------------------- Table of Contents 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) % of % of % September 30, 2014 revenue September 30, 2013 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) % of % of % September 30, 2014 revenue September 30, 2013 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) % of % of % September 30, 2014 revenue September 30, 2013 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) % of % of % September 30, 2014 revenue September 30, 2013 revenue Change Change Other income and expense $ 215 0.2 % $ 46 - % $ 169 367.4 % Six Months Ended (Dollars in thousands) % of % of % September 30, 2014 revenue September 30, 2013 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-------------------------------------------------------------------------------- Table of Contents Income Taxes Three Months Ended (Dollars in thousands) % of % of % September 30, 2014 pre-tax income September 30, 2013 pre-tax loss Change Change Income tax provision $ 356 22.2 % $ 534 (7.3 )% $ (178 ) (33.3 )% Six Months Ended (Dollars in thousands) % of % of % September 30, 2014 pre-tax loss September 30, 2013 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-------------------------------------------------------------------------------- Table of Contents 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-------------------------------------------------------------------------------- Table of Contents 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-------------------------------------------------------------------------------- Table of Contents 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. CRITICAL ACCOUNTING ESTIMATES AND POLICIES Our discussion and analysis of the financial condition and results of operations is based on the accompanying unaudited Condensed Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these statements requires us to make significant estimates and judgments about future uncertainties that affect reported assets, liabilities, revenues and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions believed to be reasonable under the circumstances. In the event that estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current information. The accounting estimates requiring our most difficult, subjective or complex judgments because these matters are inherently uncertain are unchanged. These critical accounting estimates and policies have been disclosed in our Annual Report on Form 10-K for the year ended March 31, 2014 filed with the Securities and Exchange Commission on June 6, 2014. |