QUANTUM CORP /DE/ - Quarter Report: 2011 December (Form 10-Q)

Form 10-Q
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Commission File Number 1-13449
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QUANTUM CORPORATION
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Incorporated Pursuant to the Laws of the State of Delaware

IRS Employer Identification Number 94-2665054

1650 Technology Drive, Suite 800, San Jose, California 95110

(408) 944-4000
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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 o

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 o

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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of the close of business on February 3, 2012, approximately 234.3 million shares of Quantum Corporation’s common stock were issued and outstanding.

QUANTUM CORPORATION

INDEX

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

QUANTUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)

See accompanying Notes to Condensed Consolidated Financial Statements.

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QUANTUM CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
(Unaudited)

See accompanying Notes to Condensed Consolidated Financial Statements.

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QUANTUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)

See accompanying Notes to Condensed Consolidated Financial Statements.

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QUANTUM CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1: BASIS OF PRESENTATION

Quantum Corporation (“Quantum”, the “Company”, “us” or “we”) (NYSE: QTM), founded in 1980, is a global expert in data protection and big data management. Combining focused expertise, customer-driven innovation and platform independence, we provide a comprehensive, integrated range of disk, tape and software solutions to solve data protection and big data management challenges supported by our sales and service organization. We work closely with a broad network of distributors, value-added resellers (“VARs”), direct marketing resellers, original equipment manufacturers (“OEMs”) and other suppliers to meet customers’ evolving data protection and big data management needs.

The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of Quantum and its wholly-owned subsidiaries. On June 13, 2011, we acquired Pancetera Software, Inc. (“Pancetera”), and Pancetera’s results of operations are included in our Condensed Consolidated Statement of Operations from that date. 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 Consolidated Balance Sheet as of March 31, 2011 has been derived from the audited financial statements at that date. However, it does not include all of the information and notes 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, 2011 included in our Annual Report on Form 10-K, as filed with the Securities and Exchange Commission on June 14, 2011.

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES; NEW ACCOUNTING STANDARDS

Significant Accounting Policies

Except for the business combination policy noted below, the significant accounting policies used in the preparation of our Condensed Consolidated Financial Statements are unchanged and are disclosed in our Annual Report on Form 10-K for the year ended March 31, 2011, as filed with the Securities and Exchange Commission on June 14, 2011.

We allocate the purchase price paid to the assets acquired and liabilities assumed in a business combination at their estimated fair values as of the acquisition date. Any excess purchase price above the identified net tangible and intangible assets and assumed liabilities is allocated to goodwill. We consider fair value to be the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy is used to assess the fair value of assets acquired and liabilities assumed. We evaluate the tangible and intangible assets as well as liabilities and contingencies of the acquired company.

New Accounting Standards Adopted

In the first quarter of fiscal 2012, we adopted the goodwill impairment guidance for reporting units with zero or negative carrying amounts. Adoption of this standard did not have an impact on our financial position or results of operations.

In the first quarter of fiscal 2012, we adopted the guidance for disclosure of supplementary pro forma information for business combinations. Adoption of this standard did not have an impact on our financial position or results of operations, other than the additional disclosures included in the notes to the Condensed Consolidated Financial Statements.

Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”), which amends the accounting standards for fair value measurements and disclosures. ASU 2011-04 provides clarifications about the application of existing fair value measurement and disclosure requirements. In addition, ASU 2011-04 changes how to measure fair value of financial instruments managed within a portfolio and how to apply premiums and discounts. There are also additional disclosures required. ASU 2011-04 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We will apply this standard beginning in fiscal 2013 and do not anticipate adoption will impact our statements of financial position or results of operations.

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In June 2011, the FASB issued Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (“ASU 2011-05”) and in December 2011, the FASB issued Accounting Standards Update No. 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 (“ASU 2011-12”). ASU 2011-05 requires that components of other comprehensive income be presented in a single continuous statement of comprehensive income or in two separate but consecutive statements of net income and its components followed immediately by a statement of total other comprehensive income. ASU 2011-12 defers the reclassification adjustments that were initially required in ASU 2011-05. Both ASU 2011-05 and ASU 2011-12 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, or our fiscal 2013. We are considering early adoption of ASU 2011-05 and ASU 2011-12. Adoption of these ASUs will affect presentation only and will not impact our statements of financial position or results of operations.

In September 2011, the FASB issued Accounting Standards Update No. 2011-08, Intangibles—Goodwill and Other (Topic 350) Testing Goodwill for Impairment (“ASU 2011-08”). ASU 2011-08 provides entities the option to perform a qualitative assessment for step one impairment testing. ASU 2011-08 is effective for fiscal years beginning after December 15, 2011; however, early adoption is permitted if the current fiscal year test has not been performed. We plan to early adopt ASU 2011-08 in the fourth quarter of fiscal 2012 and do not anticipate adoption will impact our statements of financial position or results of operations.

NOTE 3: ACQUISITION

On June 13, 2011, in order to enhance our product offerings and technology portfolio we acquired Pancetera pursuant to a statutory merger in exchange for approximately $11.0 million, comprised of $8.2 million in cash and $2.8 million in Quantum common stock. We acquired all outstanding shares of Pancetera and assumed all of Pancetera’s outstanding unvested stock options according to the option exchange ratio defined in the merger agreement with Pancetera. We also assumed unvested restricted Pancetera common stock in accordance with the merger agreement. Pancetera’s results of operations are included in our Condensed Consolidated Statements of Operations and Cash Flows from the June 13, 2011 acquisition date.

The acquisition was recorded under the acquisition method of accounting, resulting in the purchase price being allocated to the assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase price over the assets acquired and liabilities assumed was recorded as goodwill. The preliminary allocation of assets acquired and liabilities assumed is set forth below (in thousands):

In performing our purchase price allocation, we considered, among other factors, our intention for future use of acquired assets, analyses of historical financial performance and estimates of future performance of Pancetera’s existing and future products. The fair value of current assets, property and equipment and current liabilities was based on market prices at the acquisition date. The fair value of amortizable intangible assets and in-process research and development (“IPR&D”) was based, in part, on a valuation using a discounted cash flow approach and other valuation techniques as well as management’s estimates and assumptions.

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The amortizable intangible assets are all related to developed technology and are included in purchased technology within Note 6: “Intangible Assets and Goodwill.” Purchased technology, which comprises products that have reached technological feasibility, was primarily related to SmartRead^®. SmartRead is patented technology, primarily comprised of a set of algorithms that reduce storage input-output when performing maintenance tasks such as backup, replication or migration of virtual machines. Pancetera products containing the SmartRead technology included SmartView ^TM and SmartMotion ^TM, which have been rebranded as vmPRO software solutions. Purchased technology intangible assets also include a combination of Pancetera processes, patents and trade secrets related to the design and development of these products. This proprietary know-how can be leveraged to develop new technology and improve our products. The SmartRead purchased technology intangible asset has an amortization period of four years.

IPR&D represents incomplete Pancetera research and development projects that had not reached technological feasibility as of the acquisition date. Due to the nature of IPR&D, the expected life is indeterminate and we periodically evaluate for attainment of technological feasibility or impairment. Technological feasibility is established when an enterprise has completed all planning, designing, coding and testing activities that are necessary to establish that a product can be produced to meet its design specifications including functions, features and technical performance requirements. The value assigned to IPR&D was determined by considering the importance of each project to our overall development plan, estimating costs to develop the purchased IPR&D into commercially viable products, estimating the resulting net cash flows from the projects when completed and discounting the net cash flows using a discount rate of 18% to their present value based on the percentage of completion of the IPR&D projects.

The goodwill as a result of this acquisition is not expected to be deductible for tax purposes. The results of operations for the third quarter and first nine months of fiscal 2012 included immaterial revenue and a $0.6 million and $1.7 million net loss, respectively, of Pancetera since the acquisition date. In addition, we incurred acquisition expenses of $0.3 million during the first nine months of fiscal 2012 which are included in general and administrative expense in our Condensed Consolidated Statements of Operations.

The following unaudited supplemental pro forma information presents the combined results of operations of Quantum and Pancetera as if the acquisition had occurred as of the beginning of fiscal 2011. The first nine months of fiscal 2011 supplemental pro forma earnings were adjusted to include $1.0 million in nonrecurring acquisition expenses incurred in the first nine months of fiscal 2012. This amount has been excluded from the first nine months of fiscal 2012 supplemental pro forma earnings (in thousands):

NOTE 4: FAIR VALUE

The assets acquired and liabilities assumed from Pancetera were recorded at their respective fair values on the acquisition date. The following fair value disclosures are in regard to the remainder of our assets and liabilities.

The assets measured and recorded at fair value on a recurring basis consist of money market funds which are valued using quoted market prices at the respective balance sheet dates and are level 1 fair value measurements (in thousands):

We have certain non-financial assets that are measured at fair value on a non-recurring basis when there is an indicator of impairment, and they are recorded at fair value only when an impairment is recognized. These assets include property and equipment, amortizable intangible assets, IPR&D and goodwill. We did not record impairments to any non-financial assets in the third quarter or first nine months of fiscal 2012 or 2011. We do not have any non-financial liabilities measured and recorded at fair value on a non-recurring basis.

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We have financial liabilities for which we are obligated to repay the carrying value. The carrying value and fair value of these financial liabilities at December 31, 2011 and March 31, 2011 were as follows (in thousands):

NOTE 5: INVENTORIES

Manufacturing inventories and service parts inventories consisted of the following (in thousands):

NOTE 6: INTANGIBLE ASSETS AND GOODWILL

Intangible assets are evaluated for impairment whenever indicators of impairment are present. During the third quarter of fiscal 2012 and 2011, we considered whether there were any indicators of impairment for both our goodwill and our long-lived assets, including amortizable and indefinite-lived intangible assets, and determined there were none.

The following provides a summary of the carrying value of amortizable intangible assets (in thousands):

Total intangible amortization expense was $4.7 million and $16.1 million for the three and nine months ended December 31, 2011, respectively, and was $5.9 million and $22.5 million for the three and nine months ended December 31, 2010, respectively.

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We evaluate goodwill for impairment annually during the fourth quarter of our fiscal year, or more frequently when indicators of impairment are present. The following provides a summary of the carrying value of goodwill (in thousands):

NOTE 7: ACCRUED WARRANTY

The quarterly and year-to-date changes in the accrued warranty balance were (in thousands):

NOTE 8: RESTRUCTURING CHARGES

In fiscal 2011 and continuing in fiscal 2012, restructuring actions to consolidate operations supporting the business were the result of strategic management decisions. We did not incur restructuring charges in the third quarter of fiscal 2012 or 2011. The types of restructuring expense (benefit) for the nine months ended December 31, 2011 and 2010 were (in thousands):

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Fiscal 2011

For the nine months ended December 31, 2010, severance and benefits expense from additional positions eliminated was mostly offset by facility reversals. The facility reversals were primarily due to negotiating settlements for lease liabilities on two vacated facilities in the U.S. for amounts lower than the outstanding lease contracts.

Accrued Restructuring

The following tables show the activity and the estimated timing of future payouts for accrued restructuring (in thousands):

Overview

Our stock incentive plans (“Plans”) are broad-based, long-term retention programs that are intended to attract and retain talented employees and align stockholder and employee interests. The Plans provide for the issuance of stock options, stock appreciation rights, stock purchase rights and long-term performance awards to our employees, officers and affiliates. We also have an employee stock purchase plan (“Purchase Plan”) that allows for the purchase of stock at 85% of fair market value at the date of grant or the exercise date, whichever value is less.

During the first quarter of fiscal 2012, we assumed outstanding unvested options and unvested restricted shares of Pancetera which were exchanged into options and unvested restricted shares of Quantum common stock, respectively, in accordance with the merger agreement. As of June 13, 2011, Pancetera had approximately 0.8 million unvested stock options and 0.5 million unvested restricted shares outstanding. Based on the exchange ratio of 0.2403 calculated in accordance with the formula in the merger agreement, we assumed the outstanding unvested options, which are exercisable for an aggregate of 194,000 shares of Quantum common stock. Based on the relative cash and stock consideration for Pancetera shares per the merger agreement, the unvested restricted shares became 33,000 unvested restricted shares of Quantum common stock and $200,000 in cash held in escrow. The estimated fair value of unvested Pancetera options, unvested restricted shares and cash held in escrow related to future service is being recognized over the remaining service period.

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The Black-Scholes option pricing model is used to estimate the fair value of options granted under our Plans, options assumed and rights to acquire stock granted under our Purchase Plan.

Share-Based Compensation

The following table summarizes share-based compensation (in thousands):

No stock options were granted in the third quarter of fiscal 2012 and 2011. The weighted-average grant date fair values of employee stock option grants, as well as the weighted-average assumptions used in calculating these values for the first nine months of fiscal 2012 and 2011, were based on estimates at the date of grant as follows:

The weighted-average fair value of stock options assumed from Pancetera, as well as the weighted-average assumptions used in calculating these values were based on estimates at the acquisition date as follows:

The assumed options have a 10 year contractual life from the original grant date.

Restricted Stock

The fair value of the restricted stock units granted is the intrinsic value as of the respective grant date since the restricted stock units are granted at no cost to the employees. The weighted-average grant date fair values of restricted stock units granted during the third quarter and first nine months of fiscal 2012 were $2.27 and $3.15, respectively. The weighted-average grant date fair values of restricted stock units granted during the third quarter and first nine months of fiscal 2011 were $2.73 and $1.95, respectively.

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Stock Purchase Plan

Under the Purchase Plan, rights to purchase shares are typically granted during the second and fourth quarter of each fiscal year. The value of rights to purchase shares granted in the first nine months of fiscal 2012 and fiscal 2011, respectively, was estimated at the date of the grant. The weighted-average grant date fair values and the assumptions used in calculating fair values for the nine month periods ended December 31, 2011 and 2010 are as follows:

Stock Activity

Stock Options

A summary of activity relating to our stock options follows (options and aggregate intrinsic value in thousands):

A summary of activity relating to our restricted stock follows (shares in thousands):

Income tax provisions for the third quarter and first nine months of fiscal 2012 were $0.5 million and $1.4 million, respectively. The tax benefit for the third quarter of fiscal 2011 was $0.7 million and the tax expense for the first nine months of fiscal 2011 was $0.1 million. Income tax provisions for the third quarter and first nine months of fiscal 2012 reflect expenses for foreign income taxes and state taxes. The tax benefit for the third quarter of fiscal 2011 was primarily due to the release of tax liabilities in foreign jurisdictions. The tax expense for the first nine months of fiscal 2011 was primarily comprised of foreign income taxes and state taxes largely reduced by the release of tax liabilities in foreign jurisdictions.

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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.

NOTE 11: NET INCOME PER SHARE

The following is our computation of basic and diluted net income per share (in thousands, except per-share data):

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

• For the third quarter and first nine months of fiscal 2012, 31.2 million weighted equivalent shares for the convertible subordinated notes were excluded. For the third quarter and first nine months of fiscal 2011, 15.6 million and 5.2 million weighted equivalent shares, respectively, for the convertible subordinated notes were excluded.
• For the third quarter and first nine months of fiscal 2012, options to purchase 9.2 million and 9.5 million weighted average shares, respectively, were excluded. For the third quarter and first nine months of fiscal 2011, options to purchase 4.4 million and 11.6 million weighted average shares, respectively, were excluded.
• Unvested restricted stock and restricted stock units of 5.3 million and 3.7 million weighted average shares for the third quarter and first nine months of fiscal 2012, respectively, were excluded. Negligible unvested restricted stock units were excluded for the third quarter of fiscal 2011. Unvested restricted stock units for 0.4 million weighted average shares for the first nine months of fiscal 2011 were excluded.

NOTE 12: COMPREHENSIVE INCOME

Total comprehensive income, net of tax, if any, for the three and nine months ended December 31, 2011 and 2010 was (in thousands):

NOTE 13: LEGAL PROCEEDINGS

On September 12, 2011, Compression Technology Solutions LLC (“CTS”) filed a patent infringement lawsuit against a group of companies, consisting of Quantum, CA., Inc., EMC Corporation, Hewlett-Packard Company, International Business Machines Corp., NetApp, Inc. and Quest Software, Inc., in the U.S. District Court in the Eastern District of Missouri, alleging that certain unspecified products of the defendants, characterized as “deduplication software systems,” and, in the case of Quantum, including Quantum’s “DXi Series Deduplication software,” fall within the scope of patent 5,414,650. CTS is seeking injunctive relief, as well as the recovery of monetary damages, including treble damages for willful infringement. We do not believe we infringe the CTS patent; we believe that the CTS patent is invalid, and we intend to defend ourselves vigorously. Due to the inherent uncertainty of litigation, we cannot identify probable or estimable damages related to the lawsuit.

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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 expectations relating to growing our branded disk systems and software solutions and branded tape automation systems revenue; (2) our expectation that we will continue to derive a substantial majority 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 repayments 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 belief that our ultimate liability in any infringement claims made by any third parties against us will not be material to us; (6) our expectations regarding patent infringement actions; and (7) our business goals, objectives, key focuses, opportunities and prospects which 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) the successful execution of our strategy to expand our business in new directions; (6) our ability to successfully introduce new products; (7) our ability to capitalize on changes in market demand; (8) our ability to achieve anticipated gross margin levels; (9) U.S. and global macroeconomic conditions; and (10) 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”), founded in 1980, is a global expert in data protection and big data management. Combining focused expertise, customer-driven innovation and platform independence, we provide a comprehensive, integrated range of disk, tape and software solutions to solve data protection and big data management challenges supported by our sales and service organization. We work closely with a broad network of distributors, value-added resellers (“VARs”), direct marketing resellers, original equipment manufacturers (“OEMs”) and other suppliers to meet customers’ evolving data protection and big data management needs. Our stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “QTM.”

We offer a comprehensive range of solutions for data protection and big data management challenges providing performance and value to organizations of all sizes, from small businesses to multinational enterprises. We believe our combination of expertise, innovation and platform independence allows us to solve customers’ data protection and big data management issues more easily, cost-effectively and securely. Our open systems solutions are designed to provide significant storage efficiencies and cost savings while minimizing risk and protecting customers’ prior investments. They include the DXi^®-Series disk-based deduplication and replication systems for fast backup and restore, Scalar^® tape automation products for disaster recovery and long-term data retention, StorNext^® data management software and appliances for high-performance file sharing and archiving and vmPRO^™ solutions for protecting virtual machine data. In addition, we have the global scale and scope to support our worldwide customer base. We offer a full range of service with support available in more than 100 countries.

We earn our revenue from the sale of products, systems and services through an array of channel partners and our sales force to reach end user customers, which range in size from small businesses to multinational enterprises. Our products are sold under both the Quantum brand name and the names of various OEM customers. We have a broad portfolio of disk systems, software solutions, tape automation systems, tape drives and other devices and media. Our data management software provides technology for shared workflow applications and multi-tiered archiving in high-performance, large-scale storage environments. We also offer vmPRO software, a virtualization data protection software with advanced utilities designed to dramatically improve and simplify virtual data protection in midrange and larger data centers. The majority of our disk systems and tape automation systems include software features that provide disk and tape integration capabilities with our core deduplication and replication technologies. In addition, our service offerings include a broad range of coverage options to provide the level of support for the widest possible range of information technology (“IT”) environments.

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We have implemented a number of initiatives in the past several quarters in an effort to drive branded revenue growth. One key initiative for fiscal 2012 has been to grow the independent channel for Quantum branded products. Another key area of focus for fiscal 2012 is continuing to expand and improve our products and solutions, with emphasis on branded disk systems and software solutions, including introducing and ramping sales of the StorNext appliance family and virtual offerings in addition to expanding professional services and custom engineering. We believe our current tape automation systems, disk systems and software solutions provide excellent value propositions for customers and we plan to continue to expand the breadth and depth of our product and service offerings. We are focused on advancing these objectives to take advantage of our improved position in the markets in which we participate to grow revenue and create shareholder value.

We stated that for the third quarter of fiscal 2012, we were focused on continuing to grow revenue by expanding the breadth of our product portfolio, including the introduction of several new products as well as continuing to increase sales through channel partners. We began to position our products as they relate to the data protection and the big data management and archive markets. Our data protection solutions include our DXi-Series family of products, Scalar tape automation products, devices and media as well as virtual environment offerings that include vmPRO software and vmPRO appliances. The products that address the big data management and archive market include StorNext software and our StorNext appliances.

In the third quarter of fiscal 2012, we introduced several new products and continued to increase channel traction. Branded revenue grew 3% from the third quarter of fiscal 2011 due to adding new customers, increasing our channel traction and revenue contributions from new products. New customer acquisitions were strong in the data protection market, with notable new customers for midrange and enterprise tape automation products and for disk systems. Our focus on growing our existing channel and deepening our relationships with those partners continued in the third quarter of fiscal 2012. These efforts to increase sales through channel partners were reflected in increased disk systems revenue from sales through the independent channel, more channel partners selling disk solutions and a greater number of new customers obtained through the channel compared to the third quarter of fiscal 2011.

As noted above, one key area of focus is continuing to expand and improve our products and solutions, with emphasis on branded disk systems and software solutions, including additional StorNext appliances. During the third quarter of fiscal 2012, we continued to expand and improve our product portfolio. Notable new data protection solutions introduced during the quarter included the DXi4601, the vmPRO 4601 appliance, the NDX NAS appliance and the RDX removable disk library. In addition, we added dual robot functionality to the Scalar i6000 and in mid-December, released DXi 2.1 software on the DXi8500. New products introduced in the third quarter of fiscal 2012 that address the big data management and archive market included our midrange StorNext Archive Enabled Library (“SAEL”) solution, and we began shipping our Q-Series storage systems. A number of products within our portfolio received industry recognition during the third quarter of fiscal 2012, including awards for quality. We believe that our sales execution has improved as a result of our improved product portfolio, increasing our market opportunities and awareness with end users.

Our big data management strategy is a key to our overall growth objectives. Revenue from big data management and archive products increased 18% from the third quarter of fiscal 2011 and 6% sequentially. Our StorNext software offering serves the needs of our install base customers and traditional use cases where users have decided on their hardware choices and want to deploy StorNext to create their solution. Our StorNext appliances enable us to broaden the available market and more deeply penetrate new market segments by allowing customers to purchase the whole solution from us.

For the fourth quarter of fiscal 2012, we are focused on continuing to enhance our relationships with existing partners and adding new partners. In addition, we are launching an initiative to grow revenue from products and solutions for small and medium businesses. The small and medium business market segment is one in which we historically had been strong; however, that market has evolved over the years and, in many cases, moved to other technologies. We have introduced several new products including the DXi4601, vmPRO 4601 and NAS and RDX solutions that along with our existing tape automation products, we believe provide more relevant and valuable solutions to small and medium businesses. Another initiative we are implementing in the fourth quarter of fiscal 2012 is to expand end user awareness of our data protection and our big data management and archive solutions. We expect to continue these initiatives into fiscal 2013 to increase revenue from our data protection and big data and archive solutions, including revenue from solutions for the small and medium business market. The fourth fiscal quarter is historically a seasonally weak quarter, and we recognize continued risk from economic uncertainly, particularly in Europe. However, we believe the key to revenue growth for us is to continue to leverage our expertise as well as our intelligent and unique solutions to provide customers superior value to meet their needs in data protection and big data management and archive. We continue to focus on increasing revenue from our branded products, especially disk systems and software solutions.

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Results

Revenue decreased $2.7 million, or 2%, in the third quarter of fiscal 2012 compared to the third quarter of fiscal 2011 primarily due to expected reductions in OEM and royalty revenue. Product revenue from OEM customers decreased 12% while revenue from branded products increased 5% from the third quarter of fiscal 2011 due to continued improvement in sales volumes through our partners. The royalty revenue decrease was primarily from maturing DLT media. Our efforts to increase revenue from branded disk systems and software solutions resulted in an 18% increase from the third quarter of fiscal 2011, primarily due to the addition of revenue from the recently introduced family of StorNext appliances, such as the StorNext Archive Enabled Library products, and midrange disk system revenue increases. In addition, branded tape automation revenue increased 1% in a declining market, an indicator of growing our market share. Service revenue decreased primarily due to a decline in OEM repair activity and lower hardware service contract revenues from end of service life on higher revenue service contracts for certain legacy branded tape automation products. Our focus on growing the branded business in recent years is reflected in the greater proportion of non-royalty revenue from our branded business, at 81% in the third quarter of fiscal 2012 compared to 78% in the third quarter of fiscal 2011.

Our gross margin percentage decreased 40 basis points in the third quarter of fiscal 2012 to 42.5% primarily due to decreased revenue and changes in our revenue mix, including decreased royalty revenue, mostly offset by decreased intangible amortization. Product gross margin percentage increased 70 basis points from the third quarter of fiscal 2011, primarily due to decreased intangible amortization. Service gross margin percentage decreased 160 basis points primarily due to the loss of higher revenue service contracts for certain legacy branded tape automation products that reached end of life.

Operating expenses increased 4% to $66.7 million for the third quarter of fiscal 2012 primarily due to increased salaries and benefits from investing in our sales and marketing and general and administrative teams. Income from operations was $7.0 million for a 4.0% operating margin in the third quarter of fiscal 2012 compared to a 6.5% operating margin in the third quarter of fiscal 2011. The largest contributor to the decline in operating margin was decreased revenue, specifically lower service revenue and royalty revenue, followed by incremental operating expenses in the third quarter of fiscal 2012.

Interest expense decreased $2.3 million, or 49%, compared to the third quarter of fiscal 2011 primarily due to refinancing higher rate subordinated term debt with convertible subordinated notes in fiscal 2011 and to a lesser extent from principal prepayments of senior term debt. We generated $16.1 million in cash from operating activities in the third quarter of fiscal 2012 and ended the quarter with $63.2 million in cash and cash equivalents, including restricted cash. Our outstanding senior term debt balance was $68.6 million at December 31, 2011.

RESULTS OF OPERATIONS

Revenue

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Total revenue decreased in the third quarter and first nine months of fiscal 2012 primarily due to anticipated decreases in OEM and royalty revenue. However, branded revenue increased from the third quarter and first nine months of fiscal 2011 primarily due increased branded disk and software sales. Branded product revenue increases compared to the third quarter of fiscal 2011 were primarily in Asia and to a lesser extent in North America.

Product Revenue

Our product revenue, which includes sales of our hardware and software products sold through both our Quantum branded and OEM channels, increased $0.9 million from the third quarter of fiscal 2011 primarily due to increased branded disk systems and software solutions revenue, largely offset by anticipated decreases in OEM revenue. Product revenue decreased $2.5 million compared to the first nine months of fiscal 2011 primarily due to an anticipated decrease in OEM deduplication software revenue, partially offset by an increase in branded disk systems and software solutions revenue. The relationship with a significant OEM customer for deduplication software changed from partner to competitor due to its purchase of one of our competitors in a prior year. Revenue from sales of branded products increased 5% in the third quarter of fiscal 2012 and 6% in the first nine months of fiscal 2012 compared to the respective prior year periods.

As noted earlier, a primary goal for fiscal 2012 is to grow revenue from disk systems and software solutions. For the third quarter of fiscal 2012, disk systems and software solutions revenue increased 18% compared to the third quarter of fiscal 2011 primarily due to the addition of revenue from our StorNext appliances as well as increased sales of our midrange disk systems. As a result of these revenue increases, disk systems and software solutions comprised a greater proportion of total revenue in the third quarter of fiscal 2012 compared to the prior year period. These increases were partially offset by a decrease in enterprise disk systems revenue.

For the first nine months of fiscal 2012, disk systems and software solutions revenue increased 2% primarily from increased midrange disk systems sales and the addition of StorNext appliance revenue. Midrange disk system sales increased 48%, largely from our DXi6700 family of products, and branded software and appliance revenue increased 18% from the third quarter of fiscal 2011. These increases were largely offset by the expected decrease in OEM deduplication software revenue due to revenue recognized in accordance with contractual requirements in the first quarter of fiscal 2011 and to a lesser extent from decreased enterprise disk systems revenue due to fewer large orders. Enterprise disk systems revenue was lower than planned primarily due to lower revenue from our legacy enterprise disk product, and to a lesser extent from decreased sales of the DXi 8500.

Tape automation systems revenue decreased 3% and 1% from the third quarter and first nine months of fiscal 2011, respectively, primarily due to expected decreases in sales to OEM customers. For the third quarter of fiscal 2012, OEM tape automation systems revenues from enterprise, midrange and entry-level products each decreased by a similar amount. For the first nine months of fiscal 2012, midrange and entry level tape automation systems revenue from OEM customers decreased as anticipated compared to the prior year period, while OEM enterprise tape automation product sales increased compared to the prior year. Largely offsetting these decreases, we had branded tape automation systems revenue increases of 1% and 4% in the third quarter and first nine months of fiscal 2012, respectively, primarily due to increased enterprise sales and to a lesser extent from midrange sales.

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Product revenue from devices, which includes tape drives and removable hard drives, and non-royalty media sales declined 8% and 4% from the third quarter and first nine months of fiscal 2011, respectively, primarily due to decreased sales of older technology devices, including branded and OEM devices that reached, or are nearing, end of life. These decreases were partially offset by increased branded media sales in the third quarter and first nine months of fiscal 2012 compared to the same periods in fiscal 2011. The increase in branded media revenue is primarily due to the events in Japan earlier this year and resulting concern of shortages and supply disruption in the market. Consistent with our expectations, revenue from OEM devices and media has become an immaterial part of our overall revenue mix.

Service Revenue

Service revenue includes revenue from sales of hardware service contracts, product repair, installation and professional services. Hardware service contracts are typically purchased by our customers to extend their warranties, to provide faster service response times, or both. Service revenue decreased 5% in both the third quarter and the first nine months of fiscal 2012 compared to the prior year periods primarily due to lower hardware service contract revenues from end of service life on higher revenue service contracts for certain legacy branded tape automation products and from decreased OEM product repair services. Service contracts on newer technology products provide lower revenue than service contracts on certain older technology products nearing end of service life.

Royalty Revenue

Tape media royalties decreased 10% and 14% in the third quarter and first nine months of fiscal 2012, respectively, compared to the third quarter and first nine months of fiscal 2011 primarily due to expected decreases of maturing DLT media sold by media licensees. These decreases were largely from a continued worldwide decline in demand for older media technology.

Gross Margin

*Gross margin for the nine months ended December 31, 2011 includes $0.3 million of restructuring benefit related to cost of revenue.

The 40 basis point decrease in gross margin percentage for the third quarter of fiscal 2012 compared to the third quarter of fiscal 2011 was the net result of largely offsetting factors. The primary factor decreasing gross margin was lower total revenue and changes in our revenue mix, including decreased royalty revenue. Largely offsetting this was a decrease in intangible amortization expense due to certain intangibles becoming fully amortized during fiscal 2011 and 2012. The gross margin percentage in the first nine months of fiscal 2012 compared to the first nine months of fiscal 2011 was essentially unchanged and also the net result of offsetting factors. The primary factor increasing gross margin percentage for the first nine months of fiscal 2012 was decreased intangible amortization expense from certain intangibles becoming fully amortized. This was offset by decreased OEM deduplication software revenue as noted earlier and lower royalty revenue in the first nine months of fiscal 2012 compared to the first nine months of fiscal 2011.

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We had an increased percentage of products sold through our branded channels compared to the third quarter and first nine months of fiscal 2011. Branded sales comprised 81% of non-royalty revenue for both the third quarter and first nine months of fiscal 2012 compared to 78% and 77% for the third quarter and first nine months of fiscal 2011, respectively. Sales of branded products typically generate higher gross margins than sales to our OEM customers; however, OEM deduplication software revenue provides one of our highest product margins.

Product Margin

Product gross margin dollars increased $1.1 million, or 2%, on a product revenue increase of 1% compared to the third quarter of fiscal 2011, and our product gross margin rate increased 70 basis points. These increases were primarily due to decreased intangible amortization expense, partially offset by changes in our product revenue mix. For the first nine months of fiscal 2012, product gross margin dollars increased slightly and the product gross margin rate increased 40 basis points primarily due to decreased intangible amortization expense for the first nine months of fiscal 2012, mostly offset by a decrease in high margin OEM deduplication software revenue compared to the first nine months of fiscal 2011.

Service Margin

Service gross margin dollars decreased $1.3 million and service gross margin percentage decreased 160 basis points primarily due to a $2.0 million decrease in service revenue in the third quarter of fiscal 2012, including the loss of higher revenue service contracts for certain legacy branded tape automation products that have reached end of life compared to the third quarter of fiscal 2011. Partially offsetting the lower service margin dollars was reduced costs for external service providers as a result of bringing repair of certain product lines in-house that previously were repaired by external service providers.

For the first nine months of fiscal 2012, service gross margin dollars were unchanged while the service gross margin percentage increased 210 basis points despite a decrease in service revenue of $5.8 million. The increased service margin percentage was primarily due to reduced costs from lower inventory allowance expense. We had higher inventory allowance expense in the first nine months of fiscal 2011 due to end of service life plans for several products. In addition, we had a decrease in external service provider expense compared to the first nine months of fiscal 2011 and a change in the mix of services for OEM repairs and for our branded products under contract. External service provider expense decreased due to a combination of bringing repair of certain product lines in-house and negotiating lower rates on the renewals of contracts with certain service providers. Our service activities for the first nine months of fiscal 2012 reflected a greater proportion of revenue from branded products under contract, which have relatively higher margins than margins for OEM repair services.

Research and Development Expenses

The decrease in research and development expenses compared to the third quarter of fiscal 2011 was primarily due to $0.2 million reductions in both small equipment expense and travel expense. Research and development projects during the third quarter of fiscal 2011 required more equipment than was required for projects under development during the third quarter of fiscal 2012.

The increase in research and development expenses compared to the first nine months of fiscal 2011 was primarily due to a $1.1 million increase in salaries and benefits from investments in our disk systems and software development teams for new product development efforts, partially offset by a $0.4 million decrease in licensing costs from an agreement that concluded in the prior year.

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Sales and Marketing Expenses

The increase in sales and marketing expense for the third quarter and first nine months of fiscal 2012 was largely due to a $1.3 million and $4.2 million increase, respectively, in compensation and benefits primarily due to increased commissionable revenue.

General and Administrative Expenses

The increase in general and administrative expenses for the third quarter and first nine months of fiscal 2012 compared to the third quarter and first nine months of fiscal 2011 was primarily due to a $0.6 million and $1.6 million increase in salaries and benefits, respectively, from the prior year periods. Stock compensation expense was the largest component of increased salaries and benefits for both the third quarter and first nine months of fiscal 2012 largely due to grants in fiscal 2012 for promotions and merit increases. In addition, in the third quarter of fiscal 2012 we had a $0.3 million increase in legal expense, a $0.3 million increase in net value-added tax (“VAT”) provisions and a $0.3 million net increase in bad debt expense. The increased legal expense was due to efforts to defend ourselves against the patent infringement lawsuit brought by Compression Technology Solutions LLC (“CTS”). Increased VAT provisions were due to interest income received on VAT refunds during the third quarter of fiscal 2011 that did not repeat in fiscal 2012. Bad debt expense was higher in the third quarter of 2012 as a result of lower allowance for doubtful accounts requirements in the third quarter of fiscal 2011. For the first nine months of fiscal 2012, we also had an increase of $0.6 million in facility expenses primarily due to refurbishing costs that were higher than estimated at lease inception for certain facilities returned to their respective lessors at the end of the lease terms.

The patent infringement lawsuit brought by CTS is discussed in more detail in Note 13: “Legal Proceedings.” Due to the inherent uncertainty of litigation, we cannot identify probable or estimable damages related to the lawsuit at this time. We may incur higher than typical legal costs to defend ourselves while the lawsuit is ongoing.

Restructuring Charges

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The increase in restructuring charges for the first nine months of fiscal 2012 was primarily due to facility restructuring charges for a facility vacated in India in the second quarter of fiscal 2012 compared to benefits in the first nine months of fiscal 2011 from negotiated lease settlements for amounts lower than the outstanding lease contracts. This increase in restructuring expense was partially offset by the restructuring benefit related to cost of revenue due to actual payments lower than estimated on a supplier relationship exited in fiscal 2011. For additional information, refer to Note 8: “Restructuring Charges.” We may incur additional charges in the future related to further cost reduction steps.

Gain on Sale of Patents

In the second quarter of fiscal 2012, we had a $1.5 million gain on the sale of certain patents. Under the patent sale agreement, we retain a royalty-free license for these patents. We may enter into similar transactions in the future.

Interest Income and Other, Net

The increase in interest income and other, net for the third quarter of fiscal 2012 was primarily due to $0.9 million in fees for an amendment to our senior secured credit agreement in the third quarter of fiscal 2011 that was not repeated. This was mostly offset by prior year gains on investments in private technology venture limited partnerships that were not repeated and net foreign exchange losses from the U.S. dollar strengthening against the euro and the Swiss franc in the third quarter of fiscal 2012.

The decrease in interest income and other, net for the first nine months of fiscal 2012 was primarily due to prior year gains on investments in private technology venture limited partnerships that were not repeated and, to a lesser extent, from net foreign exchange losses due to the U.S. dollar strengthening against the euro and Swiss franc during the first nine months of fiscal 2012 compared to the prior year period. This decrease was partially offset by $0.9 million in fees for an amendment to our senior secured credit agreement in the third quarter of fiscal 2011 that was not repeated.

Interest Expense

Interest expense decreased in the third quarter and first nine months of fiscal 2012 primarily due to refinancing higher rate subordinated term debt with convertible subordinated debt in the third quarter of fiscal 2011 and to a lesser extent from principal payments reducing the outstanding balance of our senior term debt. Interest expense includes the amortization of debt issuance costs for our debt facilities.

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Loss on Debt Extinguishment

During the third quarter of fiscal 2011, we issued $135.0 million aggregate principal of 3.5% convertible subordinated notes. We used the proceeds from the issuance to fully repay our subordinated term debt. In connection with this debt extinguishment, we wrote off $1.2 million of unamortized debt costs related to the subordinated term debt.

Income Taxes

Income tax provisions for the third quarter and first nine months of fiscal 2012 reflect expenses for foreign income taxes and state taxes. The tax benefit for the third quarter of fiscal 2011 was primarily due to the release of tax liabilities in foreign jurisdictions. The tax expense for the first nine months of fiscal 2011 was primarily comprised of foreign income taxes and state taxes largely reduced by the release of tax liabilities in foreign jurisdictions. 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 tables detail intangible asset amortization expense within our Condensed Consolidated Statements of Operations (in thousands):

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The decrease in intangible expense in the third quarter and first nine months of fiscal 2012 compared to the third quarter and first nine months of fiscal 2011 was primarily due to certain intangibles becoming fully amortized during fiscal 2011 as well as in the second quarter of fiscal 2012. For further information regarding amortizable intangible assets, refer to Note 6: “Intangible Assets and Goodwill.”

Share-based Compensation

The following table summarizes share-based compensation within our Condensed Consolidated Statements of Operations (in thousands):

The increase in share-based compensation for the third quarter and first nine months of fiscal 2012 compared to the third quarter and first nine months of fiscal 2011 was primarily due to an increase in restricted stock units granted in the second quarter of fiscal 2012, largely due to merit increases for our workforce.

LIQUIDITY AND CAPITAL RESOURCES

Following is a summary of cash flows from operating, investing and financing activities (in thousands):

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Nine Months Ended December 31, 2011

The $30.8 million difference between reported net income and cash provided by operating activities during the nine months ended December 31, 2011 was primarily due to $43.6 million in non-cash items, the largest of which were amortization, depreciation, share-based compensation and service parts lower of cost or market adjustment. In addition, we had a $7.1 million increase in accounts payable primarily due to the timing of payments and increased purchases. These were partially offset by a $17.5 million increase in manufacturing inventories primarily due to purchasing materials to meet projected third quarter fiscal 2012 product sales and from securing a sufficient supply of hard disk drives for forecast needs into early fiscal 2013 due to supply constraints from flooding in Thailand.

Cash used in investing activities reflects $8.5 million of equipment purchases during the first nine months of fiscal 2012 and $8.2 million of cash paid, net of cash acquired, for our acquisition of Pancetera. Equipment purchases were primarily for engineering equipment and testing hardware to support product development activities.

Cash used in financing activities during the first nine months of fiscal 2012 was primarily due to $35.7 million of principal payments on the senior term debt, partially offset by $7.5 million in proceeds received from the exercise of stock options and issuance of shares under the employee stock purchase plan.

Nine Months Ended December 31, 2010

The $22.7 million difference between reported net income and cash provided by operating activities during the nine months ended December 31, 2010 was primarily due to $52.3 million in non-cash expenses, the largest of which were amortization, depreciation, service parts lower of cost or market adjustment and share-based compensation. This was partially offset by a $15.4 million increase in accounts receivable and a $9.3 million decrease in deferred revenue. Accounts receivable increased primarily due to an increase in revenue in the third quarter of fiscal 2011 compared to the fiscal quarter ended March 31, 2010. The decrease in deferred revenue was primarily due to the final utilization of an OEM deduplication software prepayment during the first nine months of fiscal 2011.

Cash used in investing activities reflects $9.3 million of equipment purchases during the nine months ended December 31, 2010. Equipment purchases were primarily for engineering test equipment to support product development activities.

Cash used in financing activities during the first nine months of fiscal 2011 was primarily due to repaying a net $55.2 million of outstanding debt, partially offset by $13.6 million received from the issuance of common stock.

Capital Resources and Financial Condition

We have made progress in increasing operating income in recent periods, and we continue to focus on improving our operating performance, including increasing revenue in higher margin areas of the business and continuing to improve margins in an effort to return to consistent profitability and to 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 repayments, contractual obligations and sustain operations for at least the next 12 months. This belief is dependent upon our ability to achieve revenue and gross margin projections and to continue to control operating expenses in order to provide positive cash flow from operating activities. 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.

Under the Credit Suisse credit agreement (“CS credit agreement”), we have the ability to borrow up to $50 million under a senior secured revolving credit facility which expires July 12, 2012. As of December 31, 2011, we have letters of credit totaling $0.1 million reducing the amounts available to borrow on this revolver to $49.9 million. Quarterly, we are required to pay a 0.5% commitment fee on undrawn amounts under the revolving credit facility.

Our outstanding term debt under the CS credit agreement was $68.6 million at December 31, 2011. This loan matures on July 12, 2014 and has a variable interest rate. The interest rate on the term loan was 3.80% at December 31, 2011. We are required to make quarterly interest and principal payments on the term loan. In addition, on an annual basis, we are required to perform a calculation of excess cash flow which may require an additional payment of the principal amount in certain circumstances. The annual calculations of excess cash flow have not required additional payments. There is a blanket lien on all of our assets under the CS credit agreement in addition to certain financial and reporting covenants. As of December 31, 2011, we were in compliance with all debt covenants.

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We have $135 million aggregate principal amount outstanding of 3.50% convertible subordinated notes due November 15, 2015. Semi-annual interest payments are required on these notes.

Generation of positive cash flow from operating activities has historically been and will continue to be an important source of our cash to fund operating needs and meet our current and long-term obligations. We cannot provide assurance that the actions we have taken in the past or any actions we may take in the future to improve our operating results will ensure a consistent, sustainable and sufficient level of net income and positive cash flow from operating activities to fund, sustain or grow our businesses. 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: