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QUANTUM CORP /DE/ - Quarter Report: 2013 September (Form 10-Q)


 

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


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Form 10-Q

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x       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
  For the quarterly period ended September 30, 2013
 
OR
 
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
  For the transition period from         to         
 
Commission File Number 1-13449

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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

224 Airport Parkway, San Jose, California 95110

(408) 944-4000

Former Address: 1650 Technology Drive, Suite 700, San Jose, California, 95110

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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 ¨

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes x   No ¨

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨       Accelerated filer x       Non-accelerated filer ¨       Smaller reporting company ¨

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

As of the close of business on November 6, 2013, there were 248,114,430 shares of Quantum Corporation’s common stock issued and outstanding.

 



QUANTUM CORPORATION

INDEX

      Page
Number
      PART I—FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets 1
Condensed Consolidated Statements of Operations 2
Condensed Consolidated Statements of Comprehensive Loss 3  
Condensed Consolidated Statements of Cash Flows 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25
Item 4. Controls and Procedures 26
PART II—OTHER INFORMATION
Item 1.   Legal Proceedings 26
Item 1A. Risk Factors 27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 38
Item 3. Defaults Upon Senior Securities 38
Item 4. Mine Safety Disclosures   38
Item 5. Other Information 38
Item 6. Exhibits 38
SIGNATURE 39
EXHIBIT INDEX 40



PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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

      September 30, 2013       March 31, 2013
Assets
Current assets:
       Cash and cash equivalents $          73,829 $      68,976
       Restricted cash 3,255 3,023
       Accounts receivable, net of allowance for doubtful accounts of $70 and $62, respectively 87,097 97,546
       Manufacturing inventories 49,847 53,075
       Service parts inventories 30,064 35,368
       Other current assets 10,748 12,192
                            Total current assets 254,840 270,180
   
Long-term assets:
       Property and equipment, less accumulated depreciation 19,437 21,456
       Intangible assets, less accumulated amortization 8,364 12,813
       Goodwill 55,613 55,613
       Other long-term assets 9,541 9,531
                            Total long-term assets 92,955 99,413
    $ 347,795 $ 369,593
Liabilities and Stockholders’ Deficit
Current liabilities:
       Accounts payable $ 33,417 $ 47,634
       Accrued warranty 6,489 7,520
       Deferred revenue, current 84,273 91,108
       Accrued restructuring charges, current 3,529 3,021
       Accrued compensation 25,902 30,964
       Other accrued liabilities 21,766 20,188
                            Total current liabilities 175,376 200,435
   
Long-term liabilities:
       Deferred revenue, long-term 38,778 38,393
       Convertible subordinated debt 205,000 205,000
       Other long-term liabilities 9,433 9,547
                            Total long-term liabilities 253,211 252,940
  
Stockholders’ deficit:
       Common stock, $0.01 par value; 1,000,000 shares authorized; 247,904 and 243,080 shares
              issued and outstanding at September 30, 2013 and March 31, 2013, respectively
2,479 2,431
       Capital in excess of par     434,887 427,611
       Accumulated deficit (524,583 ) (520,016 )
       Accumulated other comprehensive income 6,425 6,192
                     Total stockholders’ deficit (80,792 )     (83,782 )
$ 347,795 $ 369,593

See accompanying Notes to Condensed Consolidated Financial Statements.

1



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

Three Months Ended Six Months Ended
   September 30, 2013    September 30, 2012    September 30, 2013    September 30, 2012
Product revenue $            84,707 $            100,041 $            170,676 $            193,826
Service revenue 36,194 35,711 72,686   71,798
Royalty revenue 10,529 11,562 36,037 22,543
       Total revenue 131,430 147,314 279,399 288,167
Cost of product revenue 57,882 67,884 116,665 132,634
Cost of service revenue 17,116 20,232 36,347 40,536
Restructuring charges 89 89
       Total cost of revenue 75,087 88,116 153,101 173,170
              Gross margin 56,343 59,198 126,298 114,997
Operating expenses:
       Research and development 16,359 19,475 33,053 38,024
       Sales and marketing 29,995 34,441 60,153 68,885
       General and administrative 14,813 15,279 29,510 32,059
       Restructuring charges 208 2,767
    Total operating expenses 61,375 69,195 125,483 138,968
              Income (loss) from operations (5,032 ) (9,997 ) 815 (23,971 )
Other income and expense 46 (110 ) 421 (448 )
Interest expense (2,440 ) (1,817 ) (4,879 ) (3,666 )
              Loss before income taxes (7,426 ) (11,924 ) (3,643 ) (28,085 )
Income tax provision 534 370 924 869
              Net loss $ (7,960 ) $ (12,294 ) $ (4,567 ) $ (28,954 )
 
Basic and diluted net loss per share: $ (0.03 ) $ (0.05 ) $ (0.02 ) $ (0.12 )
 
Weighted average common and common equivalent shares:
       Basic and Diluted 247,074 239,856 246,569 238,251

See accompanying Notes to Condensed Consolidated Financial Statements.

2



QUANTUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
(Unaudited)

Three Months Ended Six Months Ended
    September 30, 2013     September 30, 2012     September 30, 2013     September 30, 2012
Net loss $              (7,960 ) $            (12,294 ) $               (4,567 ) $            (28,954 )
       Other comprehensive income, net of taxes:
              Foreign currency translation adjustments 464 659 395 (143 )
              Net unrealized gain (loss) on revaluation of
                     long-term intercompany balances
(98 ) (110 ) (162 ) 174
Total other comprehensive income 366 549 233 31
                     Total comprehensive loss $ (7,594 ) $ (11,745 ) $ (4,334 ) $ (28,923 )

See accompanying Notes to Condensed Consolidated Financial Statements.

3



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

Six Months Ended
      September 30,
2013
      September 30,
2012
Cash flows from operating activities:
              Net loss $       (4,567 ) $       (28,954 )
              Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
                     Depreciation 5,671 6,151
                     Amortization 5,265 8,895
                     Service parts lower of cost or market adjustment 6,659 4,700
                     Deferred income taxes 59 274
                     Share-based compensation 6,847 8,013
                     Changes in assets and liabilities:
                            Accounts receivable 10,449 11,328
                            Manufacturing inventories 185 1,499
                            Service parts inventories 1,688 2,019
                            Accounts payable (14,245 ) (13,347 )
                            Accrued warranty (1,031 ) 318
                            Deferred revenue (6,449 ) (11,058 )
                            Accrued restructuring charges 359 (828 )
                            Accrued compensation (5,195 ) (4,546 )
                            Other assets and liabilities 2,533 1,014
       Net cash provided by (used in) operating activities 8,228 (14,522 )
 
Cash flows from investing activities:
              Purchases of property and equipment (3,226 ) (6,691 )
              (Increase) decrease in restricted cash (117 ) 169
              Purchases of other investments (534 ) (2,169 )
              Return of principal from other investments - 208
       Net cash used in investing activities (3,877 ) (8,483 )
 
Cash flows from financing activities:
              Payment of taxes due upon vesting of restricted stock (1,770 ) (1,882 )
              Proceeds from issuance of common stock 2,247 2,599
       Net cash provided by financing activities 477 717
 
Effect of exchange rate changes on cash and cash equivalents 25 (1 )
 
Net increase (decrease) in cash and cash equivalents 4,853 (22,289 )
Cash and cash equivalents at beginning of period 68,976 51,261
       Cash and cash equivalents at end of period $ 73,829 $ 28,972

See accompanying Notes to Condensed Consolidated Financial Statements.

4



QUANTUM CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1: BASIS OF PRESENTATION

Quantum Corporation (“Quantum”, the “Company”, “us” or “we”), founded in 1980, is a global expert in data protection and big data management. We provide solutions for storing and protecting information in physical, virtual, cloud and big data environments that are designed to help customers be certain they are maximizing the value of their data over its entire lifecycle. With our solutions, customers can better adapt in a world of continuing change by keeping and protecting more data for a longer period of time while reducing costs and increasing return on investment. We work closely with a broad network of distributors, value-added resellers (“VARs”), direct marketing resellers (“DMRs”), original equipment manufacturers (“OEMs”) and other suppliers to meet customers’ evolving data protection and big data management needs. Our stock is traded on the New York Stock Exchange under the symbol QTM.

The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of Quantum and our wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated. We reclassified the long-term portion of accrued restructuring from current accrued restructuring charges to other long-term liabilities in the March 31, 2013 Condensed Consolidated Balance Sheet to conform to current period presentation. In the Condensed Consolidated Statements of Cash Flows prior period income taxes payable has been reclassified into other assets and liabilities to conform to current period presentation. These reclassifications had no impact on total assets, total liabilities, income (loss) from operations, net loss or net cash used in operating activities. The interim financial statements reflect all adjustments, consisting of normal recurring adjustments that, in the opinion of management, are necessary for a fair statement of the results for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year. The Condensed Consolidated Balance Sheet as of March 31, 2013 has been derived from the audited financial statements at that date, but it does not include all disclosures required by accounting principles generally accepted in the United States for complete financial statements. The accompanying financial statements should be read in conjunction with the audited Consolidated Financial Statements for the fiscal year ended March 31, 2013 included in our Annual Report on Form 10-K, as filed with the Securities and Exchange Commission on June 7, 2013.

Recent Accounting Pronouncements

In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (“ASU 2013-11”). ASU 2013-11 requires an entity to present an unrecognized tax benefit as a reduction of a deferred tax asset for an net operating loss (“NOL”) carryforward, or similar tax loss or tax credit carryforward, rather than as a liability when (1) the uncertain tax position would reduce the NOL or other carryforward under the tax law of the applicable jurisdiction and (2) the entity intends to use the deferred tax asset for that purpose. ASU 2013-11 does not require new recurring disclosures. ASU 2013-11 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. We will adopt ASU 2013-11 prospectively in the first quarter of fiscal 2015 and do not anticipate adoption will impact our statements of financial position or results of operations.

NOTE 2: REVISION OF PRIOR PERIOD FINANCIAL STATEMENTS

During the first quarter of fiscal 2014, we identified an error related to certain allowances recorded for estimated future price adjustments on products and services sold to our customers that had accumulated over a significant number of years, resulting in a $1.5 million cumulative overstatement of revenue and accounts receivable at April 1, 2013. Revenue for fiscal 2013, 2012 and 2011 was $0.1 million overstated, $0.1 million understated and $0.1 million overstated, respectively, for this error. In addition, we identified a $0.7 million under accrual of sales commission expense for the fourth quarter of fiscal 2013 that was not recorded in fiscal 2013. The cumulative effect of recording these two items in the first quarter of fiscal 2014 would have been a $2.2 million reduction in net income.

5



In addition, we had previously identified the following items:

  • A $0.7 million overstatement of DXi OEM software revenue in fiscal 2010 that was corrected as an out-of-period adjustment in fiscal 2011;
  • A $0.5 million understatement of royalty revenue in fiscal 2011 that was corrected as an out-of-period adjustment in fiscal 2012; and
  • A $0.9 million understatement of payroll tax expense on commissions that was corrected as an out-of-period adjustment in fiscal 2013. Of the cumulative adjustment, $0.3 million related to fiscal 2012 and $0.6 million related to periods prior to fiscal 2011.

We evaluated these errors in accordance with the Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 99 and determined that the errors were not material to our results of operations, financial position or cash flows in our previously issued financial statements, and therefore amendments of previously filed reports are not required. However, if the entire correction of the error was recorded during the first quarter of fiscal 2014, the impact would be significant to the quarter ended June 30, 2013. As a result, we have determined that it is appropriate to revise our prior period financial statements in accordance with the SEC's Staff Accounting Bulletin No. 108 for the items discussed above. The revisions to correct these items in the applicable prior periods are reflected in the financial information herein and will be reflected in future filings containing such financial information. The revisions had no net impact on our Consolidated Statements of Cash Flows or net income (loss) per diluted share for any prior period.

The impact of these revisions to our Consolidated Balance Sheets at March 31, 2013 and 2012; our Consolidated Statements of Operations for the years ended March 31, 2013, 2012 and 2011; and our Condensed Consolidated Statements of Operations for each quarter of fiscal 2013 and 2012 and the six months ended September 30, 2013 and 2012 is summarized as follows (in thousands, except per share amounts):

Consolidated Balance Sheets

The As Reported column includes certain reclassifications to conform to the current presentation.

As of March 31,
2013 2012
      As Reported       As Revised       As Reported       As Revised
Accounts receivable $     99,093 $     97,546 $     110,840 $     109,399
Total current assets 271,727 270,180 281,221 279,780
Total assets 371,140 369,593 395,348 393,907
Accrued compensation 30,311 30,964 31,971 32,835
Total current liabilities 199,782 200,435 209,910 210,774
Accumulated deficit (517,816 ) (520,016 ) (465,397 ) (467,702 )
Total stockholders’ deficit (81,582 ) (83,782 ) (46,680 ) (48,985 )
Total liabilities and stockholders’ deficit 371,140 369,593 395,348 393,907

Consolidated Statements of Operations – Annual

Fiscal Year Ended March 31,
2013 2012 2011
      As Reported       As Revised       As Reported       As Revised       As Reported       As Revised
Product revenue $     399,043 $     398,937 $     451,340 $     451,468 $     456,903 $     457,505
Royalty revenue 44,492 44,492 56,666 56,154 64,272 64,784
Total revenue 587,572 587,466 652,370 651,986 672,270 673,384
Cost of service revenue 79,647 79,604 88,459 88,466 94,311 94,311
Total cost of revenue 346,921 346,878 378,535 378,542 389,288 389,288
Gross margin 240,651 240,588 273,835 273,444 282,982 284,096
Sales and marketing expenses 137,041 136,873 130,938 131,239 122,768 122,767
Total operating expenses 283,351 283,183 270,143 270,444 258,278 258,277
Income (loss) from operations (42,700 ) (42,595 ) 5,192 4,500 24,704 25,819
Income (loss) before income taxes (51,258 ) (51,153 ) (7,922 ) (8,614 ) 4,554 5,669
Net income (loss) (52,419 ) (52,314 ) (8,809 ) (9,501 ) 4,541 5,656
Diluted net income (loss) per share (0.22 ) (0.22 ) (0.04 ) (0.04 ) 0.02 0.02

6



Consolidated Statements of Operations – Quarterly – Fiscal 2013

Fiscal 2013
1st Quarter 2nd Quarter
      As Reported       As Revised       As Reported       As Revised
Product revenue $     93,811 $     93,785 $     100,067 $     100,041
Total revenue 140,879 140,853 147,340 147,314
Cost of service revenue 20,334 20,304 20,232 20,232
Total cost of revenue 85,084 85,054 88,116 88,116
Gross margin 55,795 55,799 59,224 59,198
Sales and marketing expenses 35,278 34,444 34,441 34,441
Total operating expenses 70,607 69,773 69,195 69,195
Loss from operations (14,812 ) (13,974 ) (9,971 ) (9,997 )
Loss before income taxes (16,999 ) (16,161 ) (11,898 ) (11,924 )
Net loss (17,498 ) (16,660 ) (12,268 ) (12,294 )
Diluted net loss per share (0.07 ) (0.07 ) (0.05 ) (0.05 )
   
3rd Quarter 4th Quarter
      As Reported       As Revised       As Reported       As Revised
Product revenue $    112,517 $    112,490 $    92,648 $    92,621
Total revenue 159,395 159,368 139,958 139,931
Cost of service revenue 19,360 19,360 19,721 19,708
Total cost of revenue 91,367 91,367 82,354 82,341
Gross margin 68,028 68,001 57,604 57,590
Sales and marketing expenses 33,588 33,588 33,734 34,400
Total operating expenses 73,656 73,656 69,893 70,559
Loss from operations (5,628 ) (5,655 ) (12,289 ) (12,969 )
Loss before income taxes (7,798 ) (7,825 ) (14,563 ) (15,243 )
Net loss (8,146 ) (8,173 ) (14,507 ) (15,187 )
Diluted net loss per share (0.04 ) (0.04 ) (0.06 ) (0.06 )

Six Months Ended
September 30, 2012
      As Reported       As Revised
Product revenue $    193,878 $    193,826
Total revenue 288,219 288,167
Cost of service revenue 40,566 40,536
Total cost of revenue 173,200 173,170
Gross margin 115,019 114,997
Sales and marketing expenses 69,719 68,885
Total operating expenses 139,802 138,968
Loss from operations (24,783 ) (23,971 )
Loss before income taxes (28,897 ) (28,085 )
Net loss (29,766 ) (28,954 )
Diluted net loss per share (0.12 ) (0.12 )

7



Consolidated Statements of Operations – Quarterly – Fiscal 2012

Fiscal 2012
1st Quarter 2nd Quarter
      As Reported       As Revised       As Reported       As Revised
Product revenue $       102,268 $       102,300 $       115,126 $       115,158
Royalty revenue 14,571 14,059 14,015 14,015
Total revenue 153,535 153,055 165,039 165,071
Cost of service revenue 22,066 22,064 21,129 21,132
Total cost of revenue 90,273 90,271 93,428 93,431
Gross margin 63,262 62,784 71,611 71,640
Sales and marketing expenses 30,525 30,263 31,115 31,171
Total operating expenses 64,943 64,681 66,211 66,267
Income (loss) from operations (1,681 ) (1,897 ) 6,900 6,873
Income (loss) before income taxes (4,588 ) (4,804 ) 3,866 3,839
Net income (loss) (5,226 ) (5,442 ) 3,561 3,534
Diluted net income (loss) per share (0.02 ) (0.02 ) 0.01 0.01
    
3rd Quarter 4th Quarter
As Reported As Revised As Reported As Revised
Product revenue $       124,081 $       124,113 $       109,865 $       109,897
Royalty revenue 14,049 14,049 14,031 14,031
Total revenue 173,492 173,524 160,304 160,336
Cost of service revenue 22,537 22,548 22,727 22,722
Total cost of revenue 99,775 99,786 95,059 95,054
Gross margin 73,717 73,738 65,245 65,282
Sales and marketing expenses 33,350 33,736 35,948 36,069
Total operating expenses 66,738 67,124 72,251 72,372
Income (loss) from operations 6,979 6,614 (7,006 ) (7,090 )
Income (loss) before income taxes 4,387 4,022 (11,587 ) (11,671 )
Net income (loss) 3,914 3,549 (11,058 ) (11,142 )
Diluted net income (loss) per share 0.02 0.02 (0.05 ) (0.05 )

Six Months Ended
September 30, 2011
As Reported       As Revised
Product revenue $       217,394 $       217,458
Royalty revenue 28,586 28,074
Total revenue 318,574 318,126
Cost of service revenue 43,195 43,196
Total cost of revenue 183,701 183,702
Gross margin 134,873 134,424
Sales and marketing expenses 61,640 61,434
Total operating expenses 131,154 130,948
Income from operations 5,219 4,976
Loss before income taxes (722 ) (965 )
Net loss (1,665 ) (1,908 )
Diluted net loss per share (0.01 ) (0.01 )

These revisions impacted our Consolidated Statements of Comprehensive Income (Loss) for each period by an amount equal to the impact to net income (loss) for the applicable period.

8



NOTE 3: FAIR VALUE

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

As of
  September 30, 2013       March 31, 2013
Money market funds $       63,769 $       60,496

We did not record impairments to any non-financial assets in the second quarter and first six months of fiscal 2014 or 2013. We do not have any non-financial liabilities measured and recorded at fair value on a non-recurring basis.

We had $205.0 million in convertible subordinated debt at September 30, 2013, and the estimated fair value of our convertible subordinated debt was approximately $206.3 million, based on quoted market prices in less active markets (level 2 fair value measurements). We transferred the fair value level of the convertible subordinated debt to level 2 from level 1 at September 30, 2013 due to our assessment that the convertible subordinated notes were not actively traded during the second quarter of fiscal 2014.

NOTE 4: INVENTORIES

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

As of
September 30, 2013       March 31, 2013
Manufacturing inventories:
       Finished goods $       22,105 $       19,480
       Work in process 6,455 8,633
       Materials and purchased parts 21,287 24,962
$ 49,847 $ 53,075
  
As of
September 30, 2013 March 31, 2013
Service parts inventories:
       Finished goods $ 18,647 $ 19,750
       Component parts 11,417 15,618
$ 30,064 $ 35,368

NOTE 5: INTANGIBLE ASSETS AND GOODWILL

We evaluate our amortizable and indefinite-lived intangible assets (“long-lived assets”) for impairment whenever indicators of impairment exist and concluded the carrying amount of our long-lived assets was recoverable and there was no impairment in the second quarter or first six months of fiscal 2014 and 2013. The following provides a summary of the carrying value of intangible assets (in thousands):

As of
September 30, 2013 March 31, 2013
Gross
Amount
      Accumulated
Amortization
      Net
Amount
      Gross
Amount
      Accumulated
Amortization
      Net
Amount
Purchased technology $       180,613 $       (178,904 ) $       1,709 $       180,613 $       (178,168 ) $       2,445
Trademarks 3,900 (3,900 ) 3,900 (3,900 )
Customer lists 105,719 (99,222 ) 6,497 105,719 (95,509 ) 10,210
In-process research and
       development 158 158 158 158

9



   
As of
September 30, 2013 March 31, 2013
  Gross
Amount
      Accumulated
Amortization
      Net
Amount
      Gross
Amount
      Accumulated
Amortization
      Net
Amount
$       290,390 $       (282,026 ) $       8,364 $       290,390 $       (277,577 ) $       12,813

Total intangible amortization expense was $2.2 million and $4.4 million for the three and six months ended September 30, 2013, respectively, and was $3.7 million and $8.3 million for the three and six months ended September 30, 2012, respectively.

We evaluate goodwill for impairment annually during the fourth quarter of our fiscal year, or more frequently when indicators of impairment are present. There were no changes to goodwill balances during the second quarter or first six months of fiscal 2014. The following table provides a summary of the goodwill balance at both September 30, 2013 and March 31, 2013 (in thousands):

Goodwill       Accumulated
Impairment Losses
      Net Amount
Balance $       394,613 $       (339,000) $       55,613

NOTE 6: ACCRUED WARRANTY

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

Three Months Ended Six Months Ended
September 30,
2013
      September 30,
2012
      September 30,
2013
      September 30,
2012
Beginning balance $       7,015 $       7,797 $       7,520 $       7,586
       Additional warranties issued 1,787 2,579 3,929 5,203
       Adjustments for warranties issued in prior fiscal years (22 ) 273 (82 ) 590
       Settlements (2,291 ) (2,745 ) (4,878 ) (5,475 )
Ending balance $ 6,489 $ 7,904 $ 6,489 $ 7,904

We generally warrant our products against defects for 1 to 3 years. A provision for estimated future costs and estimated returns for credit relating to warranty is recorded when products are shipped and revenue recognized. Our estimate of future costs to satisfy warranty obligations is primarily based on historical trends and, if believed to be significantly different from historical trends, estimates of future failure rates and future costs of repair including materials consumed in the repair, labor and overhead amounts necessary to perform the repair. If future actual failure rates differ from our estimates, we record the impact in subsequent periods. If future actual costs to repair were to differ significantly from our estimates, we record the impact of these unforeseen cost differences in subsequent periods.

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NOTE 7: RESTRUCTURING CHARGES

In the second quarter of fiscal 2014, restructuring actions were primarily the result of continued implementation efforts to further consolidate manufacturing and service activities with contract manufacturers that were initiated the first quarter of fiscal 2014. We had no restructuring expense in the second quarter or first six months of fiscal 2013. The types of restructuring expense for the three and six months ended September 30, 2013 were (in thousands):

Three Months Ended Six Months Ended
September 30,
2013
      September 30,
2012
      September 30,
2013
      September 30,
2012
By expense type  
Severance and benefits $       108 $       $       2,591 $      
Facilities 12 88
Other 177 177
Total $ 297 $ $ 2,856 $

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Accrued Restructuring

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

Three Months Ended September 30, 2013
Severance
and Benefits
      Facilities       Other       Total
Balance as of June 30, 2013 $       3,765 $       2,011 $       $       5,776
       Restructuring charges 503 12 177 692
       Restructuring charges reversal (395 ) (395 )
       Cash payments (748 ) (127 ) (90 ) (965 )
Balance as of September 30, 2013 $ 3,125 $ 1,896 $ 87 $ 5,108
 
Six Months Ended September 30, 2013
Severance
and Benefits
Facilities Other Total
Balance as of March 31, 2013 $ 2,711 $ 2,045 $ $ 4,756
       Restructuring charges 3,539 88 177 3,804
       Restructuring charges reversal (948 ) (948 )
       Cash payments (2,177 ) (237 ) (90 ) (2,504 )
Balance as of September 30, 2013 $ 3,125 $ 1,896 $ 87 $ 5,108
 
As of September 30, 2013
Severance and
Benefits
Facilities Other Total
Estimated timing of future payouts:
       Next twelve months $ 3,125 $ 317 $ 87 $ 3,529
       October 2014 through February 2021 1,579 1,579
$ 3,125 $ 1,896 $ 87 $ 5,108

The $0.5 million of severance and benefit restructuring costs for the three months ended September 30, 2013 was primarily due to further consolidation of sales territories to improve utilization of our global sales team, and the $3.5 million severance and benefit restructuring costs for the six months ended September 30, 2013 was primarily the result of deciding to outsource our manufacturing operations and further consolidate production and service activities. The restructuring charge reversal was primarily due to actual costs being lower than estimated, followed by employees transferring from eliminated positions to fill other staffing needs during the second quarter and first six months of fiscal 2014. Other restructuring expenses were comprised of incremental retention bonuses for certain key employees whose positions are being eliminated, freight charges and travel costs as a result of transitioning toward an outsource model.

We anticipate the $3.1 million and $0.1 million severance and benefits and other restructuring accruals, respectively, will be substantially paid by the end of fiscal 2014. Facility restructuring accruals will be paid in accordance with the respective facility lease terms. The $1.6 million of lease payments scheduled to occur between October 2014 and February 2021 is included in other long-term liabilities in the Condensed Consolidated Balance Sheets.

12



NOTE 8: STOCK INCENTIVE PLANS AND SHARE-BASED COMPENSATION

Share-Based Compensation

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

Three Months Ended Six Months Ended
September 30,
2013
      September 30,
2012
      September 30,
2013
      September 30,
2012
Share-based compensation:
       Cost of revenue $ 523 $ 642 $ 1,051 $ 1,213
       Research and development 908 947 1,776 1,847
       Sales and marketing 1,080 1,246 2,154 2,330
       General and administrative 980 891 1,866 2,623
$ 3,491 $ 3,726 $ 6,847 $ 8,013
 
Share-based compensation by type of award:
       Stock options $ 208 $ 247 $ 440 $ 1,206
       Restricted stock 2,968 3,028 5,706 5,781
       Stock purchase plan 315 451 701 1,026
$ 3,491 $ 3,726 $ 6,847 $ 8,013

Stock Options

No stock options were granted during the second quarter or first six months of fiscal 2014 or 2013. The Black-Scholes option pricing model is used to estimate the fair value of stock options.

Restricted Stock

The fair value of restricted stock units (“RSUs”) granted is the intrinsic value as of the respective grant date since the restricted stock units are granted at no cost to the employees. The weighted-average grant date fair values of RSUs granted during the second quarter and first six months of fiscal 2014 were $1.41 and $1.40, respectively. The weighted-average grant date fair values of RSUs granted during the second quarter and first six months of fiscal 2013 were $1.99 and $2.00, respectively.

During the second quarter of fiscal 2014, we granted 0.8 million RSUs with market conditions (“market RSUs”) and estimated the fair value of these market RSUs using a Monte Carlo simulation model. The number of market RSUs is dependent on Quantum’s common stock achieving certain 60-day average stock price targets as of specified dates, which vest immediately to two years after the specified dates.

The Monte Carlo model requires the input of assumptions including expected volatility, risk-free interest rate and expected term in order to simulate a large number of possible outcomes to provide an estimated fair value of the market RSUs. We used an expected volatility of 66%, a risk free interest rate of 0.5% and expected terms of ten months, twenty two months and thirty four months that mirrors the various vesting dates of the awards. The estimated fair value of the market RSUs was $0.7 million which will be recognized over the respective vesting periods of the awards.

13



Stock Purchase Plan

Under the Stock Purchase Plan, rights to purchase shares are typically granted during the second and fourth quarter of each fiscal year. The value of rights to purchase shares granted in the second quarter and first six months of fiscal 2014 and fiscal 2013, 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 three and six month periods ended September 30, 2013 and 2012 are as follows:

Three and Six Months Ended
September 30,
2013
      September 30,
2012
Option life (in years) 0.5 0.5
Risk-free interest rate 0.07 % 0.15 %
Stock price volatility 47.65 % 74.81 %
Weighted-average grant date fair value $        0.47 $        0.51

Stock Activity

Stock Options

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

Options       Weighted-
Average
Exercise Price
      Weighted-
Average
Remaining
Contractual Term
      Aggregate
Intrinsic Value
Outstanding as of March 31, 2013        16,050 $       2.14
       Exercised (345 ) 1.01
       Forfeited (1,010 ) 2.14
       Expired (2,859 ) 2.06
Outstanding as of September 30, 2013 11,836 $ 2.19 1.89 $       1,953
Vested and expected to vest at September 30, 2013 11,798 $ 2.19 1.88 $ 1,952
Exercisable as of September 30, 2013 11,279 $ 2.18 1.76 $ 1,937

Restricted Stock

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

Shares       Weighted-Average
Grant Date
Fair Value
Nonvested at March 31, 2013 9,887 $       2.43
       Granted 7,403 1.40
       Vested (4,087 ) 2.42
       Forfeited (733 ) 2.16
Nonvested at September 30, 2013        12,470 $ 1.85

NOTE 9: INCOME TAXES

Income tax provisions for the second quarter and first six months of fiscal 2014 were $0.5 million and $0.9 million, respectively, and were $0.4 million and $0.9 million for the second quarter and first six months of fiscal 2013, respectively. Income tax provisions for each of these periods reflect expenses for foreign income taxes and state taxes.

We have provided a full valuation allowance against our U.S. net deferred tax assets due to our history of net losses, difficulty in predicting future results and our conclusion that we cannot rely on projections of future taxable income to realize the deferred tax assets. Significant management judgment is required in determining our deferred tax assets and liabilities and valuation allowances for purposes of assessing our ability to realize any future benefit from our net deferred tax assets. We intend to maintain this valuation allowance until sufficient positive evidence exists to support a reversal or decrease in this allowance. Future income tax expense will be reduced to the extent that we have sufficient positive evidence to support a reversal of, or decrease in, our valuation allowance.

14



NOTE 10: NET LOSS PER SHARE

The following is the computation of basic and diluted net loss per share (in thousands, except per share data):

Three Months Ended Six Months Ended
September 30,
2013
      September 30,
2012
      September 30,
2013
      September 30,
2012
Net loss $       (7,960 ) $      (12,294 ) $      (4,567 ) $      (28,954 )
Weighted average basic and diluted shares 247,074 239,856 246,569 238,251
Basic and diluted net loss per share $ (0.03 ) $ (0.05 ) $ (0.02 ) $ (0.12 )

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

  • For all periods presented, 31.2 million weighted equivalent shares of the 3.50% convertible subordinated notes were excluded. For the second quarter and first six months of fiscal 2014, 42.5 million weighted equivalent shares of the 4.50% convertible subordinated notes were excluded.
  • For the second quarter and first six months of fiscal 2014, options to purchase 13.9 million and 14.9 million weighted average shares, respectively, were excluded. For the second quarter and first six months of fiscal 2013, options to purchase 17.6 million and 18.3 million weighted average shares, respectively, were excluded.
  • Unvested RSUs of 10.9 million and 10.4 million weighted average shares for the second quarter and first six months of fiscal 2014, respectively, were excluded. Unvested RSUs of 10.7 million and 9.7 million weighted average shares for the second quarter and first six months of fiscal 2013, respectively, were excluded.

NOTE 11: LEGAL PROCEEDINGS

Overland

On June 28, 2012, Overland Storage, Inc. (“Overland”) filed a patent infringement lawsuit against Quantum in the U.S. District Court for the Southern District of California, alleging that certain of its automated tape libraries fall within the scope of patents 6,328,766 and 6,353,581. Overland is seeking injunctive relief, as well as the recovery of unspecified monetary damages, including treble damages for willful infringement. We do not believe we infringe the Overland patents and we will defend ourselves vigorously. We do not believe there is a reasonable possibility that we will pay material damages related to this lawsuit.

On August 28, 2012, we filed a lawsuit against Overland in the U.S. District Court for the Southern District of California, for patent infringements of our patents 6,542,787; 6,498,771; 5,925,119 and 5,491,812 by the products in Overland’s NEO tape library and SnapServer product lines. We are seeking injunctive relief and the recovery of monetary damages.

On April 12, 2013, we filed a lawsuit against Overland in the U.S. District Court for the Southern District of California, for patent infringements of our patent 7,263,596 by the products in Overland’s SnapScale product lines. We are seeking injunctive relief and the recovery of monetary damages.

Compression Technology Solutions

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 for 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 was 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 defended ourselves vigorously. In April 2012, our motion to transfer venue was granted and the lawsuit was transferred to the U.S. District Court for the Northern District of California. On May 29, 2013, our motion for summary judgment was granted, with all of the asserted claims held invalid by the District Court, and the lawsuit against Quantum and the other defendants has been dismissed with prejudice. On July 10, 2013, CTS appealed the decision of the District Court to the United States Court of Appeals for the Federal Circuit.

15



ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENT

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements in this report usually contain the words “will,” “estimate,” “anticipate,” “expect,” “believe,” “project” or similar expressions and variations or negatives of these words. All such forward-looking statements including, but not limited to: (1) our goals for future operating performance including increasing revenue, investing wisely in our business, 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

Quantum Corporation (“Quantum”, the “Company”, “us” or “we”), founded in 1980, is a proven global expert in data protection and big data management. We provide solutions for storing and protecting information in physical, virtual and cloud environments and for enabling high performance sharing of content. These solutions are designed to help customers be certain they are maximizing the value of their data over its entire lifecycle. With our products, customers can better adapt in a world of continuing change by keeping and protecting more data for a longer period of time and leveraging it more effectively to meet their business or organizational objectives, while at the same time reducing costs and increasing return on investment. We work closely with a broad network of distributors, value-added resellers (“VARs”), direct marketing resellers (“DMRs”), original equipment manufacturers (“OEMs”) and other suppliers to meet customers’ evolving data protection and big data management needs. Our stock is traded on the New York Stock Exchange under the symbol QTM.

We offer a comprehensive range of solutions for data protection and big data management challenges that provide performance and value to end user customers of all sizes, from small businesses to multinational enterprises. We believe our combination of expertise, innovation and platform independence enables us to solve data protection and big data management issues more easily, cost-effectively and securely. 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 of all sizes. Our products are sold under both the Quantum brand name and the names of various OEM customers. Our data protection solutions include DXi® deduplication systems and Scalar® automated tape libraries that optimize backup and recovery, simplify management and lower cost and our vmPROTM virtual server backup and disaster recovery offerings that protect virtual environments while minimizing the impact to servers and storage. In addition, we also offer software for cloud backup and disaster recovery of physical and virtual servers. For big data environments, we provide StorNext® tiered storage and LattusTM object storage solutions designed to help maximize revenue and results by enabling customers to extract the full value from their digital assets. We have a full range of services and the global scale and scope to support our worldwide customer base.

Our goals for fiscal 2014 are to continue to capitalize on market opportunities to balance the cash flow and operating profit against revenue growth associated with potential opportunities and go-to-market strategies, with an emphasis on delivering results that we expect to be more predictable and controllable. In some cases, as was the case in the second quarter of fiscal 2014, this means we may generate lower overall revenue but more cash flow and profit in order to provide greater operating leverage for future revenue increases. Our revenue growth strategy is focused on leveraging our StorNext and Lattus solutions to drive deeper into big data vertical markets and extend their reach into the data center and the cloud in addition to expanding relationships with our partners and gaining additional access to end users through existing and new channel partners. We continue our efforts to further leverage our tape automation and DXi expertise, our installed product base and our broad data protection product portfolio in order to gain market share in the data center.

During the second quarter of fiscal 2014, we had record quarterly revenue from our big data solutions, largely from object storage solutions and StorNext appliance revenue contributions. We plan to further expand and improve our product and solution offerings in fiscal 2014, with emphasis on software solutions, branded disk systems, next generation object storage, virtual offerings and cloud solutions. New products announced during the second quarter of fiscal 2014 included StorNext 5 software, and we launched Lattus-D, an object storage system for the data center. In addition, we expanded our strategic partnerships to combine our Lattus-D offering with a partner’s software to expand data center environment solutions and provide an object storage based private cloud solution.

16



Results

We had total revenue of $131.4 million in the second quarter of fiscal 2014, an 11% decrease from the second quarter of fiscal 2013, primarily due to lower than expected revenue from sales outside of North America and to the U.S. federal government. Our gross margin percentage increased 270 basis points from the second quarter of fiscal 2013 to 42.9% primarily due to improvements in our service delivery model, partially offset by reduced high-margin royalty revenue. Operating expenses decreased $7.8 million, or 11% from the second quarter of fiscal 2013, primarily from cost controls and spending reductions that we began implementing in the third quarter of fiscal 2013. The largest spending decrease compared to the second quarter of fiscal 2013 was for compensation and benefits as a result of reduced staffing to right-size our workforce in order to align spending with revenue expectations. These cost reductions impacted sales and marketing expenses the most compared to the second quarter of fiscal 2013. Despite the 11% decrease in revenue, we had a $5.0 million loss from operations in the second quarter of fiscal 2014 compared to an operating loss of $10.0 million in the second quarter of fiscal 2013.

Interest expense increased 34% to $2.4 million primarily due to refinancing our revolving debt balance in the third quarter of fiscal 2013 with 4.50% convertible subordinated notes. We generated $8.2 million of cash from operating activities in the first six months of fiscal 2014 compared to a net use of cash from operating activities of $14.5 million in the first half of fiscal 2013.

RESULTS OF OPERATIONS

Revenue

Three Months Ended
(In thousands)       September 30,
2013
      % of
revenue
      September 30,
2012
      % of
revenue
      Change       %
Change
Product revenue $       84,707 64.5 % $ 100,041 67.9 % $ (15,334 ) (15.3 )%
Service revenue   36,194   27.5 % 35,711 24.2 % 483 1.4 %
Royalty revenue 10,529   8.0 % 11,562 7.9 % (1,033 ) (8.9 )%
       Total revenue $ 131,430      100.0 % $       147,314      100.0 % $      (15,884 )      (10.8 )%
 
Six Months Ended
September 30,
2013
% of
revenue
September 30,
2012
% of
revenue
Change %
Change
Product revenue $ 170,676 61.1 % $ 193,826 67.3 % $      (23,150 ) (11.9 )%
Service revenue 72,686 26.0 % 71,798 24.9 % 888 1.2 %
Royalty revenue 36,037 12.9 % 22,543 7.8 % 13,494 59.9 %
       Total revenue $ 279,399 100.0 % $ 288,167 100.0 % $ (8,768 ) (3.0 )%

Total revenue decreased in the second quarter of fiscal 2014 primarily due to lower than expected revenue from sales outside of North America and sales to the U.S. federal government. We believe decreased sales in Europe were largely due to economic uncertainty and its impact on the European business climate, especially in September, which is typically our highest revenue month of the second fiscal quarter. We believe sales to the U.S. federal government were also negatively impacted in September by the pending U.S. federal government shut down, causing delays and cancelations of orders. Total revenue in the first six months of fiscal 2014 decreased from the first six months of fiscal 2013, reflecting decreased sales in Europe and to the U.S. federal government, partially offset by a $15.0 million royalty received in connection with finalizing an intellectual property agreement in the first quarter of fiscal 2014.

17



Revenue from branded data protection products and services decreased $14.3 million, or 14%, from the second quarter of fiscal 2013 and decreased $19.9 million, or 10%, from the first six months of fiscal 2013, largely due to a decrease in disk systems revenue followed by a tape automation systems revenue decrease. Data protection products include our tape automation systems, disk systems and devices and media offerings. Revenue from branded big data and archive products and services increased $1.0 million, or 6% from the second quarter of fiscal 2013 and increased 10% from the first six months of fiscal 2013 largely due to increased sales of our big data appliance offerings and Lattus object storage solutions. Big data and archive products include StorNext software, StorNext and Q-Series appliances and Lattus object storage solutions. In addition, OEM product and service revenue decreased $1.6 million and $4.9 million from the second quarter and first six months of fiscal 2013, respectively. Royalty revenue decreased $1.0 million from the second quarter of fiscal 2013 and increased $13.5 million from the first six months of fiscal 2013.

Product Revenue

Our product revenue, which includes sales of our hardware and software products sold through both our Quantum branded and OEM channels, decreased $15.3 million and $23.2 million in the second quarter and first six months of fiscal 2014, respectively, compared to the prior year periods, largely due to decreased revenue from sales of enterprise disk systems and slightly larger than expected decreases in revenue from tape automation systems. As noted above, total revenue decreased largely due to lower than expected revenue from sales in Europe and to the U.S. federal government, and these were also the primary drivers of decreased product revenue. Revenue from sales of branded products decreased 17% and 12%, respectively, and sales of products to our OEM customers decreased 7% and 10%, respectively, in the second quarter and first six months of fiscal 2014 compared to the prior year periods.

Three Months Ended
(In thousands)       September 30,
2013
      % of
revenue
      September 30,
2012
      % of
revenue
      Change       %
Change
Disk systems and software solutions $       26,424 20.1 % $ 35,749 24.3 % $ (9,325 ) (26.1 )%
Tape automation systems 41,570 31.6 % 48,812 33.1 % (7,242 ) (14.8 )%
Devices and media 16,713 12.8 % 15,480 10.5 % 1,233 8.0 %
       Product revenue $ 84,707      64.5 % $        100,041      67.9 % $      (15,334 )      (15.3 )%
 
Six Months Ended
September 30,
2013
% of
revenue
September 30,
2012
% of
revenue
Change %
Change
Disk systems and software solutions $ 49,629 17.8 % $ 60,410 21.0 % $ (10,781 ) (17.8 )%
Tape automation systems 86,235 30.9 % 99,292 34.5 % (13,057 ) (13.2 )%
Devices and media 34,812 12.4 % 34,124 11.8 % 688 2.0 %
       Product revenue $ 170,676 61.1 % $ 193,826 67.3 % $ (23,150 ) (11.9 )%

Our disk systems and software solutions revenue decreased 26% and 18%, respectively, from the second quarter and first six months of fiscal 2013 primarily due to decreased sales of enterprise disk systems worldwide. We had fewer large orders, or orders over $200,000, in the second quarter and first six months of fiscal 2014 which negatively impacted enterprise disk systems revenue. Partially offsetting this decrease was increased revenue from certain of our big data offerings, notably our StorNext archive enabled libraries and server-based appliances and our Lattus object storage solutions, compared to the second quarter and first half of fiscal 2013.

The decrease in tape automation systems revenue in the second quarter and first six months of fiscal 2014 compared to the prior year periods was primarily due to decreased branded enterprise tape automation system sales as a result of a decline in large orders. Sales of branded tape automation systems decreased more than revenue from OEM product sales in both the second quarter and first half of fiscal 2014 from the prior year periods. As noted above, the largest branded revenue decrease was in enterprise products, followed by entry level then midrange products. Branded midrange tape automation sales were slightly above our expectations in the second quarter of fiscal 2014. For the second quarter of fiscal 2014, OEM tape automation revenue decreased from the second quarter of fiscal 2013 primarily due to reduced midrange tape automation sales and decreased from the first six months of fiscal 2013 primarily due to decreased enterprise sales.

18



Product revenue from devices, which includes tape drives and removable hard drives, and non-royalty media sales increased from the second quarter and first six months of fiscal 2013. The increase in the second quarter of fiscal 2014 was primarily due to increased revenue from devices while the increase in the first half of fiscal 2014 was primarily due to increased media sales.

Service Revenue

Service revenue includes revenue from sales of hardware service contracts and product repairs. Sales of hardware service contracts are typically purchased by our customers to extend the warranty or to provide faster service response time, or both. Service revenue increased 1% from both the second quarter and first six months of fiscal 2013 primarily due to increased revenue from branded service contracts associated with our StorNext appliances, partially offset by lower revenue from a decreased volume of OEM product repair services.

Royalty Revenue

Tape media royalties decreased 9% from the second quarter of fiscal 2013 primarily due to expected decreases of media unit sales sold by media licensees. For the first six months of fiscal 2014, royalty revenue increased 60% primarily due to the receipt of a one-time cash payment of $15 million from Microsoft Corporation pursuant to an intellectual property agreement entered into in May which was partially offset by expected sales decreases of media sold by media licensees.

Gross Margin

Three Months Ended
(In thousands)       September 30,
2013
      Gross
margin %
      September 30,
2012
      Gross
margin %
      Change       Basis
point
change
Product gross margin $      26,825 31.7 % $       32,157 32.1 % $      (5,332 ) (40 )
Service gross margin 19,078 52.7 % 15,479 43.3 % 3,599 940
Royalty gross margin 10,529      100.0 % 11,562      100.0 % (1,033 )
       Gross margin $ 56,343 * 42.9 %* $ 59,198 40.2 % $ (2,855 )      270
 
  Six Months Ended
September 30,
2013
Gross
margin %
September 30,
2012
Gross
margin %
Change Basis
point
change
Product gross margin $ 54,011 31.6 % $ 61,192 31.6 % $ (7,181 )
Service gross margin 36,339 50.0 % 31,262 43.5 % 5,077 650
Royalty gross margin 36,037 100.0 % 22,543 100.0 % 13,494
       Gross margin $ 126,298 * 45.2 %* $ 114,997 39.9 % $ 11,301 530

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

The 270 basis point increase in gross margin percentage compared to the second quarter of fiscal 2013 was primarily due to improvements in our service delivery model, partially offset by reduced royalty revenue. For the first six months of fiscal 2014, approximately half of the 530 basis point increase in gross margin percentage compared to the prior year period was attributable to the improvements in our service delivery model and the other half was due to the $13.5 million net increase in royalty revenue.

Product Margin

Product gross margin dollars decreased $5.3 million, or 17%, compared to the second quarter of fiscal 2013, and our product gross margin rate decreased 40 basis points. For the first six months of fiscal 2014, product gross margin decreased $7.2 million, or 12%, and our product gross margin rate was the same as the first six months of fiscal 2013. The decreased product revenue was mostly offset in the second quarter and first six months of fiscal 2014 by decreased costs as a result of several items. Product material costs decreased the most, commensurate with the decrease in product revenue, followed by reduced expenses as a result of cost reduction initiatives that began in the second half of fiscal 2013, lower intangible amortization from certain intangible assets becoming fully amortized in fiscal 2013 and a decrease in warranty expense from a reduced number of products under warranty compared to the second quarter and first six months of fiscal 2013. The most significant decreased cost as a result of cost reduction initiatives was compensation and benefits expense from reduced staffing levels.

19



Service Margin

Service gross margin dollars increased $3.6 million, or 23%, compared to the second quarter of fiscal 2013, and service gross margin percentage increased 940 basis points on a slight increase in service revenue. For the first six months of fiscal 2014 service gross margin dollars increased $5.1 million, or 16%, and service gross margin percentage increased 650 basis points on a slight increase in service revenue compared to the first half of fiscal 2013. These increases in service gross margin rate were primarily due to reduced compensation and benefits from lower staffing levels as a result of implementing improvements in our service delivery model, including outsourcing geographies with lower service and repair volumes and improving utilization of our service team. 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.

Research and Development Expenses

Three Months Ended
(In thousands)       September 30,
2013
      % of
revenue
      September 30,
2012
      % of
revenue
      Change       %
Change
Research and development $ 16,359 12.4 % $ 19,475 13.2 % $ (3,116 ) (16.0 )%
 
  Six Months Ended
September 30,
2013
% of
revenue
September 30,
2012
% of
revenue
Change %
Change
Research and development $          33,053      11.8 % $           38,024      13.2 % $      (4,971 )     (13.1 )%

The decrease in research and development expenses compared to the second quarter and first six months of fiscal 2013 was primarily due to cost controls that resulted in a $1.7 million and $3.0 million decrease, respectively, in compensation and benefits from reduced staffing levels. In addition, we had decreases of $0.7 million and $1.0 million, respectively, in external service provider expense and had decreases of $0.4 million and $0.6 million, respectively, in project materials expense related to the nature of projects under development and specific development activities in the prior year periods that were not repeated at the same levels this quarter.

Sales and Marketing Expenses

Three Months Ended
(In thousands) September 30,
2013
% of
revenue
September 30,
2012
% of
revenue
Change %
Change
Sales and marketing       $           29,995            22.8 %       $           34,441            23.4 %       $      (4,446 )            (12.9 )%
 
  Six Months Ended
September 30,
2013
% of
revenue
September 30,
2012
% of
revenue
Change %
Change
Sales and marketing $ 60,153 21.5 % $ 68,885 23.9 % $ (8,732 ) (12.7 )%

The decrease in sales and marketing expense for the second quarter and first six months of fiscal 2014 was primarily due to cost reduction initiatives that resulted in decreases of $3.1 million and $4.4 million, respectively, in compensation and benefits from decreased staffing levels compared to the second quarter and first six months of fiscal 2013. We also had decreases of $0.7 million and $ 2.1 million compared to the second quarter and first six months of fiscal 2013, respectively, in intangible amortization due to certain intangibles becoming fully amortized in fiscal 2013. Other decreases from cost reduction initiatives included declines of $0.3 million and $1.0 million, respectively, in travel expenses and $0.3 million and $0.6 million, respectively, in recruiting expenses compared to the second quarter and first six months of fiscal 2013. For the first six months of fiscal 2014, advertising and marketing expenses decreased $0.5 million compared to the first half of fiscal 2013 due to more advertising and marketing programs in the prior year.

20



General and Administrative Expenses

Three Months Ended
(In thousands)       September 30,
2013
      % of
revenue
      September 30,
2012
      % of
revenue
      Change       %
Change
General and administrative $ 14,813 11.3 % $          15,279      10.4 % $      (466 )      (3.0 )%
 
Six Months Ended
      September 30,
2013
      % of
revenue
      September 30,
2012
      % of
revenue
      Change       %
Change
General and administrative $           29,510      10.6 % $ 32,059 11.1 % $      (2,549 ) (8.0 )%

The decrease in general and administrative expense from the second quarter of fiscal 2013 was primarily due to the implementation of cost controls that resulted in a $0.2 million decrease in facility expenses from lower rates on lease renewals and consolidating facilities during fiscal 2013, a $0.2 million decrease in compensation and benefits from lower staffing levels and a $0.1 million decrease in telephone and network expenses. For the first six months of fiscal 2014, the decrease in general and administrative expense from the first six months of fiscal 2013 was primarily due to a $1.4 million decrease in compensation and benefits, largely from reduced stock compensation expense due to a modification to extend the post-retirement exercise period for certain options in the first quarter of fiscal 2013. In addition, cost reduction initiatives resulted in decreases of $0.4 million in facility expenses from lower lease renewal rates and consolidating facilities during fiscal 2013, $0.3 million in expensed equipment and $0.3 million in telephone and network expenses.

Restructuring Charges

Three Months Ended
(In thousands) September 30,
2013
      % of
revenue
      September 30,
2012
      % of
revenue
      Change       %
Change
Restructuring charges related to cost of revenue $            89 0.1 % $ —% $ 89 n/a
Restructuring charges in operating expenses 208 0.2 % —% 208 n/a
       Total restructuring charges $ 297 0.2 % $ —% $ 297 n/a
 
Six Months Ended
(In thousands) September 30,
2013
% of
revenue
September 30,
2012
% of
revenue
Change %
Change
Restructuring charges related to cost of revenue $ 89      0.1 % $                     —% $      89 n/a
Restructuring charges in operating expenses 2,767 1.0 % —% 2,767 n/a
       Total restructuring charges $ 2,856 1.0 % $ —% $ 2,856 n/a

Restructuring charges in the second quarter and first half of fiscal 2014 were primarily due to severance and benefits costs as a result of our decision to outsource our manufacturing operations and further consolidate production and service activities. In addition, we had severance and benefits costs in the second quarter of fiscal 2014 due to further consolidation of sales territories to improve utilization of our global sales team. For further information regarding restructuring charges, refer to Note 7 “Restructuring charges.”

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Other Income and Expense

Three Months Ended
(In thousands) September 30,
2013
% of
revenue
      September 30,
2012
% of
revenue
      Change       %
Change
Other income and (expense)       $ 46       0.1 % $ (110 )       0.1 % $ 156 n/a
 
  Six Months Ended
(In thousands) September 30,
2013
% of
revenue
September 30,
2012
% of
revenue
Change %
Change
Other income and (expense) $               421      0.2 % $             (448 )      0.2 % $      869 n/a

Other income in the first half of fiscal 2014 was primarily due to net foreign exchange gains compared to other expense in the first half of fiscal 2013 largely due to net foreign exchange losses. Foreign exchange gains in the first half of fiscal 2014 were primarily due to the U.S. dollar strengthening against the Australian dollar, and foreign exchange losses in the first half of fiscal 2013 were primarily due to the U.S. dollar strengthening against the euro.

Interest Expense

Three Months Ended
(In thousands)       September 30,
2013
      % of
revenue
      September 30,
2012
      % of
revenue
      Change       %
Change
Interest expense $ 2,440 1.9 % $ 1,817 1.2 % $ 623      34.3 %
 
  Six Months Ended
September 30,
2013
% of
revenue
September 30,
2012
% of
revenue
Change %
Change
Interest expense $            4,879      1.7 % $            3,666      1.3 % $      1,213 33.1 %

Interest expense increased compared to the second quarter and first six months of fiscal 2013 due to refinancing our revolving debt balance in the third quarter of fiscal 2013 with 4.50% convertible subordinated notes. These convertible subordinated notes have a higher interest rate and a larger principal balance.

Income Taxes

Three Months Ended
(In thousands) September 30,
2013
% of
pre-tax loss
September 30,
2012
% of
pre-tax loss
Change %
Change
Income tax provision       $               534       (7.2 )%       $               370               (3.1 )%       $       164            44.3 %
 
  Six Months Ended
September 30,
2013
% of
pre-tax loss
September 30,
2012
% of
pre-tax loss
Change %
Change
Income tax provision $ 924        (25.4 )% $ 869 (3.1 )% $     55 6.3 %

The income tax provision for the second quarter and first six months of fiscal 2014 and 2013 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.

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Amortization of Intangible Assets

The following tables detail intangible asset amortization expense within our Condensed Consolidated Statements of Operations (in thousands):

Three Months Ended
September 30, 2013 September 30, 2012 Change % Change
Cost of revenue       $       368       $ 1,134 $      (766 ) (67.5 )%
Sales and marketing 1,857 2,556       (699 )            (27.3 )%
$ 2,225 $ 3,690 $ (1,465 ) (39.7 )%
 
Six Months Ended
September 30, 2013 September 30, 2012 Change % Change
Cost of revenue $ 736 $ 2,496 $ (1,760 ) (70.5 )%
Sales and marketing 3,713 5,812 (2,099 ) (36.1 )%
$ 4,449 $ 8,308 $ (3,859 ) (46.4 )%

The decrease in intangible amortization expense in the second quarter and first six months of fiscal 2014 compared to the second quarter and first six months of fiscal 2013 was primarily due to certain intangibles becoming fully amortized during fiscal 2013. For further information regarding amortizable intangible assets, refer to Note 5 “Intangible Assets and Goodwill.”

Share-based Compensation

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

Three Months Ended
September 30, 2013 September 30, 2012 Change % Change
Cost of revenue $ 523 $ 642 $ (119 ) (18.5 )%
Research and development       908       947 (39 )       (4.1 )%
Sales and marketing 1,080 1,246       (166 )      (13.3 )%
General and administrative 980 891 89 10.0 %
$       3,491 $ 3,726 $ (235 ) (6.3 )%
 
Six Months Ended
September 30, 2013 September 30, 2012 Change % Change
Cost of revenue $ 1,051 $ 1,213 $      (162 ) (13.4 )%
Research and development 1,776 1,847 (71 ) (3.8 )%
Sales and marketing 2,154 2,330 (176 ) (7.6 )%
General and administrative 1,866 2,623 (757 ) (28.9 )%
$ 6,847 $ 8,013 $ (1,166 ) (14.6 )%

The decrease in share-based compensation expense in the second quarter of fiscal 2014 compared to the prior year period was primarily due to options that completed their vesting period and corresponding expense at the beginning of the second quarter of fiscal 2014. For the first six months of fiscal 2014, the decrease in share-based compensation expense was primarily due to a modification to extend the post-retirement exercise period for certain options in the first quarter of fiscal 2013 that was not repeated.

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LIQUIDITY AND CAPITAL RESOURCES

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

Six Months Ended
      September 30, 2013       September 30, 2012
Net loss $                (4,567 ) $              (28,954 )
Net cash provided by (used in) operating activities 8,228 (14,522 )
Net cash used in investing activities (3,877 ) (8,483 )
Net cash provided by financing activities 477 717

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 $10.4 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. The majority of our service contracts renew in our third and fourth fiscal quarters.

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.

Six Months Ended September 30, 2012

The $14.4 million difference between reported net loss and cash used in operating activities during the six months ended September 30, 2012 was primarily due to $28.0 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 an $11.3 million decrease in accounts receivable primarily due to decreased sales in the second quarter of fiscal 2013 compared to the fourth quarter of fiscal 2012. These were partially offset by cash uses from a $13.3 million decrease in accounts payable and an $11.1 million decrease in deferred revenue. Accounts payable decreased due to decreased 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 was primarily due to $6.7 million of property and equipment purchases and $2.2 million used to purchase other investments. Equipment purchases were primarily for engineering equipment and testing hardware to support product development activities, and we made leasehold improvements to a facility in the first quarter of fiscal 2013. 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, contractual obligations and 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. 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.

24



We have $205 million of convertible subordinated debt in addition to a line of credit under a Wells Fargo Credit agreement (“WF credit agreement”). The $205 million of convertible subordinated debt is comprised of $135 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 have required semi-annual interest payments.

Under the WF credit agreement, we have the ability to borrow the lesser of $55 million or the amount of the monthly borrowing base under a senior secured revolving credit facility. The WF credit agreement matures March 29, 2017, or on August 16, 2015 if our 3.50% notes remain outstanding on that date. We had no outstanding borrowings on the revolving credit line as of September 30, 2013 and were in compliance with all debt covenants.

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 have taken many actions in recent years to offset the negative impact of economic uncertainty and slow economic growth and their impact on the data protection and big data and archive markets. 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, 2013 filed with the Securities and Exchange Commission on June 7, 2013.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Changes in interest rates affect interest income earned on our cash equivalents, which consisted solely of money market funds during the three months ended September 30, 2013. During the second quarter of fiscal 2014, interest rates on these funds were under 1.0% and we earned a negligible amount of interest income, thus a hypothetical 100 basis point decrease in interest rates would have an insignificant impact on interest income.

We had no outstanding borrowings under the WF credit agreement and our convertible subordinated notes have a fixed interest rate, thus a hypothetical 100 basis point increase in interest rates would not impact interest expense.

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ITEM 4. CONTROLS AND PROCEDURES

(a)        Evaluation of disclosure controls and procedures. We evaluated the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of the end of the period covered by this Quarterly Report on Form 10-Q. This control evaluation was performed under the supervision and with the participation of management, including our CEO and our CFO. Disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified by the SEC. Disclosure controls are also designed to ensure that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Based on the controls evaluation, our CEO and CFO have concluded that as of the end of the period covered by this Quarterly Report on Form 10-Q, our disclosure controls were effective.
 
(b) Changes in internal control over financial reporting. There was no change in our internal control over financial reporting that occurred during the fiscal quarter covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Overland

On June 28, 2012, Overland Storage, Inc. (“Overland”) filed a patent infringement lawsuit against Quantum and Venture Corporation Limited in the U.S. District Court for the Southern District of California, alleging that certain automated tape libraries of the defendants fall within the scope of patents 6,328,766 and 6,353,581. Overland is seeking injunctive relief, as well as the recovery of unspecified monetary damages, including treble damages for willful infringement. We do not believe we infringe the Overland patents and we will defend ourselves vigorously. We do not believe there is a reasonable possibility that we will pay material damages related to this lawsuit.

On August 28, 2012, we filed a lawsuit against Overland in the U.S. District Court for the Southern District of California, for patent infringements of our patents 6,542,787; 6,498,771; 5,925,119 and 5,491,812 by the products in Overland’s NEO tape library and SnapServer product lines. We are seeking injunctive relief and the recovery of monetary damages.

On April 12, 2013, we filed a lawsuit against Overland in the U.S. District Court for the Southern District of California, for patent infringements of our patent 7,263,596 by the products in Overland’s SnapScale product lines. We are seeking injunctive relief and the recovery of monetary damages.

Compression Technology Solutions

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 for 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 was 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. In April 2012, our motion to transfer venue was granted and the lawsuit was transferred to the U.S. District Court for the Northern District of California. On May 29, 2013, our motion for summary judgment was granted, with all of the asserted claims held invalid by the District Court, and the lawsuit against Quantum and the other defendants has been dismissed with prejudice. On July 10, 2013, CTS appealed the decision of the District Court to the United States Court of Appeals for the Federal Circuit.

26



ITEM 1A. RISK FACTORS

YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW, TOGETHER WITH ALL OF THE OTHER INFORMATION INCLUDED IN THIS QUARTERLY REPORT ON FORM 10-Q. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY ONES FACING QUANTUM. ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY KNOWN TO US OR THAT ARE CURRENTLY DEEMED IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS AND OPERATIONS. THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS “FORWARD-LOOKING” STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. PLEASE SEE “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” FOR ADDITIONAL DISCUSSION OF THESE FORWARD-LOOKING STATEMENTS.

We rely on indirect sales channels to market and sell our branded products. Therefore, the loss of or deterioration in our relationship with one or more of our resellers or distributors, or our inability to establish new indirect sales channels to drive growth of our branded revenue, especially for disk systems and software solutions, could negatively affect our operating results.

We sell the majority of our branded products to value-added resellers, or VARs, and to direct marketing resellers such as CDW Corporation, who in turn sell our products to end users, and to distributors such as Ingram Micro, Inc. and others. The success of these sales channels is hard to predict, particularly over time, and we have no purchase commitments or long-term orders from them that assure us of any baseline sales through these channels. Several of our resellers carry competing product lines that they may promote over our products. A reseller might not continue to purchase our products or market them effectively, and each reseller determines the type and amount of our products that it will purchase from us and the pricing of the products that it sells to end user customers. Establishing new indirect sales channels is an important part of our strategy to drive growth of our branded revenue.

As we introduce new products and solutions, we could negatively impact our relationship with channel partners that historically have sold other products and solutions that now compete with our new offerings. For example, we introduced various StorNext appliance solutions beginning in fiscal 2012 causing us to more directly compete for hardware sales with channel partners that sold other hardware products in conjunction with our StorNext software.

Certain of our contracts with customers contain “most favored nation” pricing provisions mandating that we offer our products to these customers at the lowest price offered to other similarly situated customers. In addition, sales of our enterprise products, and the revenue associated with the on-site service of those products, are somewhat concentrated in specific customers, including government agencies and government-related companies. Our operating results could be adversely affected by any number of factors including:

  • A change in competitive strategy that adversely affects a reseller’s willingness or ability to distribute our products;
  • The reduction, delay or cancellation of orders or the return of a significant amount of products;
  • Our inability to gain traction in developing new indirect sales channels for our branded products;
  • The loss of one or more of such distributors or resellers;
  • Any financial difficulties of such distributors or resellers that result in their inability to pay amounts owed to us; or
  • Changes in requirements or programs that allow our products to be sold by third parties to government customers.

We derive the majority of our revenue from products incorporating tape technology. Our future operating results depend in part on continued market acceptance and use of products employing tape technology and decreases in the market could materially and adversely impact our business, financial condition and operating results. In addition, if we are unable to compete with new or alternative storage technologies, our business, financial condition and operating results could be materially and adversely affected.

We derive the majority of our revenue from products that incorporate some form of tape technology and we expect to continue to derive significant revenue from these products in the next several years. As a result, our future operating results depend in part on continued market acceptance and use of products employing tape technology. The use of products employing tape technology continues to decrease and is projected to continue to decrease. Decreased market acceptance or use of products employing tape technology has materially and adversely impacted our business, financial condition and operating results and could materially and adversely impact our business, financial condition and operating results in the future.

27



Disk products as well as various software solutions and alternative technologies continue to gain broader market acceptance. We face risks that our tape customers migrate toward these products and solutions. We are addressing this risk through our own targeted investment in disk systems and other alternative technologies; however, these markets are characterized by rapid innovation, evolving customer demands and strong competition, including competition with several companies who are also significant customers. If we are not successful in our efforts, our business, financial condition and operating results could be materially and adversely affected.

If our products fail to meet our or our customers’ specifications for quality and reliability, our results of operations may be adversely impacted and our competitive position may suffer.

Although we place great emphasis on product quality, we may from time to time experience problems with the performance of our products, which could result in one or more of the following:

  • Increased costs related to fulfillment of our warranty obligations;
  • The reduction, delay or cancellation of orders or the return of a significant amount of products;
  • Focused failure analysis causing distraction of the sales, operations and management teams; or
  • The loss of reputation in the market and customer goodwill.

These factors could cause our business, financial condition and results of operations to be materially and adversely affected.

A large percentage of our sales come from a few customers, some of which are also competitors, and these customers generally have no minimum or long-term purchase commitments. The loss of, or a significant reduction in demand from, one or more key customers could materially and adversely affect our business, financial condition and operating results.

Our sales have been and continue to be concentrated among a few customers because under our business model, we sell to OEMs, distributors, VARs and DMRs to reach end user customers. Furthermore, customers are not obligated to purchase any minimum product volume and our relationships with customers are terminable at will. Revenue from OEM customers has decreased in recent years. If we experience further declines in revenue from OEM customers or any of our other large customers, we could be materially and adversely affected. In addition, certain of our large customers are also our competitors, and such customers could decide to reduce or terminate their purchases of our products for competitive reasons.

Some of our tape and disk products are incorporated into larger storage systems or solutions that are marketed and sold to end users by large OEM customers as well as VARs, channel partners and other distributors. Because of this, we have limited market access to these end users, limiting our ability to reach and influence their purchasing decisions. These market conditions further our reliance on these OEM and other large customers such as distributors and VARs. Thus if they were to significantly reduce, cancel or delay their orders with us, our results of operations could be materially and adversely affected.

A portion of our sales are to various agencies and departments of the U.S. federal government. The U.S. Congress passed the American Taxpayer Relief Act of 2012, which implemented automatic spending cuts beginning March 1, 2013. Additionally, from October 1 to October 16, 2013, the U.S. federal government partially shut down and curtailed most routine operations during this period. These spending cuts as well as the shut down could decrease revenue from sales to the federal government that could materially and adversely affect our results of operations.

Our operating results depend on a limited number of products and on new product introductions, which may not be successful, in which case our business, financial condition and operating results may be materially and adversely affected.

A limited number of products comprise a significant majority of our sales, and due to rapid technological change in the industry, our future operating results depend on our ability to develop and successfully introduce new products. To compete effectively, we must continually improve existing products and introduce new ones. We have devoted and expect to continue to devote considerable management and financial resources to these efforts. We cannot provide assurance that:

  • We will introduce new products in the timeframe we are forecasting;
  • We will not experience technical, quality, performance-related or other difficulties that could prevent or delay the introduction and market acceptance of new products;
  • Our new products will achieve market acceptance and significant market share, or that the markets for these products will continue or grow as we have anticipated;
  • Our new products will be successfully or timely qualified with our customers by meeting customer performance and quality specifications which must occur before customers will place large product orders; or
  • We will achieve high volume production of these new products in a timely manner, if at all.

28



If we are not successful in timely completion of our new product qualifications and then ramping sales to our key customers, our revenue and results of operations could be adversely impacted. In addition, if the quality of our products is not acceptable to our customers, this could result in customer dissatisfaction, lost revenue and increased warranty and repair costs.

We continue to face risks related to economic uncertainty and slow economic growth.

Uncertainty about economic conditions poses a risk as businesses may further reduce or postpone spending in response to reduced budgets, tightening of credit markets, negative financial news and declines in income or asset values which could adversely affect our business, financial condition and results of operations. The slow economic growth in recent years along with periods of economic uncertainty in various countries around the world have had a material and adverse impact on our business and our financial condition, including reduced demand for IT products and services overall and more specifically for products with tape technology in the data protection market. We continue to face risks related to economic conditions in Europe, including concerns about the potential default of various national bonds and debt backed by individual countries, as well the politics impacting these, which could negatively impact the U.S. and global economies and adversely affect our financial results. In addition, our ability to access capital markets may be restricted which could have an impact on our ability to react to changing economic and business conditions and could also adversely affect our results of operations and financial condition.

Competition may intensify in the data protection market as a result of competitors introducing products based on new technology standards and merger and acquisition activity, which could materially and adversely affect our business, financial condition and results of operations.

Our competitors in the data protection market for disk systems and virtual machine solutions are aggressively trying to advance and develop new technologies and products to compete against our technologies and products, and we face the risk that customers could choose competitor products over ours. Competition in our markets is characterized by technological innovation and advancement. As a result of competition and new technology standards, our sales or gross margins could decline, which could materially and adversely affect our business, financial condition and results of operations.

Technological developments and competition over the years in the tape automation market has resulted in decreased prices for tape automation products and product offerings. Pricing pressure is more pronounced in the tape automation market for entry-level products and least pronounced for enterprise products. Similar to our competitors, our products may be priced lower and often incorporate new and/or different features and technologies than prior years. We face risks that customers could choose competitor products over ours due to these features and technologies or due to pricing differences. We have managed pricing pressure by reducing production costs and/or adding features to increase value to maintain a certain level of gross margin for our tape automation systems. If competition further intensifies, or if there is additional industry consolidation, our sales and gross margins for tape automation systems could decline, which could materially and adversely affect our business, financial condition and results of operations.

Industry consolidation and competing technologies with device products, which include tape drives and removable hard drives, have resulted in decreased prices and increasingly commoditized device products. Our response has been to manage our device business at the material margin level and we have chosen not to compete for sales in intense price-based situations or if we would be unable to maintain a certain gross margin level. Our focus has shifted to higher margin opportunities in other product lines. Although revenue from devices has decreased in recent years, our material margins have remained relatively stable over this period. We have exited certain portions of the device market and have anticipated decreased sales of devices. We face risk of reduced shipments of our devices beyond our plans, and could have reduced margins on these products, which could adversely impact our business, financial condition and results of operations.

Additionally, the competitive landscape could change due to merger and acquisition activity in the data protection market. Such transactions may impact us in a number of ways. For instance, they could result in:

  • Competitors decreasing in number but having greater resources and becoming more competitive with us;
  • Companies that we have not historically competed against entering into one or more of our primary markets and increasing competition in that market(s); and
  • Customers that are also competitors becoming more competitive with us and/or reducing their purchase of our products.

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These transactions also create uncertainty and disruption in the market because whether a pending transaction will be completed, the timing of such a transaction and its degree of impact are often unknown. Given these factors and others, such merger and acquisition activity may materially and adversely impact our business, financial condition and results of operations.

Competition may intensify in the big data and archive market as a result of competitors introducing products based on new technology standards and merger and acquisition activity, which could materially and adversely affect our business, financial condition and results of operations.

Competition in the big data and archive market is characterized by technological innovation and advancement, including performance and scale features, and our competitors are aggressively trying to advance and develop new technologies and solutions. We face the risk that customers could choose competitor solutions over ours due to these features and technologies. As a result of competition and new technology standards, our sales from software solutions and appliances could decline, which could materially and adversely affect our business, financial condition and results of operations.

Additionally, the competitive landscape could change due to merger and acquisition activity. Transactions such as these may impact us in a number of ways. For instance, they could result in:

  • Competitors decreasing in number but having greater resources and becoming more competitive with us;
  • Companies that we have not historically competed against entering into one or more of our primary markets and increasing competition in that market(s);
  • Customers that are also competitors becoming more competitive with us and/or reducing their purchase of our products and
  • Competitors acquiring our current suppliers or business partners and negatively impacting our business model.

These transactions also create uncertainty and disruption in the market, because whether a pending transaction will be completed, the timing of such a transaction and its degree of impact are often unknown. Given these factors and others, such merger and acquisition activity may materially and adversely impact our business, financial condition and results of operations.

A significant decline in media royalty, branded software or OEM deduplication software revenues could materially and adversely affect our business, financial condition and operating results.

Our media royalties, branded software and OEM deduplication software revenues are relatively profitable and can significantly impact total company profitability. We receive media royalty revenue based on tape media cartridges sold by various tape media manufacturers and resellers. Under our license agreements with these companies, each of the licensees determines the pricing and number of units of tape media cartridges that it sells. Our media royalty revenue varies depending on the level of sales of the various media cartridge offerings sold by the licensees and other factors, including:

  • The size of the installed base of devices and similar products that use tape media cartridges;
  • The performance of our strategic licensing partners, which sell tape media cartridges;
  • The relative growth in units of newer device products, since the associated media cartridges for newer products typically sell at higher prices than the media cartridges associated with older products;
  • The media consumption habits and rates of end users;
  • The pattern of device retirements; and
  • The level of channel inventories.

Our media royalties depend on royalty rates and the quantity of media consumed in the market. We do not control licensee sales of these tape media cartridges. Reduced royalty rates, or a reduced installed device base using tape media cartridges, would result in further reductions in our media royalty revenue and could reduce gross margins. This could materially and adversely affect our business, financial condition and results of operations.

Our branded software revenues are also dependent on many factors, including the success of competitive offerings, our ability to execute on our product roadmap and our effectiveness at marketing and selling our branded software solutions directly or through our channel partners. Disruptions to any one of these factors could reduce our branded software revenues, which could adversely affect our business, financial condition and operating results.

Our OEM deduplication software revenues also depend on many factors, including the success of competitive offerings, our ability to execute on our product roadmap with our OEM deduplication software partners, the effort of our OEM deduplication software partners in marketing and selling the resulting products, the market acceptance of the resulting products and changes in the competitive landscape, including the impact of acquisitions. At various times, we had significant revenue from OEM deduplication software revenue and at times we had negligible revenue from OEM deduplication software, which negatively impacted our results. Any further disruptions to the factors on which our OEM deduplication software revenues depends could adversely affect our business, financial condition and operating results.

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Some of our products contain licensed, third-party technology that provides important product functionality and features. Our license agreements contain contractual protections; however, the risk of continued access to this technology, along with other risks, remains.

Our products may contain technology licensed from third parties that provides important product functionality and features. For example, our Lattus product family contains technology licensed from a private, international company. We have contractual protections within our license agreements to help mitigate against the risks of incorporating third-party technology into our products. However, there remains a risk that we may not have continued access to this technology, for instance if the licensing company ceased to exist, either from bankruptcy, dissolution or purchase by a competitor. In addition, legal actions, such as intellectual property actions, brought against the licensing company could impact our future access to the technology. We also have limited control of the technology roadmap and cannot ensure that the licensing company will advance the roadmap of the licensed technology in the manner best for Quantum. Any of these actions could negatively impact our technology licensing, thereby reducing the functionality and/or features of our products, and adversely affect our business, financial condition and operating results. We also face the risk of not being able to quickly implement a replacement technology or otherwise mitigating the risks associated with not having access to this licensed technology, which may adversely affect our business, financial condition and operating results.

We have taken considerable steps towards reducing our cost structure and may take further cost reduction actions. The steps we have taken and may take in the future may not reduce our cost structure to a level appropriate in relation to our future sales and therefore, these anticipated cost reductions may be insufficient to result in consistent profitability.

In the last several years, we have recorded significant restructuring charges and made cash payments in order to reduce our cost of sales and operating expenses to respond to adverse economic and industry conditions, from strategic management decisions and to rationalize our operations following acquisitions. We may take future steps to further reduce our operating costs, including future cost reduction steps or restructurings in response to strategic decisions, adverse changes in our business or industry or future acquisitions. We may be unable to reduce our cost of sales and operating expenses at a rate and to a level appropriate in relation to our future sales, which may adversely affect our business, financial condition and operating results.

If we are unable to attract and retain skilled employees, our business could be adversely impacted.

We may be subject to increased turnover in our employee base or the inability to fill open headcount requisitions due to competition, concerns about our operational performance or other factors. In addition, we may rely on the performance of employees whose skill sets are not sufficiently developed to fulfill their expected job responsibilities. Either of these situations could impair or delay our ability to realize operational and strategic objectives and cause increased expenses and lost sales opportunities.

Economic or other business factors may lead us to write down the carrying amount of our goodwill or long-lived assets, such as the goodwill impairment charge in fiscal 2009, which could have a material and adverse effect on our results of operations.

We evaluate our goodwill for impairment annually during the fourth quarter of our fiscal year, or more frequently when indicators of impairment are present. Long-lived assets are reviewed for impairment whenever events or circumstances indicate impairment might exist. We continue to monitor relevant market and economic conditions, including the price of our stock, and perform appropriate impairment reviews when conditions deteriorate such that we believe the value of our goodwill could be further impaired or an impairment exists in our long-lived assets. It is possible that conditions could deteriorate due to economic or other factors that affect our business, resulting in the need to write down the carrying amount of our goodwill or long-lived assets to fair value at the time of such assessment. As a result, our operating results could be materially and adversely affected.

Third party intellectual property infringement claims could result in substantial liability and significant costs, and, as a result, our business, financial condition and operating results may be materially and adversely affected.

From time to time, third parties allege our infringement of and need for a license under their patented or other proprietary technology, such as our current litigation with Overland Storage and Compression Technology Solutions described in Legal Proceedings. While we currently believe the amount of ultimate liability, if any, with respect to any such actions will not materially affect our financial position, results of operations or liquidity, the ultimate outcome of any license discussion or litigation is uncertain. Adverse resolution of any third party infringement claim could subject us to substantial liabilities and require us to refrain from manufacturing and selling certain products. In addition, the costs incurred in intellectual property litigation can be substantial, regardless of the outcome. As a result, our business, financial condition and operating results could be materially and adversely affected.

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In addition, certain products or technologies acquired or developed by us may include “open source” software. Open source software is typically licensed for use at no initial charge. Certain open source software licenses, however, require users of the open source software to license to others any software that is based on, incorporates or interacts with, the open source software under the terms of the open source license. Although we endeavor to comply fully with such requirements, third parties could claim that we are required to license larger portions of our software than we believe we are required to license under open source software licenses. If such claims were successful, they could adversely impact our competitive position and financial results by providing our competitors with access to sensitive information that may help them develop competitive products. In addition, our use of open source software may harm our business and subject us to intellectual property claims, litigation or proceedings in the future because:

  • Open source license terms may be ambiguous and may subject us to unanticipated obligations regarding our products, technologies and intellectual property;
  • Open source software generally cannot be protected under trade secret law; and
  • It may be difficult for us to accurately determine the origin of the open source code and whether the open source software infringes, misappropriates or violates third party intellectual property or other rights.

As a result of our global manufacturing and sales operations, we are subject to a variety of risks that are unique to businesses with international operations of a similar scope, any of which could, individually or in the aggregate have a material adverse effect on our business.

A significant portion of our manufacturing and sales operations and supply chain occurs in countries other than the U.S. We also have sales outside the U.S. We utilize contract manufacturers to produce certain of our products and have suppliers for various components, several of which have operations located in foreign countries including China, Hungary, Japan, Malaysia, Singapore and Thailand. Because of these operations, we are subject to a number of risks including:

  • Shortages in component parts and raw materials;
  • Import and export and trade regulation changes that could erode our profit margins or restrict our ability to transport our products;
  • The burden and cost of complying with foreign and U.S. laws governing corporate conduct outside the U.S.;
  • Adverse movement of foreign currencies against the U.S. dollar (the currency in which our results are reported) and global economic conditions generally;
  • Inflexible employee contracts and employment laws that may make it difficult to terminate or change the compensation structure for employees in some foreign countries in the event of business downturns;
  • Potential restrictions on the transfer of funds between countries;
  • Political, military, social and infrastructure risks, especially in emerging or developing economies;
  • Import and export duties and value-added taxes; and
  • Natural disasters, including earthquakes, flooding, typhoons and tsunamis.

Any or all of these risks could have a material adverse effect on our business.

Our quarterly operating results could fluctuate significantly, and past quarterly operating results should not be used to predict future performance.

Our quarterly operating results have fluctuated significantly in the past and could fluctuate significantly in the future. As a result, our quarterly operating results should not be used to predict future performance. Quarterly operating results could be materially and adversely affected by a number of factors, including, but not limited to:

  • Failure to complete shipments in the last month of a quarter during which a substantial portion of our products are typically shipped;
  • Customers canceling, reducing, deferring or rescheduling significant orders as a result of excess inventory levels, weak economic conditions or other factors;

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  • Customer fiscal year-ends and budget availability impacting customer demand for our products;
  • Declines in large orders, or orders greater than $200,000;
  • Declines in royalty revenues;
  • Declines in software revenues;
  • Product development and ramp cycles and product performance or quality issues;
  • Poor execution of and performance against expected sales and marketing plans and strategies;
  • Reduced demand from our OEM or distribution, VAR, DMR and other large customers; and
  • Increased competition.

For instance, for the first quarter of fiscal 2013, our financial results were below our guidance for the period in part because we were unable to close a number of larger transactions. After we reported results on July 9, 2012, our share price declined by 28%. If we fail to meet our projected quarterly results, our business, financial condition and results of operations may be materially and adversely affected.

If we fail to protect our intellectual property or if others use our proprietary technology without authorization, our competitive position may suffer.

Our future success and ability to compete depends in part on our proprietary technology. We rely on a combination of copyright, patent, trademark, and trade secrets laws and nondisclosure agreements to establish and protect our proprietary technology. However, we cannot provide assurance that patents will be issued with respect to pending or future patent applications that we have filed or plan to file or that our patents will be upheld as valid or will prevent the development of competitive products or that any actions we have taken will adequately protect our intellectual property rights. We generally enter into confidentiality agreements with our employees, consultants, customers, potential customers and others as required, in which we strictly limit access to, and distribution of, our software, and further limit the disclosure and use of our proprietary information.

Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain or use our products or technology. Enforcing our intellectual property rights can sometimes only be accomplished through the use of litigation. Our competitors may also independently develop technologies that are substantially equivalent or superior to our technology. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as the laws of the U.S.

Because we may order components from suppliers in advance of receipt of customer orders for our products that include these components, we could face a material inventory risk, which could have a material and adverse effect on our results of operations and cash flows.

Although we use third parties to manufacture certain of our products, we also manufacture products in-house. Managing our in-house manufacturing capabilities presents a number of risks that could materially and adversely affect our financial condition. For instance, as part of our component planning, we place orders with or pay certain suppliers for components in advance of receipt of customer orders. We occasionally enter into negotiated orders with vendors early in the manufacturing process of our products to ensure that we have sufficient components for our products to meet anticipated customer demand. Because the design and manufacturing process for these components can be complicated, it is possible that we could experience a design or manufacturing flaw that could delay or even prevent the production of the components for which we previously committed to pay. We also face the risk of ordering too many components, or conversely, not enough components, since supply orders are generally based on forecasts of customer orders rather than actual customer orders. In addition, in some cases, we make non-cancelable order commitments to our suppliers for work-in-progress, supplier’s finished goods, custom sub-assemblies, discontinued (end-of-life) components and Quantum-unique raw materials that are necessary to meet our lead times for finished goods. If we cannot change or be released from supply orders, we could incur costs from the purchase of unusable components, either due to a delay in the production of the components or other supplies or as a result of inaccurately predicting supply orders in advance of customer orders. These same risks exist with our third party contract manufacturing partners. Our business and operating results could be materially and adversely affected if we incur increased costs, or are unable to fulfill customer orders.

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Some of our manufacturing, component production and service repair are outsourced to third party contract manufacturers, component suppliers and service providers. If we cannot obtain products, parts and services from these third parties in a cost effective and timely manner that meets our customers’ expectations, this could materially and adversely impact our business, financial condition and results of operations.

Many aspects of our supply chain and operational results are dependent on the performance of third party business partners. We have announced our intention to increase the use of third party contract manufacturers, service providers and/or product integrators over the next several months. We face a number of risks as a result of these relationships, including, among others:

  • Sole source of product supply
    In many cases, our business partner may be the sole source of supply for the products or parts they manufacture, or the services they provide, for us. Because we are relying on one supplier, we are at greater risk of experiencing shortages, reduced production capacity or other delays in customer deliveries that could result in customer dissatisfaction, lost sales and increased expenses, each of which could materially damage customer relationships and result in lost revenue.
     
  • Cost and purchase commitments
    We may not be able to control the costs for the products our business partners manufacture for us or the services they provide to us. They procure inventory to build our products based upon a forecast of customer demand that we provide. We could be responsible for the financial impact on the contract manufacturer, supplier or service provider of any reduction or product mix shift in the forecast relative to materials that they had already purchased under a prior forecast. Such a variance in forecasted demand could require us to pay them for finished goods in excess of current customer demand or for excess or obsolete inventory and generally incur higher costs. As a result, we could experience reduced gross margins and operating losses based on these purchase commitments. With respect to service providers, although we have contracts for most of our third party repair service vendors, the contract period may not be the same as the underlying service contract with our customer. In such cases, we face risks that the third party service provider may increase the cost of providing services over subsequent periods contracted with our customer.
     
  • Financial condition and stability
    Our third party business partners may suffer adverse financial or operational results or may be negatively impacted by global and local economic conditions. Therefore, we may face interruptions in the supply of product components or service as a result of financial or other volatility affecting our supply chain. We could suffer production downtime or increased costs to procure alternate products or services as a result of the possible inadequate financial condition of one or more of our business partners.
     
  • Quality and supplier conduct
    We have limited control over the quality of products and components produced and services provided by our supply chain and third party contract manufacturing business partners. Therefore, the quality of the products, parts or services may not be acceptable to our customers and could result in customer dissatisfaction, lost revenue and increased warranty costs. In addition, we have limited control over the manner in which our business partners conduct their business. Sub-tier suppliers selected by the primary third party could have process control issues or could select components with latent defects that manifest over a longer period of time. We may face negative consequences or publicity as a result of a third party’s failure to comply with applicable compliance, trade, environmental or employment regulations.

Any or all of these risks could have a material adverse effect on our business. In the past we have successfully transitioned products or component supply from one supplier or manufacturing location to another without significant financial or operational impact, but there is no guarantee of our continued ability to do so.

If we do not successfully manage the changes that we have made and may continue to make to our infrastructure and management, our business could be disrupted, and that could adversely impact our results of operations and financial condition.

Managing change is an important focus for us. In recent years, we have implemented several significant initiatives involving our sales and marketing, engineering and operations organizations, aimed at increasing our efficiency and better aligning these groups with our corporate strategy. In addition, we have reduced headcount to streamline and consolidate our supporting functions as appropriate in response to market or competitive conditions and following past acquisitions and are increasing our reliance on certain third party business relationships. Our inability to successfully manage the changes that we implement, and detect and address issues as they arise could disrupt our business and adversely impact our results of operations and financial condition.

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Because we rely heavily on distributors and other resellers to market and sell our products, if one or more distributors were to experience a significant deterioration in its financial condition or its relationship with us, this could disrupt the distribution of our products and reduce our revenue, which could materially and adversely affect our business, financial condition and operating results.

In certain product and geographic segments we heavily utilize distributors and value added resellers to perform the functions necessary to market and sell our products. To fulfill this role, the distributor must maintain an acceptable level of financial stability, creditworthiness and the ability to successfully manage business relationships with the customers it serves directly. Under our distributor agreements with these companies, each of the distributors determines the type and amount of our products that it will purchase from us and the pricing of the products that it sells to its customers. If the distributor is unable to perform in an acceptable manner, we may be required to reduce the amount of sales of our product to the distributor or terminate the relationship. We may also incur financial losses for product returns from distributors or for the failure or refusal of distributors to pay obligations owed to us. Either scenario could result in fewer of our products being available to the affected market segments, reduced levels of customer satisfaction and/or increased expenses, which could in turn have a material and adverse impact on our business, results of operations and financial condition.

Our capital structure includes debt, which imposes upon us debt service obligations, and our credit facility contains various operating and financial covenants that limit our discretion in the operation of our business. If we are unable to generate sufficient cash flows from operations to meet these debt obligations or remain in compliance with the covenants, our business, financial condition and operating results could be materially and adversely affected.

Our level of indebtedness presents risks to investors, both in terms of the constraints that it places on our ability to operate our business and because of the possibility that we may not generate sufficient cash to pay the principal and interest on our indebtedness as it becomes due.

Potential consequences of having debt include:

  • Requiring that we dedicate a portion of our cash flow from operations and other capital resources to debt service, thereby reducing our ability to fund working capital, capital expenditures, research and development and other cash requirements;
  • Limiting our flexibility in planning for, or reacting to, changes and opportunities in the markets in which we compete, such as limiting our ability to engage in mergers and acquisitions activity, which may place us at a competitive disadvantage;
  • Mandatory field audits and control of cash receipts by the lender if we do not maintain liquidity above certain thresholds;
  • Increasing our vulnerability to adverse economic and industry conditions;
  • Making it more difficult or impossible for us to make payments on other indebtedness or obligations; and 
  • Limiting our ability to incur additional debt on acceptable terms, if at all.

Our credit facility agreement contains restrictive covenants that require us to comply with and maintain certain financial tests and ratios, as well as restrict our ability, subject to certain thresholds, to:

  • Incur debt; 
  • Incur liens; 
  • Make acquisitions of businesses or entities or sell certain assets;
  • Make investments, including loans, guarantees and advances; 
  • Engage in transactions with affiliates; 
  • Pay dividends or engage in stock repurchases; and 
  • Enter into certain restrictive agreements.

Our ability to comply with covenants contained in this credit agreement may be affected by events beyond our control, including prevailing economic, financial and industry conditions.

Our credit facility agreement is collateralized by a pledge of all of our assets. If we were to default and were unable to obtain a waiver for such a default, the lender would have a right to foreclose on our assets in order to satisfy our obligations under the credit agreement. Any such action on the part of the lender against us could have a materially adverse impact on our business, financial condition and results of operations.

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Our stock price could become more volatile if certain institutional investors were to increase or decrease the number of shares they own. In addition, there are other factors and events that could affect the trading prices of our common stock.

A small number of institutional investors have owned a significant portion of our common stock at various times in recent years. If any or all of these investors were to decide to purchase significant additional shares or to sell significant amounts or all of the common shares they currently own, or if there is a perception that those sales may occur, that may cause our stock price to be more volatile. For example, there have been instances in the past where a shareholder with a significant equity position began to sell shares, putting downward pressure on our stock price for the duration of their selling activity. In these situations, selling pressure outweighed buying demand and our stock price declined. This situation has occurred due to our stock price falling below institutional investors’ price thresholds and our volatility increasing beyond investors’ volatility parameters causing even greater sell pressure.

Trading prices of our common stock may fluctuate in response to a number of other events and factors, such as:

  • General economic conditions; 
  • Changes in interest rates; 
  • Fluctuations in the stock market in general and market prices for technology companies in particular; 
  • Quarterly variations in our operating results; 
  • New products, services, innovations and strategic developments by our competitors or us, or business combinations and investments by our competitors or us; 
  • Changes in financial estimates by us or securities analysts and recommendations by securities analysts; 
  • Changes in our capital structure, including issuance of additional debt or equity to the public; and 
  • Strategic acquisitions.

Any of these events and factors may cause our stock price to rise or fall and may adversely affect our business and financing opportunities.

Our design and production processes are subject to safety and environmental regulations which could lead to increased costs, or otherwise adversely affect our business, financial condition and results of operations.

We are subject to a variety of laws and regulations relating to, among other things, the use, storage, discharge and disposal of materials and substances used in our facilities and manufacturing processes as well as the safety of our employees and the public. Current regulations in the U.S. and various international jurisdictions restrict the use of certain potentially hazardous materials used in electronic products and components, including lead and some flame retardants impose a “take back” obligation on manufacturers for the financing of the collection, recovery and disposal of electrical and electronic equipment and require extensive investigation into and disclosure regarding certain minerals used in our supply chain. We anticipate that future regulations might further restrict allowable materials in our products, require the establishment of additional recycling or take back programs or require additional public disclosure of environmental impact information. We have implemented procedures and will likely continue to introduce new processes to comply with current and future safety and environmental legislation. However, measures taken now or in the future to comply with such legislation may adversely affect our manufacturing or personnel costs or product sales by requiring us to acquire costly equipment or materials, redesign production processes or to incur other significant expenses in adapting our manufacturing programs or waste disposal and emission management processes. Furthermore, safety or environmental claims or our failure to comply with present or future regulations could result in the assessment of damages or imposition of fines against us, or the suspension of affected operations, which could have an adverse effect on our business, financial condition and results of operations.

We are subject to many laws and regulations, and violation of or changes in those requirements could materially and adversely affect our business.

We are subject to numerous U.S. and international laws regarding corporate conduct, fair competition, preventing corruption and import and export practices, including requirements applicable to U.S. government contractors. While we maintain a rigorous corporate ethics and compliance program, we may be subject to increased regulatory scrutiny, significant monetary fines or penalties, suspension of business opportunities or loss of jurisdictional operating rights as a result of any failure to comply with those requirements. We may also be exposed to potential liability resulting from our business partners’ violation of these requirements. If we were to be subject to a compliance investigation, we may incur increased personnel and legal costs. Further, our U.S. and international business models are based on currently applicable regulatory requirements and exceptions. Changes in those requirements or exceptions could necessitate changes to our business model. Any of these consequences could materially and adversely impact our business and operating results.

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We may be sued by our customers as a result of failures in our products.

We face potential liability for performance problems of our products because our end users employ our storage technologies for the storage and backup of important data and to satisfy regulatory requirements. Although we maintain technology errors and omissions liability insurance, our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed. Any imposition of liability or accrual of litigation costs that is not covered by insurance or is in excess of our insurance coverage could harm our business. In addition, we could potentially face claims for product liability from our customers if our products cause property damage or bodily injury. Although we maintain general liability insurance, our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed. Any imposition of liability or accrual of litigation costs that is not covered by insurance or is in excess of our insurance coverage could harm our business.

We must maintain appropriate levels of service parts inventories. If we do not have sufficient service parts inventories, we may experience increased levels of customer dissatisfaction. If we hold excessive service parts inventories, we may incur financial losses.

We maintain levels of service parts inventories to satisfy future warranty obligations and also to earn service revenue by providing enhanced and extended warranty and repair service during and beyond the warranty period. We estimate the required amount of service parts inventories based on historical usage and forecasts of future warranty requirements, including estimates of failure rates and costs to repair, and out of warranty revenue. Given the significant levels of judgment inherently involved in the process, we cannot provide assurance that we will be able to maintain appropriate levels of service parts inventories to satisfy customer needs and to avoid financial losses from excess service parts inventories. If we are unable to maintain appropriate levels of service parts inventories, our business, financial condition and results of operations may be materially and adversely impacted.

From time to time we have made acquisitions. The failure to successfully integrate future acquisitions could harm our business, financial condition and operating results.

As a part of our business strategy, we have in the past and may make acquisitions in the future, subject to certain debt covenants. We may also make significant investments in complementary companies, products or technologies. If we fail to successfully integrate such acquisitions or significant investments, it could harm our business, financial condition and operating results. Risks that we may face in our efforts to integrate any recent or future acquisitions include, among others:

  • Failure to realize anticipated savings and benefits from the acquisition; 
  • Difficulties in assimilating and retaining employees; 
  • Potential incompatibility of business cultures; 
  • Coordinating geographically separate organizations; 
  • Diversion of management’s attention from ongoing business concerns; 
  • Coordinating infrastructure operations in a rapid and efficient manner; 
  • The potential inability to maximize our financial and strategic position through the successful incorporation of acquired technology and rights into our products and services;
  • Failure of acquired technology or products to provide anticipated revenue or margin contribution; 
  • Insufficient revenues to offset increased expenses associated with the acquisition; 
  • Costs and delays in implementing or integrating common systems and procedures; 
  • Reduction or loss of customer orders due to the potential for market confusion, hesitation and delay; 
  • Impairment of existing customer, supplier and strategic relationships of either company;
  • Insufficient cash flows from operations to fund the working capital and investment requirements; 
  • Difficulties in entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions; 
  • The possibility that we may not receive a favorable return on our investment, the original investment may become impaired, and/or we may incur losses from these investments; 
  • Dissatisfaction or performance problems with the acquired company; 
  • The assumption of risks of the acquired company that are difficult to quantify, such as litigation; 
  • The cost associated with the acquisition, including restructuring actions, which may require cash payments that, if large enough, could materially and adversely affect our liquidity; and 
  • Assumption of unknown liabilities or other unanticipated adverse events or circumstances.

Acquisitions present many risks, and we may not realize the financial and strategic goals that were contemplated at the time of any transaction. We cannot provide assurance that we will be able to successfully integrate any business, products, technologies or personnel that we may acquire in the future, and our failure to do so could negatively impact our business, financial condition and operating results.

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If the future outcomes related to the estimates used in recording tax liabilities to various taxing authorities result in higher tax liabilities than estimated, then we would have to record tax charges, which could be material.

We have provided amounts and recorded liabilities for probable and estimable tax adjustments that may be proposed by various taxing authorities in the U.S. and foreign jurisdictions. If events occur that indicate payments of these amounts will be less than estimated, then reversals of these liabilities would create tax benefits recognized in the periods when we determine the liabilities have reduced. Conversely, if events occur which indicate that payments of these amounts will be greater than estimated, then tax charges and additional liabilities would be recorded. In particular, various foreign jurisdictions could challenge the characterization or transfer pricing of certain intercompany transactions. In the event of an unfavorable outcome of such challenge, there exists the possibility of a material tax charge and adverse impact on the results of operations in the period in which the matter is resolved or an unfavorable outcome becomes probable and estimable.

Certain changes in stock ownership could result in a limitation on the amount of net operating loss and tax credit carryovers that can be utilized each year. Should we undergo such a change in stock ownership, it would severely limit the usage of these carryover tax attributes against future income, resulting in additional tax charges, which could be material.

We are exposed to fluctuations in foreign currency exchange rates, and an adverse change in foreign currency exchange rates relative to our position in such currencies could have a materially adverse impact on our business, financial condition and results of operations.

We do not currently use derivative financial instruments for foreign currency hedging or speculative purposes. We have used in the past, and may use in the future, foreign currency forward contracts to hedge our exposure to foreign currency exchange rates. To the extent that we have assets or liabilities denominated in a foreign currency that are inadequately hedged or not hedged at all, we may be subject to foreign currency losses, which could be significant.

Our international operations can act as a natural hedge when both operating expenses and sales are denominated in local currencies. In these instances, although an unfavorable change in the exchange rate of a foreign currency against the U.S. dollar would result in lower sales when translated to U.S. dollars, operating expenses would also be lower in these circumstances. An increase in the rate at which a foreign currency is exchanged for U.S. dollars would require more of that particular foreign currency to equal a specified amount of U.S. dollars than before such rate increase. In such cases, and if we were to price our products and services in that particular foreign currency, we would receive fewer U.S. dollars than we would have received prior to such rate increase for the foreign currency. Likewise, if we were to price our products and services in U.S. dollars while competitors priced their products in a local currency, an increase in the relative strength of the U.S. dollar would result in our prices being uncompetitive in those markets. Such fluctuations in currency exchange rates could materially and adversely affect our business, financial condition and results of operations.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

The Exhibit Index beginning on page 40 of this report sets forth a list of exhibits and is hereby incorporated by reference.

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

QUANTUM CORPORATION
  
/s/ LINDA M. BREARD
Linda M. Breard
Chief Financial Officer
(Principal Financial and Chief Accounting Officer)
Date: November 12, 2013

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EXHIBIT INDEX

Exhibit
Number
Incorporated by Reference
      Exhibit Description       Form       File No.       Exhibit(s)       Filing Date
3.1 Amended and Restated Certificate of Incorporation of Registrant. 8-K 001-13449 3.1 August 16, 2007
3.2 Amended and Restated By-laws of Registrant, as amended. 8-K 001-13449 3.1 December 5, 2008
3.3 Certification of Amendment to the Bylaws of Quantum Corporation, as adopted on January 20, 2010. 8-K 001-13449 3.1 January 26, 2010
4.1 Indenture for 3.50% Convertible Senior Subordinated Notes due 2015, between the Registrant and U.S. Bank National Association, as trustee, dated November 15, 2010, including the form of 3.50% Convertible Senior Subordinated Note due 2015. 8-K 001-13449 4.1 November 15, 2010
4.2 Indenture for 4.50% Convertible Senior Subordinated Notes due 2017, between the Registrant and U.S. Bank National Association, as trustee, dated October 31, 2012, including the form of 4.50% Convertible Senior Subordinated Note due 2017. 8-K 001-13449 4.1 November 15, 2010
10.1 Offer Letter, dated May 14, 2013, between Registrant and Mr. Jeffrey C. Smith.* 10-Q 001-13449 10.2 August 9, 2013
10.2 Offer Letter, dated August 7, 2013, between Registrant and Mr. Philip Black.*‡
10.3 Offer Letter, dated August 7, 2013, between Registrant and Louis DiNardo.*‡    
10.4 Offer Letter, dated August 7, 2013, between Registrant and Gregg J. Powers.*‡  
31.1 Certification of the Chief Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002. ‡  
31.2 Certification of the Chief Financial Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002. ‡
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley act of 2002. †
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley act of 2002. †
101.INS XBRL Instance Document.††
101.SCH XBRL Taxonomy Extension Schema Document.††
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document.††
101.DEF XBRL Taxonomy Extension Definition Linkbase Document.††
101.LAB XBRL Taxonomy Extension Label Linkbase Document.††
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document.††

*       Indicates management contract or compensatory plan, contract or arrangement.
Filed herewith.
Furnished herewith.
†† XBRL (Extensible Business Reporting Language) information is furnished and not filed herewith, is not a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

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