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

Commission File Number 1-13449

––––––––––––––––
QUANTUM CORPORATION
––––––––––––––––

Incorporated Pursuant to the Laws of the State of Delaware

IRS Employer Identification Number 94-2665054

224 Airport Parkway, San Jose, California 95110

(408) 944-4000
––––––––––––––––

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No ¨

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

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

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

QUANTUM CORPORATION

INDEX

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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

See accompanying Notes to Condensed Consolidated Financial Statements.

1

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

See accompanying Notes to Condensed Consolidated Financial Statements.

2

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

See accompanying Notes to Condensed Consolidated Financial Statements.

3

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

See accompanying Notes to Condensed Consolidated Financial Statements.

4

QUANTUM CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1: BASIS OF PRESENTATION

Quantum Corporation (“Quantum”, the “Company”, “us” or “we”), founded in 1980, is a leading expert in end-to-end scale-out storage and data protection, providing solutions for sharing, archiving and accessing digital assets over the entire data lifecycle. Our customers, ranging from small businesses to major enterprises, have trusted us to address their most demanding content workflow challenges. We provide solutions for storing and protecting information in physical, virtual and cloud environments that are designed to help customers Be Certain^TM they have a comprehensive storage foundation to maximize the value of their data by making it accessible whenever and wherever needed, offering indefinite retention and reducing total cost and complexity. We work closely with a broad network of distributors, value-added resellers (“VARs”), direct marketing resellers (“DMRs”), original equipment manufacturers (“OEMs”) and other suppliers to meet customers’ evolving needs. Our stock is traded on the New York Stock Exchange under the symbol QTM.

The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of Quantum and our wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated. 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. This reclassification had no impact on total assets, total liabilities, income (loss) from operations, net loss or net cash provided by (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.

During fiscal 2014, we also identified three balance sheet misclassifications between current and long-term related to certain prepaid expenses, restructuring accruals and straight-line rent balances. As of March 31, 2013, current assets were overstated by $0.4 million and current liabilities were overstated by $7.4 million for these items. As of March 31, 2012, current liabilities were overstated by $5.2 million for the straight-line rent item.

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 had been recorded during the first quarter of fiscal 2014, the impact would have been significant to the Condensed Consolidated Statement of Operations for 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 net income (loss) per diluted share for any prior period.

The foregoing revisions are not material to any prior period’s Consolidated Balance Sheets, Consolidated Statements of Operations, Consolidated Statements of Comprehensive Income (Loss) or Consolidated Statements of Stockholders’ Deficit and have no impact on the Consolidated Statement of Cash Flows. 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 nine months ended December 31, 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.

6

Consolidated Statements of Operations – Annual

Consolidated Statements of Operations – Quarterly – Fiscal 2013

7

Consolidated Statements of Operations – Quarterly – Fiscal 2012

8

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

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):

We did not record impairments to any non-financial assets in the third quarter and first nine 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 December 31, 2013, and the estimated fair value of our convertible subordinated debt was approximately $200.2 million, based on quoted market prices in less active markets (level 2 fair value measurements).

NOTE 4: INVENTORIES

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

9

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 third quarter or first nine months of fiscal 2014 and 2013. The following provides a summary of the carrying value of intangible assets (in thousands):

Total intangible amortization expense was $2.2 million and $6.7 million for the three and nine months ended December 31, 2013, respectively, and was $2.8 million and $11.1 million for the three and nine months ended December 31, 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 third quarter or first nine months of fiscal 2014. The following table provides a summary of the goodwill balance at both December 31, 2013 and March 31, 2013 (in thousands):

NOTE 6: ACCRUED WARRANTY

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

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.

10

NOTE 7: RESTRUCTURING CHARGES

In the third quarter of fiscal 2014, restructuring charges were primarily the result of right-sizing our workforce with our continuing operations plans and for the first nine months of fiscal 2014 restructuring charges were largely due to strategic management decisions to outsource our manufacturing operations and further consolidate production and service activities. In the third quarter and first nine months of fiscal 2013, restructuring charges were primarily due to severance charges for various positions eliminated worldwide across most functions of the business to align spending with revenue expectations. The types of restructuring expense for the three and nine months ended December 31, 2013 and December 31, 2012 were (in thousands):

Accrued Restructuring

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

11

The $1.8 million of severance and benefit restructuring costs for the three months ended December 31, 2013 was primarily due to right-sizing our workforce with our continuing operations plans, and the $5.4 million severance and benefit restructuring costs for the nine months ended December 31, 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 third quarter and first nine 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 incurred as a result of these restructuring actions.

We anticipate the majority of the $3.1 million and $0.1 million severance and benefits and other restructuring accruals, respectively, will be paid by the end of fiscal 2014. Facility restructuring accruals will be paid in accordance with the respective facility lease terms. The $1.5 million of lease payments scheduled to occur between January 2015 and February 2021 is included in other long-term liabilities in the Condensed Consolidated Balance Sheets.

NOTE 8: STOCK INCENTIVE PLANS AND SHARE-BASED COMPENSATION

Share-Based Compensation

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

Stock Options

No stock options were granted during the third quarter or first nine 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 third quarter and first nine months of fiscal 2014 were $1.25 and $1.40, respectively. The weighted-average grant date fair values of RSUs granted during the third quarter and first nine months of fiscal 2013 were $1.44 and $1.99, respectively

During the third quarter of fiscal 2014, we granted 0.2 million RSUs with performance conditions (“performance RSUs”) and the fair value of the performance RSUs at the grant date was $0.2 million. Performance RSUs will become eligible for vesting based on Quantum achieving certain revenue and operating income targets through the end of fiscal 2014. Share-based compensation expense for performance RSUs is recognized when it is probable that the performance conditions will be achieved. As of December 31, 2013, no share-based compensation expense was recognized for the performance RSUs.

12

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.

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 first nine 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 nine months ended December 31, 2013 and 2012 are as follows:

Stock Activity

Stock Options

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

13

Restricted Stock

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

NOTE 9: INCOME TAXES

Income tax provisions for the third quarter and first nine months of fiscal 2014 were $0.3 million and $1.2 million, respectively, and were $0.3 million and $1.2 million for the third quarter and first nine 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.

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):

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 3.50% convertible subordinated notes were excluded. For the third quarter and first nine months of fiscal 2014, 42.5 million weighted equivalent shares of 4.50% convertible subordinated notes were excluded. For the third quarter and first nine months of fiscal 2013, 28.5 million and 9.4 million weighted equivalent shares of 4.50% convertible subordinated notes were excluded.
• For the third quarter and first nine months of fiscal 2014, options to purchase 11.5 million and 13.8 million weighted average shares, respectively, were excluded. For the third quarter and first nine months of fiscal 2013, options to purchase 16.4 million and 17.7 million weighted average shares, respectively, were excluded.
• Unvested RSUs of 11.5 million and 10.7 million weighted average shares for the third quarter and first nine months of fiscal 2014, respectively, were excluded. Unvested RSUs of 10.7 million and 10.1 million weighted average shares for the third quarter and first nine months of fiscal 2013, respectively, were excluded.

14

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 is a leading expert in end-to-end scale-out storage and data protection, providing solutions for sharing, archiving and accessing digital assets over the entire data lifecycle. Our customers, ranging from small businesses to major enterprises, have trusted us to address their most demanding content workflow challenges. We provide solutions for storing and protecting information in physical, virtual and cloud environments that are designed to help customers Be Certain^TM they have a comprehensive storage foundation to maximize the value of their data by making it accessible whenever and wherever needed, offering indefinite retention and reducing total cost and complexity. We work closely with a broad network of distributors, value-added resellers (“VARs”), direct marketing resellers (“DMRs”), original equipment manufacturers (“OEMs”) and other suppliers to meet customers’ evolving needs. Our stock is traded on the New York Stock Exchange under the symbol QTM.

We believe our combination of expertise, innovation and platform independence enables us to solve data protection and scale-out storage 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. 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 vmPRO^TM 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. Our StorNext^® file system and archive solutions and Lattus^TM object storage systems are designed to provide the extreme performance, scalability and durability for managing, protecting and repurposing large content workflows. We have a full range of services and the global scale and scope to support our worldwide customer base.

Our goals for fiscal 2014 were 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 and third quarters 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 rich media and other 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. We believe the increased revenue in the third quarter of fiscal 2014 compared to the second quarter of fiscal 2014 reflects the market demand for our products and the positive changes we have made in our sales model during fiscal 2014, including improved sales execution and efficiency.

16

We planned 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. During the third quarter of fiscal 2014 StorNext 5 software became generally available and we expanded our strategic partnerships to combine our Lattus software with a partner’s software to create an archiving solution that reduces the burden of unstructured data growth on primary storage. We introduced a new program enabling managed service providers and VARs to expand their businesses with a cloud backup service powered by our DXi appliances and vmPRO backup software that has capacity-based subscription pricing. In addition, we received industry recognition during the quarter with an award for our channel sales program and with award nominations for our Lattus and StorNext products.

We began implementing a series of steps in the third quarter of fiscal 2013 to reduce our cost structure to adjust to the changing storage environment. During the third quarter of fiscal 2014, we completed the majority of our manufacturing outsource transition to transfer production of our products to contract manufacturers. The transition began in the first quarter of fiscal 2014 and we expect to complete it in the fourth quarter of fiscal 2014. We will continue to source and supply components for certain of our products in accordance with the agreements with our contract manufacturer partners. As a result of this transition, our manufacturing facilities are expected to be vacated and we expect to incur facility restructuring charges for remaining lease payments which continue through February 2021. Facility restructuring charges will be recognized when we fully vacate the various locations and may occur in the fourth quarter of fiscal 2014, the first quarter of fiscal 2015 or a portion in each period.

Results

We had total revenue of $145.9 million in the third quarter of fiscal 2014, an 8% decrease from the third quarter of fiscal 2013, primarily due to decreased tape automation systems revenue and a decline in disk systems sales, largely as a result of the changing storage environment. We saw a significant decrease in demand for data protection products during the first half of fiscal 2013 and adjusted our sales model to align with this change, reducing sales resources and territories. With the decreased investment in our sales resources and territories, we expected lower revenue than a year ago. Partially offsetting these revenue decreases was increased branded revenue from our StorNext product family, which nearly doubled from the third quarter of fiscal 2013.

However, total revenue in the third quarter of fiscal 2014 increased 11% from the second quarter of fiscal 2014 largely due to increased sales of branded tape automation systems and DXi disk systems sales in addition to StorNext appliances. Revenue for the quarter approximated expectations in each major geography of North America, Europe and Asia. In Europe, revenue from branded tape automation systems and DXi disk systems increased sequentially largely due to increased large orders, or orders greater than $200,000, and an improved business climate. Our commercial business in North America improved sequentially across our major product lines, notably our branded tape automation systems sales.

Our gross margin percentage decreased 60 basis points from the third quarter of fiscal 2013 to 42.1% primarily due to the 8%, or $13.4 million, decrease in revenue and was partially offset by decreased costs as a result of cost reduction actions implemented over the past year. Operating expenses decreased $12.2 million, or 17% from the third 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 third quarter of fiscal 2013 was for compensation and benefits, including severance, as a result of reduced staffing to right-size our workforce in order to align spending with revenue expectations and to outsource our manufacturing operations. Despite the 8% decrease in revenue, we improved the loss from operations from a $5.7 million loss in the third quarter of fiscal 2013 to breakeven in the current quarter. We believe these improved operating results demonstrate the progress we have made implementing our business model to better align spending and revenue, improve sales execution and efficiency and to increase our operational flexibility.

Interest expense increased 9% 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 $15.5 million of cash from operating activities in the first nine months of fiscal 2014 compared to a net use of cash from operating activities of $8.1 million in the first nine months of fiscal 2013. We ended the quarter with $80.1 million in cash and cash equivalents, the highest quarter end balance in the past three years.

17

RESULTS OF OPERATIONS

Revenue

Total revenue decreased in the third quarter of fiscal 2014 primarily due to decreased tape automation systems revenue and disk systems revenue, partially offset by increased revenue from StorNext software and related appliances. As noted above, we believe this is due to the changing storage environment including reduced demand for data protection products and increased market demand for scale-out storage and archive solutions in addition to our actions related to reducing our investments in sales while improving our sales model. For the first nine months of fiscal 2014, total revenue decreased due to the changing storage environment as well as from lower revenue in Europe and decreased sales to the U.S. federal government, particularly in the second quarter of fiscal 2014, partially offset by a $15.0 million royalty received in connection with finalizing an intellectual property agreement in the first quarter of fiscal 2014. We believe decreased sales in Europe were largely due to economic uncertainty and its impact on the European business climate. We believe sales to the U.S. federal government were negatively impacted in the second and third quarters of fiscal 2014 by the U.S. federal government shut down, causing delays and cancelations of orders.

Revenue from branded data protection products and services decreased $12.1 million, or 11%, from the third quarter of fiscal 2013 and decreased $32.1 million, or 11%, from the first nine 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 scale-out storage and archive products and services increased $2.7 million, or 22% from the third quarter of fiscal 2013 and increased 13% from the first nine months of fiscal 2013 largely due to increased sales of our Q-Series and StorNext appliance offerings. Scale-out storage and archive products include StorNext software, StorNext and Q-Series appliances and Lattus object storage solutions. OEM product and service revenue decreased $3.2 million and $8.0 million from the third quarter and first nine months of fiscal 2013, respectively. Royalty revenue decreased $0.9 million from the third quarter of fiscal 2013 and increased $12.6 million from the first nine 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 $14.1 million and $37.3 million in the third quarter and first nine months of fiscal 2014, respectively, compared to the prior year periods due to the business reasons noted above. The decrease from the third quarter and first nine months of fiscal 2013 was largely due to decreased revenue from sales of enterprise tape automation systems and enterprise and midrange disk systems. Revenue from sales of branded products decreased 12% from both the third quarter and first nine months of fiscal 2013, and sales of products to our OEM customers decreased 13% and 11%, respectively, in the third quarter and first nine months of fiscal 2014 compared to the prior year periods.

18

Our disk systems and software solutions revenue decreased 14% and 16%, respectively, from the third quarter and first nine months of fiscal 2013. The decrease in the third quarter of fiscal 2014 was primarily due to decreased sales of midrange systems followed by enterprise disk systems. For the first nine months of fiscal 2014, the decrease was primarily due to decreased sales of enterprise disk systems worldwide. We had fewer large orders, or orders over $200,000, in the third quarter and first nine months of fiscal 2014 which negatively impacted enterprise and midrange disk systems revenue. Partially offsetting this decrease was increased revenue from certain of our scale-out storage offerings, notably our Q-Series server-based appliances and StorNext archive enabled libraries compared to the third quarter and first nine months of fiscal 2013. We had record quarterly revenue from our StorNext appliances in the third quarter of fiscal 2014, in large part due to increased sales in North America.

The decrease in tape automation systems revenue in the third quarter and first nine 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, especially in the commercial market in North America. Sales of branded tape automation systems decreased more than revenue from OEM product sales in both the third quarter and first nine months of fiscal 2014 from the prior year periods. As noted above, the largest branded revenue decrease was in enterprise products. This was followed by midrange then entry level product revenue decreases compared to the third quarter and first nine months of fiscal 2013. However, branded midrange tape automation sales were slightly above our expectations in the third quarter and first nine months of fiscal 2014. For the third quarter and first nine months of fiscal 2014, OEM tape automation revenue decreased from the prior year periods primarily due to reduced midrange tape automation sales.

Product revenue from devices, which includes tape drives and removable hard drives, and non-royalty media sales decreased $0.5 million from the third quarter of fiscal 2013 primarily due to decreased media sales. For the first nine months of fiscal 2014, devices and media increased slightly, primarily due to increased revenue from devices compared to the first nine months of fiscal 2013.

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 4% and 2%, respectively, from the third quarter and first nine months of fiscal 2013 primarily due to increased revenue from branded service contracts associated with our StorNext appliances and our data protection products, partially offset by lower revenue from a decreased volume of OEM product repair services.

Royalty Revenue

Tape media royalties decreased 8% from the third quarter of fiscal 2013 primarily due to expected decreases of media unit sales sold by media licensees. For the first nine months of fiscal 2014, royalty revenue increased 37% 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.

19

Gross Margin