Quantum Corp: Form 10-Q for the period ended Jun 30, 2024

The following discussion and analysis compares the change in the consolidated financial statements for quarters ending June 30 2024 and June 30, 2023 and should be read together with our consolidated financial statements, the accompanying notes, and other information included in this Quarterly Report. In particular, the risk factors contained in Part II, Item 1A may reflect trends, demands, commitments, events, or uncertainties that could materially impact our results of operations and liquidity and capital resources. For comparisons of quarters ended June 30, 2023 and June 30, 2022, see our Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 2 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2023, filed with the SEC on August 8, 2023, and incorporated herein by reference.

The following discussion contains forward-looking statements, such as statements regarding anticipated impacts on our business, our future operating results and financial position, our business strategy and plans, our market growth and trends, and our objectives for future operations. Please see "Note Regarding Forward-Looking Statements" for more information about relying on these forward-looking statements.

OVERVIEW

We are a technology company whose mission is to deliver innovative solutions to organizations across the world. We design, manufacture and sell technology and services that help customers capture, create and share digital content, and protect it for decades. We specialize in solutions for unstructured data including video, images, audio, and other large files. We emphasize innovative technology in the design and manufacture of our products to help our customers unlock the value in their video and unstructured data in new ways to solve their most pressing business challenges.

We generate revenue by designing, manufacturing, and selling technology and services. Our most significant expenses are related to compensating employees; designing, manufacturing, marketing, and selling our products and services; data center costs in support of our cloud-based services; and interest associated with our long-term debt and income taxes.

Macroeconomic Conditions

We continue to actively monitor, evaluate and respond to the current uncertain macro environment, including the impact of higher interest rates, inflation, lingering supply chain challenges, and a stronger U.S. dollar. During the quarter we continued to experience longer sales cycle for opportunities with our enterprise as well as commercial customers.

The macro environment remains unpredictable and our past results may not be indicative of future performance.

RESULTS OF OPERATIONS

(in thousands)

(1) Includes stock-based compensation as follows:

(in thousands)

19

Comparison of the Three Months Ended June 30, 2024 and 2023

Revenue

(dollars in thousands)

Product revenue

In the three months ended June 30, 2024, product revenue decreased $17.6 million, or 30%, as compared to the same period in 2023. The primary driver of the decrease was a $20 million decrease in demand from our large hyperscale customers, as well as more general decreases in the overall tape market with declines in media and devices revenue. Outside of the Tape and Hyperscale business, our remaining Secondary and Primary storage systems are also offered as a subscription. We expect the product revenue portion of our Primary and Secondary storage systems to decrease as we continue to transition to subscription-based offerings.

Service revenue

Service and subscription revenue decreased 3.5 million, or 11%, in the three months ended June 30, 2024 compared to the same period in 2023, partially driven by certain long-lived products reaching their end-of-service-life, partially offset by new support bookings and the transition towards subscription-based licensing.

Royalty revenue

We receive royalties from third parties that license our linear-tape open (“LTO”) media patents through our membership in the LTO consortium. Royalty revenue decreased $0.1 million, or 2%, in the three months ended June 30, 2024 compared to the same period in 2023 due to decreased market volume of older generation LTO media.

Gross Profit and Margin

(dollars in thousands)

Product Gross Margin

Product gross margin decreased to 20.6% or by 350 basis points for the three months ended June 30, 2024, as compared with the same period in 2023. This decrease was primarily due to a less favorable mix of revenues, weighted towards our lower margin product lines, which were partially offset from improvements in our operational efficiency and logistics costs.

Service and Subscription Gross Margin

Service and subscription gross margins decreased 600 basis points for the three months ended June 30, 2024, as compared with the same period in 2023. This decrease was primarily driven by lower service revenues.

Royalty Gross Margin

Royalties do not have significant related cost of sales.

Operating expenses

(dollars in thousands)

In the three months ended June 30, 2024, sales and marketing expense decreased $2.5 million, or 16%, as compared with the same period in 2023. This decrease was primarily driven by improved operational efficiency and increased leverage from our channel.

In the three months ended June 30, 2024, general and administrative expense increased $8.4 million, or 66%, as compared with the same period in 2023. This increase was primarily driven by non-recurring costs related to our previously announced restatement of our historical financial statements, and other related projects.

In the three months ended June 30, 2024, research and development expense decreased $2.6 million, or 24%, as compared with the same period in 2023. This decrease was the result of the continued consolidation of acquisition costs, and efficiencies realized through improved organization design.

In the three months ended June 30, 2024, restructuring expenses decreased $0.1 million as compared with the same period in 2023. The decrease was the result of cost reduction initiatives.

Other expense

(dollars in thousands)

The change in other income (expense), net during the three months ended June 30, 2024 compared with the same period in 2023 was related primarily to fluctuations in foreign currency exchange rates during the three months ended June 30, 2024.

Interest expense

(dollars in thousands)

In the three months ended June 30, 2024, interest expense increased $0.6 million, or 18%, as compared with the same period in 2023 due to a principal balance and interest rate on our Term Loan.

Loss on debt extinguishment

(dollars in thousands)

In the three months ended June 30, 2024, loss on debt extinguishment of $0.7 million was related to prepayment of our Term Loan.

Warrant liabilities

(dollars in thousands)

In June 30, 2024, the change in fair value of warrant liabilities increased $0.9 million, or 129%, as compared with the same period in 2023 due to a lower average stock price in the first fiscal quarter of 2024.

Income taxes

(dollars in thousands)

The income tax provision for the three months ended June 30, 2024 and 2023 is primarily influenced by foreign and state income taxes. Due to our history of net losses in the United States, the protracted period for utilizing tax attributes in certain foreign jurisdictions, and the difficulty in predicting future results, we believe that we cannot rely on projections of future taxable income to realize most of our deferred tax assets. Accordingly, we have established a full valuation allowance against our U.S. and certain foreign net deferred tax assets. Significant management judgement is required in 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 its reversal. Our income tax expense recorded in the future will be reduced to the extent that sufficient positive evidence materializes to support a reversal of, or decrease in, our valuation allowance.

LIQUIDITY AND CAPITAL RESOURCES

We consider liquidity in terms of the sufficiency of internal and external cash resources to fund our operating, investing and financing activities. Our principal sources of liquidity include cash from operating activities, cash and cash equivalents on our balance sheet and amounts available under our credit facility with PNC Bank, National Association (as amended from time to time, the “PNC Credit Facility”) pursuant to the Amended Restated Revolving Credit and Security Agreement dated December 27, 2018. We require significant cash resources to meet obligations to pay principal and interest on our outstanding debt, provide for our research and development activities, fund our working capital needs, and make capital expenditures. Our future liquidity requirements will depend on multiple factors, including our research and development plans and capital asset needs.

We had cash and cash equivalents of $17.3 million as of June 30, 2024, which consisted primarily of bank deposits and money market accounts. As of June 30, 2024, our total outstanding Term Loan debt was $75.8 million and out outstanding PNC Credit Facility was $35.8 million with $0.1 million available to borrow.

We are subject to various debt covenants under our debt agreements. Our failure to comply with our debt covenants could materially and adversely affect our financial condition and ability to service our obligations. On August 13, 2024 the Company entered into amendments to the Credit Agreements, which, among other things, (i) waived compliance with the June 30, 2024 net leverage ratio financial covenant; (ii) waived any non-compliance with the minimum liquidity financial covenant through the date of the amendments; (iii) removed the fixed charges coverage ratio financial covenant until the fiscal quarter ending September 30, 2025; (iii) waived the testing requirement for the net leverage financial covenant for the fiscal quarter ending September 30, 2024; (iv) replaced the net leverage financial covenant with a minimum EBITDA financial covenant for the fiscal quarters ending December 31, 2024 and March 31, 2025; (v) reset the net leverage financial covenant requirements for the fiscal quarters ending June 30, 2025 and September 30, 2025; reduced the minimum liquidity covenant to $10 million through September 30, 2025; (vi) adjusted the applicable interest rates on the Term Loan and PNC Credit Facility; (vii) removed required 2021 Term Loan principal amortization until the fiscal quarter ending September 30, 2025; (viii) repriced certain Lender Warrants.We believe we were in compliance with all covenants under our debt agreements as of the date of filing of this Quarterly Report on Form 10-Q.

In connection with the August 2024 Amendments, the Company received additional available Term Loan borrowing capacity with a commitment of up to $26.3 million ($25.0 million after original issuance discount) structured as a senior secured delayed draw sub-facility with a commitment period expiring on October 31, 2024 (the “August 2024 Term Loan”). The Company borrowed $10.5 million at closing. Borrowings under the August 2024 Term Loan have an August 5, 2026 maturity date which aligns with the Term Debt. Principal is payable at a rate per annum equal to 5% of the original principal balance thereof payable quarterly beginning the quarter ending September 30, 2025. In connection with the August 2024 Term Loan, the Company issued warrants to purchase an aggregate of 7,610,190 shares of the Company’s common stock, at an exercise price of $0.31 per share.

For additional information about our debt, see the sections entitled “Risk Factors—Risks Related to Our Business Operations” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” in our Annual Report on Form 10-K for the fiscal year ended March 31, 2024.

Cash Flows

The following table summarizes our consolidated cash flows for the periods indicated.

(in thousands)

23

Cash Used In Operating Activities

Net cash used in operating activities was $1.9 million for the three months ended June 30, 2024. This use of cash was primarily attributed to cash used in operations excluding changes in assets and liabilities of $16.3 million offset in part by cash provided by working capital changes.

Net cash used in operating activities was $9.4 million for the three months ended June 30, 2023. This use of cash was primarily attributable to changes in working capital of $7.2 million.

Cash Used in Investing Activities

Net cash used in investing activities was $1.6 million in the three months ended June 30, 2024, which was attributable to capital expenditures.

Net cash used in investing activities was $2.3 million in the three months ended June 30, 2023, which was primarily attributable to capital expenditures.

Cash Provided by Financing Activities

Net cash used in financing activities was $4.8 million for the three months ended June 30, 2024, which was related primarily to borrowings on our PNC Credit Facility.

Net cash provided by financing activities was $11.2 million in the three months ended June 30, 2023, which was related primarily to borrowings on our Term Loan of $12.9 million.

Commitments and Contingencies

Our contingent liabilities consist primarily of certain financial guarantees, both express and implied, related to product liability and potential infringement of intellectual property. We have little history of costs associated with such indemnification requirements and contingent liabilities associated with product liability may be mitigated by our insurance coverage. In the normal course of business to facilitate transactions of our services and products, we indemnify certain parties with respect to certain matters, such as intellectual property infringement or other claims. We also have indemnification agreements with our current and former officers and directors. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of our indemnification claims, and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under these agreements have not had a material impact on our operating results, financial position or cash flows.

We are also subject to ordinary course litigation.

Off Balance Sheet Arrangements

Except for the indemnification commitments described under “—Commitments and Contingencies” above, we do not currently have any other off-balance sheet arrangements and do not have any holdings in variable interest entities.

Contractual Obligations

We have contractual obligations and commercial commitments, some of which, such as purchase obligations, are not recognized as liabilities in our financial statements. There have not been any other material changes to the contractual obligations disclosed in our Annual Report on Form 10-K for the fiscal year ended March 31, 2024.

Critical Accounting Estimates and Policies

The preparation of our consolidated financial statements in accordance with generally accepted accounting principles requires management to make judgments, estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes included elsewhere in this Quarterly Report on Form 10-Q. On an ongoing basis, we evaluate estimates, which are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. We consider certain accounting policies to be critical to understanding our financial statements because the application of these policies requires significant judgment on the part of management, which could have a material impact on our financial statements if actual performance should differ from historical experience or if our assumptions were to change. Our accounting policies that include estimates that require management’s subjective or complex judgments about the effects of matters that are inherently uncertain are summarized in our most recently filed Annual Report on Form 10-K for the fiscal year ended March 31, 2024 under the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates and Policies.” For additional information on our significant accounting policies, see Note 1 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

Recently Issued and Adopted Accounting Pronouncements

See Note 1 to the notes to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q and in our most recently filed Annual Report on Form 10-K.

There have been no material changes to our quantitative and qualitative disclosures about market risk from those described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our most recent Annual Report on Form 10-K, which such section is incorporated herein by reference.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our principal executive and principal financial officers, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934), as of the end of the period covered by this Quarterly Report. Based on such evaluation, our principal executive and principal financial officers have concluded that as of such date, our disclosure controls and procedures were not effective at the reasonable assurance level as the material weaknesses in internal control over financial reporting as of March 31, 2024, described in Part II, Item 9A, “Controls and Procedures” of the Annual Report, had not been remediated as of June 30, 2024.

Notwithstanding the identified material weaknesses, management, including our chief executive officer and chief financial officer have determined, that the condensed consolidated financial statements included in this Form 10-Q fairly represent in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, for the periods presented in accordance with U.S. generally accepted accounting principles.

Remediation Plan

The Company is committed to maintaining a strong internal control environment and believes the remediation efforts, as described in Part II, Item 9A, “Controls and Procedures” of the Annual Report, will represent significant improvements in its controls over the control environment. These steps will take time to be fully implemented and confirmed to be effective and sustainable. Additional controls may also be required over time. While the Company believes that these efforts will improve its internal control over financial reporting, the Company will not be able to conclude whether the steps the Company is taking will remediate the material weakness in internal control over financial reporting until a sufficient period has passed to allow management to test the design and operational effectiveness of the new and enhanced controls. Until the remediation steps set forth above are fully implemented and tested, the material weaknesses will continue to exist.

Changes in Internal Control

In addition to working on the remediation plan to address the identified material weaknesses, the Company implemented a new Enterprise Resource Planning (“ERP”) system during the quarter ended June 30, 2024. The implementation of the ERP system is expected to improve the accuracy, efficiency, and reliability of our financial reporting processes and enhance the effectiveness of our internal controls over financial reporting. Except for these items, in connection with the evaluation required by Rule 13a-15(d) under the Securities Exchange Act of 1934, there were no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2024 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness of Controls

Our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

There have been no material changes to the previously disclosed risk factors discussed in “Part I, Item 1A, Risk Factors” in our Annual Report on Form 10-K for the year ended March 31, 2024. You should consider carefully these factors, together with all of the other information in this Quarterly Report on Form 10-Q, including our unaudited condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q, before making an investment decision.