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Crossroads Systems Inc – ‘10-Q’ for 4/30/12

On:  Thursday, 6/14/12, at 11:38am ET   ·   For:  4/30/12   ·   Accession #:  1144204-12-34778   ·   File #:  1-15331

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  As Of               Filer                 Filing    For·On·As Docs:Size             Issuer                      Filing Agent

 6/14/12  Crossroads Systems Inc            10-Q        4/30/12   29:1.4M                                   Toppan Merrill/FA

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16: R2          Condensed Consolidated Balance Sheets               HTML    106K 
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                [Parenthetical]                                                  
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED April 30, 2012

OR

¨      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: 001-15331

CROSSROADS SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

(512) 349-0300

(Registrant's telephone number, including area code)

Indicate by check mark whether 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.x  Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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). xYes ¨No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or 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 x No

As of June 14, 2012 Registrant had outstanding 11,073,700 shares of common stock, par value $0.001 per share.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

FORM 10-Q

QUARTER ENDED APRIL 30, 2012

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

See accompanying notes to the condensed consolidated financial statements.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(In thousands, except share and per share data)

See accompanying notes to the condensed consolidated financial statements.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(In thousands)

See accompanying notes to the condensed consolidated financial statements.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Crossroads Systems, Inc. (“Crossroads”) and its subsidiaries (collectively with Crossroads, the “Company”) have been prepared in accordance with the instructions to Form 10-Q and therefore do not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with United States generally accepted accounting principles (“GAAP”).  The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto together with management’s discussion and analysis of financial condition and results of operations contained in the Company’s 2011 Annual Report on Form 10-K filed on January 27, 2012 (“2011 Form 10-K”).  In the opinion of management, the accompanying condensed consolidated financial statements reflect all adjustments of a normal recurring nature considered necessary to fairly state the financial position of the Company at October 31, 2011 and April 30, 2012, the results of its operations for the three and six months periods ended April 30, 2011 and 2012, and its cash flows for the six months periods ended April 30, 2011 and 2012.  The results of operations for the periods presented are not necessarily indicative of results that may be expected for the year ending October 31, 2012.

Use of Estimates

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in the Company’s condensed consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates.

Contracts to Modify or Customize Software Products

During the quarter ended April 30, 2012, the Company entered into contracts with certain customers to significantly modify or customize software products. In accounting for such arrangements, the Company first looks to the guidance in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Subtopic 985-605, Software - Revenue Recognition (“ASC 985-605”), and then ASC Subtopic 605-25, Revenue Recognition – Multiple-Element Arrangements, to determine the appropriate accounting elements in the arrangement.  The Company then considers the appropriate recognition model for each accounting element based on the nature of the element and applies the guidance in ASC Subtopic 605-35, Revenue Recognition – Construction-Type and Production-Type Contracts, ASC Subtopic 985-60, ASC Subtopic 605-15, Revenue Recognition – Products, or ASC Subtopic 605-20, Revenue Recognition – Services, as applicable.  Amounts allocated to the modification/customization service element are evaluated for income statement classification as either revenue or reduction of research and development expense based on the following considerations: whether and in what circumstances the consideration received is refundable, ownership of the final product and intellectual property rights to develop the product, and exclusivity of the final product.  The Company recorded no amounts as revenue and approximately $0 and $0.4 million as a reduction of research and development expense related to these contracts for the six month periods ended April 30, 2011 and 2012, respectively.

Recently Issued Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued ASU 2011-04, Fair Value Measurement (Topic 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”). ASU 2011-04 updated accounting guidance related to fair value measurements and disclosures that result in common fair value measurements and disclosures between GAAP and International Financial Reporting Standards. This guidance includes amendments that clarify the intent about the application of existing fair value measurements and disclosures or change a particular principle or requirement for fair value measurements or disclosures. This guidance is effective for interim and annual periods beginning after December 15, 2011. The Company does not believe that the adoption of this guidance will have a material impact on its consolidated financial statements or disclosures.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income (Topic 220) (“ASU 2011-05”). ASU 2011-05 modifies how comprehensive income is presented in an entity’s financial statements. The guidance issued requires an entity to present the components of net income and total net income, the components of other comprehensive income and total other comprehensive income, and the total comprehensive income either in a single continuous statement of comprehensive income, or in two separate but consecutive statements and eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholder’s equity. The revised financial statement presentation for comprehensive income will be effective for the Company for annual periods beginning after December 15, 2011. The Company anticipates adopting ASU 2011-05 beginning November 1, 2012. The Company does not anticipate that these changes will have a material impact on its consolidated financial statements or disclosures.

Management does not believe that any other recently issued, but not yet effective accounting pronouncements, if adopted, would have a material impact on its consolidated financial statements or disclosures.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. To increase the comparability of fair value measurements, a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies, is as follows:

Level 1 – Valuations based on quoted prices for identical assets and liabilities in active markets.

Level 2 – Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

Level 3 – Valuations based on unobservable inputs reflecting management’s assumptions, consistent with reasonably available assumptions made by other market participants. These valuations require significant judgment.

As of October 31, 2011 and April 30, 2012, the fair value of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, approximates book value due to the short maturity of these instruments. As of October 31, 2011, the Company held $2,683,000 of commercial paper, and $702,000 of fixed income government agency debt securities. As of April 30, 2012, the Company held $350,000 of fixed income government agency debt securities. These instruments are classified as Level 1 of the fair value hierarchy, as fair value for these instruments is determined using observable, quoted prices for identical assets in active markets.

At April 30, 2012, the Company had no assets or liabilities that were measured at fair value on a non-recurring basis. The estimated fair value of the Company's line of credit approximates the carrying value presented in its consolidated balance sheet based on discounting the expected future cash flows using current market rates as of April 30, 2012.

Inventory, net consists of the following (in thousands):

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Property and equipment, net consist of the following (in thousands, except number of years):

Depreciation expense was approximately $227,000 and $336,000 for the six months ended April 30, 2011 and 2012, respectively.

In 2006, the Company acquired Tape Laboratories, Inc, resulting in an intangible asset, purchased technology, in the amount of $5.7 million. In 2007, the Company acquired Grau Data Storage, AG, resulting in an intangible asset, purchased technology, in the amount of $0.7 million.

The following table presents details of intangible assets acquired (in thousands, except number of years):

Amortization expense was approximately $535,000 and $94,000 for the six months ended April 30, 2011 and 2012, respectively. Such assets will be fully amortized at October 31, 2012.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Accrued expenses consist of the following (in thousands):

Included in payroll related accrued expenses as of October 31, 2011 was $407,000 related to bonus compensation which was subsequently settled in January 2012 with 83,959 shares of common stock. The stock grants were valued using the intrinsic value, which is the amount by which the stock price exceeded the exercise price of the shares on the date of grant. These stock grants, having no exercise price, were effectively valued at the full share price on the date of the grant.

Warranty reserve activity during the year ended October 31, 2011 and six months ended April 30, 2012 was as follows (in thousands):

Deferred revenue, current portion, consists of the following (in thousands):

The Company has a line of credit with its bank. The committed revolving line provides for an advance of up to $4.0 million with a borrowing base of 80% of eligible accounts receivable. Interest accrues monthly at a rate of prime rate, plus a margin of 0.25%. The Company is required to satisfy certain financial and reporting covenants in conjunction with the line of credit. The line of credit will mature on December 27, 2012. At the November 2011 measurement date, the Company was in default of the tangible net worth covenant relating to the line of credit. The lender waived the default, and the parties modified the loan covenants. As of April 30, 2012, there was $1.97 million drawn and outstanding on the line of credit, and the Company was in compliance with the modified covenants.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

On November 9, 2011, the Company entered into a term loan agreement with its bank.  The loan is available in draws of $0.5 million, with a maximum drawn balance of $3.0 million.  Each individual draw is to be repaid in equal monthly payments over 36 months, fully amortized, bearing an interest rate of Prime Rate, plus a margin of 2.5%.  The Company is required to satisfy certain financial and reporting covenants in conjunction with the term loan. As of April 30, 2012, there was $2.8 million outstanding on the term loan, and the Company was in compliance with all modified covenants.

Current portion of long term debt and long term liabilities consists of the following (in thousands):

Interest expense relating to the line of credit and the term loan was approximately $45,000 and $73,000 for the six months ended April 30, 2011 and 2012, respectively.

Leases

The Company leases office space and equipment under long-term operating lease agreements that expire on various dates through August 31, 2016. Rental expense under these agreements was approximately $265,000 and $204,000 for the six months ended April 30, 2011 and 2012, respectively. Crossroads leases its headquarters, approximately 37,800 square feet of general office, laboratory, data center and administrative space in Austin, Texas. The original lease was effective October 31, 2005 and extended in accordance with an extension agreement through February 28, 2015. The term of the extension agreement is five years, from March 1, 2010 through February 28, 2015, and represents a lease commitment of $373,000 per year through the remaining lease term.

Legal Proceedings

Intellectual Property Litigation

The Company filed a lawsuit in September of 2010, against 3Par, Inc., American Megatrends, Inc., Rorke Data, Inc., D-Link Systems, Inc., Chelsio Communications, Inc., DataCore Software Corporation, and IStor Networks, Inc. in a lawsuit styled Crossroads Systems, Inc. v. 3Par, Inc. et al, Civil Action No. 1:10-CV-652-SS (W.D. Tex – Austin Division) alleging infringement by each of the defendants of one or both of U.S. Patent Nos. 6,425,035 and 7,051,147.  With the exception of Rorke Data, Inc., all of the defendants have settled in fiscal year 2011.  The Markman Order construing the claims of the patent has been entered by the Court, and both parties are in the process of discovery.  The lawsuit is proceeding against Rorke Data, Inc.

The Company filed a lawsuit in January 2012, against Infortrend Corporation, Aberdeen LLC, Boost Systems, Inc., iXsystems, Inc. and Storageflex, Inc. in a lawsuit styled Crossroads Systems, Inc. v. Infortrend Corporation et al, Civil Action No. 1:12-CV-00104-SS (W.D. Tex – Austin Division) alleging infringement by each of the defendants of one or both of U.S. Patent Nos. 6,425,035 and 7,051,147.  The Defendants have filed a motion to transfer the case to the Northern District of California; this motion is currently pending before the Court. 

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

On October 23, 2010 the Company sold 3,125,000 shares of its common stock at $3.20 per share for gross proceeds to the Company of $10.0 million.  In conjunction with this private placement, the Company also issued warrants to purchase an additional 1,074,212 shares of common stock with an exercise price of $3.20 per share.   Fees in the amount of $0.8 million relating to the stock placement were netted against proceeds.  The warrants were valued at $1.3 million using the Black-Sholes model.  The Black-Sholes inputs used were:  expected dividend rate of 0%, expected volatility of 68%, risk free interest rate of 1.47%, and expected term of 2.5 years.  The warrants were exercisable immediately upon issue, and expire October 22, 2015.

In August 2011, the Company filed an amendment to its Certificate of Incorporation to effect a reverse stock split of its issued and outstanding common stock, pursuant to which every four outstanding shares of common stock were combined and reclassified into one share of common stock. This reverse stock split was effective August 12, 2011. All references to the number of shares of common stock issued and outstanding have been restated to give retroactive effect to the reverse stock split.

The Company has a stock-based compensation plan available to grant incentive stock options, non-qualified stock options and restricted stock to employees and non-employee members of the Board of Directors and advisors.

The Company’s 1999 Stock Option/Stock Issuance Plan (the “1999 Plan”) was succeeded by the 2010 Stock Incentive Plan (the “2010 Plan”).  As of April 30, 2012, options to purchase 1,145,344 shares of common stock were outstanding, and no further grants can be made under the 1999 Plan.

The 2010 Plan was approved by the board of directors on May 26, 2010 and became effective on August 13, 2010, upon approval by shareholders.  A maximum of 3,000,000 shares of Crossroads common stock may be awarded, plus the automatic increase as detailed below. The total number of shares that will be reserved, and that may be issued, under the 2010 Plan will automatically increase on the first trading day of each calendar year, by a number of shares equal to four percent (4%) of the total outstanding shares on the last day of the prior calendar year, subject to a maximum annual increase of 250,000.  As of April 30, 2012, options to purchase 1,107,629 shares of common stock were granted from the 2010 Plan, of which 1,021,875 were outstanding as of April 30, 2012. During the six months ended April 30, 2012, common stock share grants of 83,959 were granted from the 2010 Plan.

As of April 30, 2012, options to purchase an aggregate of 2,167,219 shares of common stock were outstanding under the 1999 Plan and the 2010 Plan, of which 1,293,207 were vested. Under the 2010 Plan, 1,863,862 shares of common stock were available for future grants as of April 30, 2012.  The shares of common stock reserved for future grant are reduced by 30,304 options previously exercised under the 2010 Plan, and 83,959 shares of stock granted under the plan.  The exercise price, term and other conditions applicable to each stock option granted under the 2010 Plan are determined by the Compensation Committee of the Board of Directors. The exercise price of stock options is set on the grant date and may not be less than the fair market value per share of the Company’s stock on that date (at market close). The 2010 Plan options generally become exercisable over a four year period (vesting 25% after one year, the remaining 75% vesting quarterly thereafter) and expire after ten years.  Stock option exercises are fulfilled with new shares of common stock.

The Company realized share-based compensation expense for all awards issued under the Company’s stock plans in the following line items in the consolidated statements of operations (in thousands):

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

During the fourth quarter of the fiscal year ended October 31, 2011, management made the decision to pay 67% of the management bonus for the fiscal year ended October 31, 2011 with shares of the Company’s common stock. Accordingly, 83,959 shares of common stock were granted in January 2012 valued at $433,000. During the six months ended April 30, 2012 share based compensation expense of $138,000 has been accrued for 67% of the total estimated management bonuses for the fiscal year ended October 31, 2012.

The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model. Expected volatility is based on historical volatility of the Company’s stock. The expected term represents an estimate of the time options are expected to remain outstanding. The Company’s options that are exercised are restricted for one year from the date of exercise, therefore it does not believe the actual history of shares exercised is an accurate method of calculating expected term and use the simplified method to derive an expected term. The risk-free rate for periods within the contractual life of the option is based on the U.S. treasury yield curve in effect at the time of grant. The variables used in the Black-Sholes calculation are listed below for the respective periods:

The following table summarizes information about stock option activity for the six months ended April 30, 2012 (unaudited):

The weighted average fair value per option granted during the six months ended April 30, 2011 and 2012 was $2.76 and $3.56 respectively. The total intrinsic value of options (which is the amount by which the stock price exceeded the exercise price of the options on the date of exercise) exercised during the six months ended April 30, 2011 and 2012 was $155,815 and $172,379, respectively. During the six months ended April 30, 2011 and 2012, the amount of cash received from the exercise of stock options was $59,412 and $112,986, respectively.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Company did not grant any options to non-employees during the six months ended April 30, 2011 and granted 13,000 options during the six months ended April 30, 2012, the fair value of which was approximately $37,000.

At April 30, 2012, there was approximately $1,392,000 of total unrecognized compensation cost related to non-vested stock option awards which is expected to be recognized over a weighted-average period of 1.3 years. There were 129,161 and 162,027 options that became vested during the six months ended April 30, 2011 and 2012, respectively, with the total fair value of these awards of approximately $223,000 and $231,000 respectively.

The following table shows information about outstanding stock options at April 30, 2012:

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

The following discussion and analysis of the financial condition and results of our operations should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this quarterly report on Form 10-Q and the audited consolidated financial statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended October 31, 2011. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section entitled “Risk Factors” included elsewhere in our filings with the Securities and Exchange Commission.

Forward-Looking Statement

Various statements contained in or incorporated by reference into this quarterly report that express a belief, expectation, or intention, or that are not statements of historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). These forward-looking statements may include projections and estimates concerning capital expenditures, our liquidity and capital resources, the timing and success of specific projects, outcomes and effects of litigation, claims and disputes, elements of our business strategy and other statements concerning our operations, economic performance and financial condition. When used in this quarterly report, the words “could,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “may,” “continue,” “predict,” “potential,” “project” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. In particular, the factors discussed below and detailed in our prospectus dated August 30, 2011 and filed with the SEC pursuant to Rule 424(b) on September 14, 2011, could affect our actual results and cause our actual results to differ materially from expectations, estimates, or assumptions expressed in, forecasted in, or implied in such forward-looking statements.

Forward-looking statements may include statements about our:

All forward-looking statements involve risks, assumptions and uncertainties. The occurrence of the events described, and the achievement of the expected results, depend on many events, some or all of which are not predictable or within our control. Actual results may differ materially from expected results. These risks, assumptions and uncertainties are not necessarily all of the important factors that could cause actual results to differ materially from those expressed in any of our forward-looking statements. Other unknown or unpredictable factors also could harm our results. In light of these risks, uncertainties and assumptions, the forward-looking events might not occur.

Readers are cautioned not to place undue reliance on forward-looking statements, as there can be no assurance that the plans, intentions or expectations upon which they are based will occur. By their nature, forward-looking statements involve numerous assumptions, known and unknown risks and uncertainties, both general and specific, that contribute to the possibility that the predictions, forecasts, projections and other things contemplated by the forward-looking statements will not occur. Forward-looking statements in this quarterly report are based on management’s beliefs and opinions at the time the statements are made. The forward-looking statements contained in this quarterly report are expressly qualified in their entirety by this cautionary statement. The forward-looking statements included in this quarterly report are made as of the date of this quarterly report and we undertake no obligation to publicly update or revise any forward-looking statements to reflect new information, future events or otherwise, except as required by applicable securities laws.

Overview

We are a global provider of solutions to connect, protect and secure business-critical data for enterprise storage and the cloud computing marketplace.  Our storage software solutions leveraging our extensive patent portfolio enable highly-resilient data protection, pro-active data security and intelligent storage connectivity.

Our strategy and operations are currently focused on the following initiatives:

Strategic Focus

Our strategic focus is on high growth segments in the storage sector that utilize our intellectual property and experience.  We continue to expand our focus from solely offering bridging and routing solutions. Our research and development efforts have resulted in the creation of our currently shipping products: StrongBox, RVA, and SPHiNX. We identified specific segments we are initially targeting for Strongbox utilizing LTFS to expand the usability and access of tape media. We have identified a market need to verify the integrity of tape archives, and accomplish this through our RVA offering. Our SPHiNX product offers a vitual tape library capability that provides low cost storage with data replication, encryption, and WAN acceleration features for backups as well as complete disaster recovery capabilities for mid-range servers and open system host environments.

We deliver our current offerings to the market through hardware appliances. This strategy allows us to use off-the-shelf hardware platforms, which can easily be customized to support specific original equipment manufacturer (“OEM”) or system integrator (“SI”) specifications. We believe this strategy provides us with low-cost, high performance options that can be quickly deployed with minimal disruption to customers all the while minimizing inventory and associated excess and obsolete costs.

Substantially all of our current products have been sold in combination with support and services contracts. Our support and services contracts are typically offered for periods of one to three years. We mainly sell these products through a network of OEMs, SIs and value added resellers (“VARs”).

We expect growth in international markets for StrongBox, RVA and SPHiNX to be a significant factor contributing to our revenue growth in future periods. International revenue accounted for approximately 2.6% and 7.6% of our total revenue in the six months ended April 30, 2011 and 2012, respectively. As we expand internationally, we may incur additional costs to conform our products to comply with local laws or local product specifications and to ship our products to our international customers. We may also incur increased foreign currency risk as we have more exposure to international markets.

IP Licensing Campaign Focus

We continue to realize revenue from existing intellectual property licensees with go-forward royalties derived from the ‘972 patent family, which accounts for 8 of our existing 100 granted patents and 91 pending patents as of April 30, 2012. We maintain an active licensing program related to the ‘972 family, which has been licensed to over 40 of the leading storage industry providers. We pursue licensing fees for past shipments and recurring licensing fees related to ongoing shipments. In some cases we are required to litigate where we believe other companies are infringing our claims. Generally, these cases are settled quickly as we engage in business discussions with the opposing parties; however, one or more of the litigants may pursue their defense to greater lengths, which would require higher expenses to continue the lawsuit. Our IP licensing revenue for the six months ended April 30, 2012 was $0.4 million, or approximately 6.4% of revenues.

We continue to look for different ways to extract value from our patents outside the ‘972 family, which may include commercial, financial and strategic initiatives.  Intellectual property, or IP, holds value beyond pure monetary reasons.  For example, we believe that the proprietary nature of our products is appealing to both end-users and strategic partners who view our products as not being easily replaceable.  Additionally, IP may be a significant barrier to entry for potential competitors.  Therefore, we will continue to assess the value of our current portfolio and attempt to expand and take advantage of our IP portfolio.

Leveraging our IP, Current Products and Capital

Our product development strategy includes the creation of code modules using current patented IP and other proprietary information, that can be used across different products, enabling fast development and high quality and reliability.  For example, StrongBox used code modules from our existing solutions, including RVA and SPHiNX.  This allowed for the architecture, development and release of StrongBox only one year after the start of the program, resulting in what we believe to be a first-to-market and best-of-breed product.

Growing Our Market Reach

We expect that our launch strategy for StrongBox provides visibility, customer acquisition and strategic partner relationships that can lead to OEM partnerships and to expand the reach of StrongBox globally. Our initial target customers include many of our existing OEM partners, as well as new partner relationships. Our initial market for StrongBox focuses on Media and Entertainment, Healthcare, and Video Surveillance markets, all of which utilize rich content media, making data compression difficult.  Strongbox is fully usable with internal networks, as well as cloud environments. With the expansion of on-line web access globally, we are also focused on delivering valuable information and content which enables our website to be a lead generation engine to grow our visibility to end users.  While our marketing efforts are focused on this vertical approach, we believe that StrongBox can work for any company with a long-term archive need.  Therefore, we focus on website and search engine optimization and expansion of strategic partners to work with cloud storage and archiving service providers directly to offer the non-proprietary, secure, low cost and highly portable options we believe to be missing in cloud-based and end-user solutions today.  

Key Financial Definitions

Revenue.  Revenue consists of sales of hardware, software and services, as well as royalties we earn for products and the license of certain intellectual property. Our “product revenue” is composed of sales of our hardware products and software products sold to value added resellers, original equipment manufacturers and end users. Our “IP license, royalty and other revenue” is derived from the licensing of intellectual property, royalty payments, and sales of service contracts.

Cost of Revenue.  Cost of revenue is composed of cost of product revenue and IP license, royalty and other revenue. “Cost of product revenue” consists primarily of the cost charged by our previous contract manufacturer to manufacture our products, shipping charges and warranty obligations. “Cost of IP license, royalty and other revenue” consists of professional fees and services, overhead allocations, and obsolete inventory adjustments.

Operating Expenses.  Operating expenses consist of sales and marketing, research and development, general and administrative expenses and amortization of intangible assets. Personnel-related costs, which include stock-based compensation expense, are the most significant component of each of these expense categories. We had 98 employees as of April 30, 2011 and 105 employees as of April 30, 2012. We expect our headcount to increase during fiscal year 2012 to fulfill product development requirements by strategic partners. We expect customer reimbursed research and development will offset a portion of the added development expense. In any particular period, the timing of additional hires could materially affect our operating expenses, both in absolute dollars and as a percentage of revenue.

Sales and Marketing.  Sales and marketing expenses include personnel costs, employee sales commissions and marketing programs. We have sales and marketing personnel throughout the United States and in our sales office in Germany.

Research and Development.  Research and development expenses primarily include personnel costs, depreciation on lab equipment, costs of prototype equipment, other related costs of quality assurance and overhead allocations. We expense research and development costs as incurred. Though we incur software development costs, the costs of software development that we incur after a product has reached marketability are considered immaterial, and to date, we have not capitalized any such costs.

General and Administrative.  General and administrative expenses consist primarily of compensation and related costs for personnel and facilities related to our executive, finance, human resource, information technology and legal organizations, and fees for professional services. Professional services, excluding those for IP (which are included in cost of revenue), consists of outside legal, tax and audit costs.

Amortization of Intangibles.  Amortization of intangibles consists of the amortization of purchased technology.

Critical Accounting Policies and Estimates

Contracts to Modify or Customize Software Products

During the quarter ended April 30, 2012, we entered into contracts with certain customers to significantly modify or customize software products. In accounting for such arrangements, we first look to the guidance in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Subtopic 985-605, Software - Revenue Recognition (“ASC 985-605”), and then ASC Subtopic 605-25, Revenue Recognition – Multiple-Element Arrangements, to determine the appropriate accounting elements in the arrangement.  We then consider the appropriate recognition model for each accounting element based on the nature of the element and apply the guidance in ASC Subtopic 605-35, Revenue Recognition – Construction-Type and Production-Type Contracts, ASC Subtopic 985-60, ASC Subtopic 605-15, Revenue Recognition – Products, or ASC Subtopic 605-20, Revenue Recognition – Services, as applicable.  Amounts allocated to the modification/customization service element are evaluated for income statement classification as either revenue or reduction of research and development expense based on the following considerations: whether and in what circumstances the consideration received is refundable, ownership of the final product and intellectual property rights to develop the product, and exclusivity of the final product.  We recorded no amounts as revenue and approximately $0 and $0.4 million as a reduction of research and development expense related to these contracts for the six month periods ended April 30, 2011 and 2012, respectively.

There have been no other material updates to our critical accounting policies and estimates set forth in “Part II—Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates” in our 2011 Form 10-K.

Results of Operations

Three and Six Months Ended April 30, 2012 Compared to the Three and Six Months Ended April 30, 2011

Revenue. Total revenue increased $0.9 million, or 34%, to $3.5 million for the three months ended April 30, 2012 from $2.6 million for the three months ended April 30, 2011. The increase is mainly due to the increase in product revenue from RVA sales, due to a one-time corporate RVA software license to a customer, not including the rollout of systems across the corporation which will occur in subsequent quarters.

Total revenue decreased $0.2 million, or 2%, to $6.0 million for the six months ended April 30, 2012 from $6.2 million for the six months ended April 30, 2011. An increase in product revenue was offset by a decrease in IP license, royalty and other due to decreases in IP license revenue.

Product revenue for the three months ended April 30, 2012 increased $0.8 million, or 74%, to $1.9 million compared with $1.1 million for the three months ended April 30, 2011 due to an increase in RVA revenue of $0.8 million and an increase in Strongbox revenue of $0.1 million, offset by a decrease in SPHiNX revenue by $0.1 million.

Product revenue for the six months ended April 30, 2012 increased $0.6 million, or 25%, to $3.0 million compared with $2.4 million for the six months ended April 30, 2011 due to an increase in RVA revenue of $1.0 million, offset by a decrease in SPHiNX revenue of approximately $0.3 million and a decrease in router revenue of $0.1 million.

IP license, royalty and other revenue consists of the following for the three and six months ended April 30, 2011 and 2012:

IP license, royalty and other revenues for the three months ended April 30, 2012 increased $0.1 million, or 5%, to $1.6 million compared with $1.5 million for the three months ended April 30, 2011.

IP license revenue for the three months ended April 30, 2012 decreased $0.1 million compared to the same period in the prior fiscal year due to the reduction in royalty amounts received from a significant customer, based on the shipments made, compared to the same period in 2011. No IP agreements were signed in the second quarter of 2011 or 2012, therefore, no up-front payments were allocated to past shipments or recognized as revenue.

HP royalty and PCS service revenue for the three months ended April 30, 2012 increased approximately $0.1 million compared to the same period in the prior fiscal year due to increased shipments by HP of SPHiNX products.

PCS service revenue (non-HP) for the three months ended April 30, 2012 increased $0.1 million compared to the same period in the prior fiscal year due to an increase in the number of customers covered by PCS contracts and an increase in PCS contract rates due to our newer product offerings.

IP license, royalty and other revenue for the six months ended April 30, 2012 decreased $0.8 million, or 20%, to $3.0 million compared with $3.8 million for the six months ended April 30, 2011, primarily due to the reduction in IP license revenue. No IP agreements were signed during the six months ended April 30, 2012, thus no up-front payments were allocated to past shipments or recognized as revenue, compared to four IP agreements being entered into during the six months ended April 30, 2011. The economic nature of these agreements is such that they are not consistent in terms of revenue recognition. The agreements include an initial receipt of cash upon entering into an agreement as consideration for royalties on past shipments. The amounts for past shipments reflected in historical financial statements have fluctuated from period to period and, to the extent that the number of new customers resulting from our licensing campaign decreases, historical results may not be indicative of future results.

HP royalty and PCS service revenue remained consistent at approximately $2.3 million for both six month periods ended April 30, 2011 and 2012.

PCS service revenue (non-HP) revenue remained consistent at approximately $0.4 million for both six month periods ended April 30, 2011 and 2012.

Cost of Revenue.   Cost of revenue remained consistent at approximately $0.4 million for both three month periods ended April 30, 2011 and 2012.

Cost of revenue decreased $0.2 million, or 19%, to $0.7 million, for the six months ended April 30, 2012 from $0.9 million for the three months ended April 30, 2011 due to reduced IP license, royalty and other costs of revenue resulting from the decrease in professional fees in relation to our IP licensing activities.

Sales and Marketing.   Sales and marketing expenses increased $0.3 million, or 31%, to $1.5 million for the three months ended April 30, 2012 from $1.2 million for the three months ended April 30, 2011. This increase was mainly due to increases in payroll and related benefits by $0.3 million from an increase in headcount of three employees since the fiscal second quarter 2011, or approximately 11%. We expect the sales and marketing expenses to continue to increase as we increase our promotion of our Strongbox product.

Sales and marketing expenses increased $0.5 million, or 23%, to $2.9 million for the six months ended April 30, 2012 from $2.4 million for the six months ended April 30, 2011. This increase was mainly due to increases in payroll and related benefits by $0.5 million due to the increase in headcount.

Research and Development.    Research and development expenses decreased $0.1 million, or 6%, to $2.7 million for the three months ended April 30, 2012 from $2.8 million for the three months ended April 30, 2011. This decrease was due to customer reimbursed research and development of $0.4 million, a decrease in recruiting and relocation by $0.2 million, partially offset by increases in payroll and related benefits by $0.4 million and an increase in equipment depreciation by $0.1 million. Headcount in the research and development departments has increased by three employees since the second quarter of fiscal year 2011, or approximately 5%. This increase is related to the increase in StrongBox development and support.

Research and development expenses increased $0.5 million, or 10%, to $5.4 million for the six months ended April 30, 2012 from $4.9 million for the six months ended April 30, 2011. This increase was due to increases in payroll and related benefits of $1.0 million, and equipment depreciation by $0.1 million offset by customer reimbursed research and development of $0.4 million, and a decrease in recruiting and relocation by $0.2 million.

General and Administrative.   General and administrative expenses remained consistent at approximately $0.8 million for both three month periods ended April 30, 2011 and 2012.

General and administrative expenses remained consistent at approximately $1.6 million for the six months ended April 30, 2012 and $1.5 million for the six months ended April 30, 2012.

Amortization of intangible assets.   Amortization of intangible assets expense decreased $177,000, or 79%, to $47,000 for the three months ended April 30, 2012 from $224,000 for the three months ended April 30, 2011. The decrease was due to the 2011 period containing amortization of purchased technology that was fully amortized by the end of the second quarter of fiscal year 2011, and the corresponding period in 2012 containing no amortization related to this purchased technology.

Amortization of intangible assets expense decreased $0.4 million, or 82%, to $0.1 million for the six months ended April 30, 2012 from $0.5 million for the six months ended April 30, 2011. The decrease was due to the 2011 period containing amortization of purchased technology that was fully amortized by the end of the second quarter of fiscal year 2011, as described above.

Liquidity and Capital Resources

Cash Flows

Our principal liquidity requirements are to meet our lease obligations and our working capital and capital expenditure needs, as we continue to introduce StrongBox into the marketplace. We expect to finance our operations through cash on hand, cash provided by operations, and customer reimbursed research and development. We cannot be sure, however, that this will be the case, and we may seek additional financing in the future. The following table summarizes our primary sources and uses of cash in the periods presented:

Net cash used in operating activities increased from approximately $0.6 million during the six months ended April 30, 2011 to approximately $3.1 million during the six months ended April 30, 2012 due to increased losses for the six months ended April 30, 2012, as well as less cash provided by accounts receivable due to fluctuations in cash receipts from IP license agreements. There was also a favorable change in accrued expenses in the six months ended April 30, 2012, primarily due to cash received from customers for research and development we have not yet completed, which have been classified as customer deposits. In addition, the change in cash from accounts payable decreased primarily due to payments made for professional services made during the six months ended April 30, 2012 relating to IP license agreements closed during the fourth quarter of fiscal year 2011.

Cash flows from investing activities primarily relate to capital expenditures to support our employees, our capital needs in our research and development efforts, and the purchase of investments with available cash, offset by maturities of our short term investments. Net cash provided by investing activities was approximately $2.5 million during the six months ended April 30, 2012 compared to a use of $5.0 million in cash during the six months ended April 30, 2011. Included in the six months ended April 30, 2012 are maturities of short-term investments of $3.0 million net of purchases. During the six months ended April 30, 2011 purchases of $4.2 million of short-term investments net of maturities accounted for the large use of cash.

Cash flows provided by financing activities during the six months ended April 30, 2012 was $2.9 million, compared to cash provided by financing activities during the six months ended April 30, 2011 of $59,000. The increase is primarily from the $2.8 million draw, net of principal repayments, on our term loan during the six months ended April 30, 2012.

Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued ASU 2011-04, Fair Value Measurement (Topic 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”).  ASU 2011-04 updated accounting guidance related to fair value measurements and disclosures that result in common fair value measurements and disclosures between GAAP and International Financial Reporting Standards. This guidance includes amendments that clarify the intent about the application of existing fair value measurements and disclosures or change a particular principle or requirement for fair value measurements or disclosures. This guidance is effective for interim and annual periods beginning after December 15, 2011. We do not believe that the adoption of this guidance will have a material impact on our consolidated financial statements or disclosures.

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income (Topic 220) (“ASU 2011-05”).  ASU 2011-05 modifies how comprehensive income is presented in an entity’s financial statements. The guidance issued requires an entity to present the components of net income and total net income, the components of other comprehensive income and total other comprehensive income, and the total comprehensive income either in a single continuous statement of comprehensive income, or in two separate but consecutive statements and eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholder’s equity. The revised financial statement presentation for comprehensive income will be effective for us for fiscal years, and interim periods within those years, beginning after December 15, 2011.  We anticipate adopting ASU 2011-05 beginning November 1, 2012.  We do not anticipate that these changes will have a significant impact on our consolidated financial statements or disclosures.

We do not believe that any other recently issued, but not yet effective accounting pronouncements, if adopted, would have a material impact on our consolidated financial statements or disclosures.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, our management has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective (i) to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms; and (ii) to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

Changes in Internal Controls

During the last fiscal quarter, there were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Intellectual Property Litigation

The Company filed a lawsuit in September of 2010, against 3Par, Inc., American Megatrends, Inc., Rorke Data, Inc., D-Link Systems, Inc., Chelsio Communications, Inc., DataCore Software Corporation, and IStor Networks, Inc. in a lawsuit styled Crossroads Systems, Inc. v. 3Par, Inc. et al, Civil Action No. 1:10-CV-652-SS (W.D. Tex – Austin Division) alleging infringement by each of the defendants of one or both of U.S. Patent Nos. 6,425,035 and 7,051,147.  With the exception of Rorke Data, Inc., all of the defendants have settled in fiscal year 2011.  The Markman Order construing the claims of the patent has been entered by the Court, and both parties are in the process of discovery.  The lawsuit is proceeding against Rorke Data, Inc.

The Company filed a lawsuit in January 2012, against Infortrend Corporation, Aberdeen LLC, Boost Systems, Inc., iXsystems, Inc. and Storageflex, Inc. in a lawsuit styled Crossroads Systems, Inc. v. Infortrend Corporation et al, Civil Action No. 1:12-CV-00104-SS (W.D. Tex – Austin Division) alleging infringement by each of the defendants of one or both of U.S. Patent Nos. 6,425,035 and 7,051,147.  The Defendants have filed a motion to transfer the case to the Northern District of California; this motion is currently pending before the Court. 

In addition to the Rorke Data, Inc. and Infotrend lawsuits, from time to time, we may become involved in legal proceedings arising in the ordinary course of our business. We are not presently involved in any legal proceeding in which the outcome, if determined adversely to us, would be expected to have a material adverse effect on our business, operating results or financial condition.

ITEM 1A. RISK FACTORS

Not applicable.

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

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS.

SIGNATURES

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.

EXHIBIT INDEX

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Dates Referenced Herein   and   Documents Incorporated by Reference

This ‘10-Q’ Filing		Date		Other Filings
		8/31/16
		10/22/15		4
		2/28/15
		12/27/12
		11/1/12
		10/31/12		10-K,  4
Filed on:		6/14/12
For Period end:		4/30/12
		1/27/12		10-K
		12/15/11		4
		11/9/11		8-K
		10/31/11		10-K,  4
		9/14/11		424B3
		8/30/11		3,  3/A,  EFFECT,  S-1/A
		8/12/11
		4/30/11
		10/23/10
		8/13/10
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		10/31/05
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