Overland Storage 10Q 2014 Q2 Quarterly report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

_____________________________________

FORM 10-Q

_____________________________________

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2013

Commission File Number: 000-22071

OVERLAND STORAGE, INC.

(Exact name of registrant as specified in its charter)



California	95-3535285
(State or other jurisdiction of incorporation)	(IRS Employer Identification No.)



9112 Spectrum Center Boulevard,
San Diego, California	92123
(Address of principal executive offices)	(Zip Code)

(858) 571-5555

(Registrant’s telephone number, including area code)

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 check mark whether the registrant has submitted electronically and posted on its corporate Web site every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 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 check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer o	Accelerated filer o	Non-accelerated filer o	Smaller reporting company x
		(Do not check if a smaller reporting company)

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

As of February 4, 2014, there were 86,932,020 shares of the registrant's common stock, no par value, issued and outstanding.

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OVERLAND STORAGE, INC.

FORM 10-Q

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PART I — FINANCIAL INFORMATION

Item 1.	Financial Statements:

	Consolidated Condensed Statements of Operations (unaudited) - Three and Six Months Ended December 31, 2013 and 2012	1

	Consolidated Condensed Statements of Comprehensive Loss (unaudited) - Three and Six Months Ended December 31, 2013 and 2012	2

	Consolidated Condensed Balance Sheets (unaudited) - December 31, 2013 and June 30, 2013	3

	Consolidated Condensed Statements of Cash Flows (unaudited) - Six Months Ended December 31, 2013 and 2012	4

	Notes to Consolidated Condensed Financial Statements (unaudited)	5

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	15

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	23

Item 4.	Controls and Procedures	23

PART II — OTHER INFORMATION

Item 1.	Legal Proceedings	24

Item 1A.	Risk Factors	25

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	25

Item 3.	Defaults Upon Senior Securities	26

Item 4.	Mine Safety Disclosures	26

Item 5.	Other Information	26

Item 6.	Exhibits	26

	Signatures	27

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PART I — FINANCIAL INFORMATION


Item 1.	Financial Statements.

OVERLAND STORAGE, INC.

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)



	Three Months Ended						Six Months Ended
	December 31,						December 31,
	2013			2012			2013			2012
	(Unaudited)						(Unaudited)
Net revenue:
Product revenue	$	6,594		$	7,782		$	12,727		$	14,421
Service revenue	4,042			4,817			8,515			9,889
	10,636			12,599			21,242			24,310
Cost of product revenue	5,350			6,333			10,727			12,385
Cost of service revenue	1,620			1,669			3,280			3,385
Gross profit	3,666			4,597			7,235			8,540
Operating expenses:
Sales and marketing	3,295			4,353			7,040			8,478
Research and development	1,352			1,591			2,661			3,188
General and administrative	3,518			2,765			6,129			5,649
	8,165			8,709			15,830			17,315
Loss from operations	(4,499		)	(4,112		)	(8,595		)	(8,775		)
Interest expense	(269		)	(46		)	(583		)	(88		)
Other income (expense), net	(62		)	(47		)	(223		)	(156		)
Loss before income taxes	(4,830		)	(4,205		)	(9,401		)	(9,019		)
Provision for (benefit from) income taxes	(514		)	68			(495		)	117
Net loss	$	(4,316	)	$	(4,273	)	$	(8,906	)	$	(9,136	)
Net loss per share:
Basic and diluted	$	(0.12	)	$	(0.15	)	$	(0.27	)	$	(0.33	)
Shares used in computing net loss per share:
Basic and diluted	36,884			28,339			33,414			28,108

See accompanying notes to consolidated condensed financial statements.

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OVERLAND STORAGE, INC.

CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE LOSS

(In thousands)



	Three Months Ended						Six Months Ended
	December 31,						December 31,
	2013			2012			2013			2012
	(Unaudited)						(Unaudited)

Net loss	$	(4,316	)	$	(4,273	)	$	(8,906	)	$	(9,136	)
Other comprehensive income:
Change in unrealized gains, net of tax of $1,546, $0, $1,546, $0, respectively	1,306			—			2,690			—
Foreign currency translation adjustments	25			25			99			119
Total other comprehensive income	1,331			25			2,789			119
Comprehensive loss	$	(2,985	)	$	(4,248	)	$	(6,117	)	$	(9,017	)

See accompanying notes to consolidated condensed financial statements.

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OVERLAND STORAGE, INC.

CONSOLIDATED CONDENSED BALANCE SHEETS

(In thousands)



	December 31, 2013			June 30, 2013
	(Unaudited)
Assets
Current assets:
Cash	$	4,894		$	8,831
Short-term investment — related party	4,717			—
Accounts receivable, net of allowance for doubtful accounts of $155 and $94, respectively	6,335			6,640
Inventories	10,171			10,354
Other current assets	1,695			1,923
Total current assets	27,812			27,748
Property and equipment, net	2,205			2,014
Intangible assets, net	823			652
Other assets	782			989
Total assets	$	31,622		$	31,403
Liabilities and Shareholders' Equity (Deficit)
Current liabilities:
Accounts payable	$	5,467		$	5,221
Accrued liabilities	5,392			5,003
Accrued payroll and employee compensation	1,532			2,140
Income taxes payable	202			178
Accrued warranty	599			790
Deferred revenue	7,131			7,732
Total current liabilities	20,323			21,064
Deferred revenue, long-term	2,561			2,975
Long-term debt	11,028			16,750
Other long-term liabilities	1,019			910
Total liabilities	34,931			41,699
Commitments and contingencies (Note 6)
Shareholders’ equity (deficit):
Preferred stock, no par value, 1,000 shares authorized; no shares issued and outstanding as of December 31, 2013 and June 30, 2013	—			—
Common stock, no par value, 90,200 shares authorized; 39,771 and 30,403 shares issued and outstanding as of December 31, 2013 and June 30, 2013, respectively	136,169			123,065
Accumulated other comprehensive income (loss)	1,798			(991		)
Accumulated deficit	(141,276		)	(132,370		)
Total shareholders’ equity (deficit)	(3,309		)	(10,296		)
Total liabilities and shareholders’ equity (deficit)	$	31,622		$	31,403

See accompanying notes to consolidated condensed financial statements.

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OVERLAND STORAGE, INC.

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(In thousands)



	Six Months Ended
	December 31,
	2013			2012
	(Unaudited)
Operating activities:
Net loss	$	(8,906	)	$	(9,136	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	654			593
Deferred tax benefit	(560		)	—
Share-based compensation	1,746			2,504
Changes in operating assets and liabilities:
Accounts receivable	305			1,523
Inventories	191			283
Accounts payable and accrued liabilities	(375		)	(1,680		)
Accrued payroll and employee compensation	(430		)	(255		)
Deferred revenue	(1,015		)	(1,110		)
Other assets and liabilities, net	343			871
Net cash used in operating activities	(8,047		)	(6,407		)
Investing activities:
Purchase of fixed assets	(457		)	(672		)
Purchase of intangible assets	(250		)	—
Net cash used in investing activities	(707		)	(672		)
Financing activities:
Payment for restricted stock tax liability on net settlement	(239		)	(429		)
Proceeds from exercise of stock options and ESPP purchases	49			145
Proceeds from convertible notes	5,000			—
Net cash provided by (used in) financing activities	4,810			(284		)
Effect of exchange rate changes on cash	7			4
Net decrease in cash	(3,937		)	(7,359		)
Cash, beginning of period	8,831			10,522
Cash, end of period	$	4,894		$	3,163
Supplemental disclosures of non-cash activities:
Conversion of convertible notes	$	10,700		$	—
Short-term investment — related party	$	481		$	—
Equity award fair value adjustment to liability	$	204		$	829
Common stock issued for purchase of intangible assets	$	250		$	—
Accounts payable for purchase of property and equipment	$	166		$	—

See accompanying notes to consolidated condensed financial statements.

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OVERLAND STORAGE, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 — BASIS OF PRESENTATION

Financial Statement Preparation

The accompanying interim unaudited consolidated condensed financial statements of Overland Storage, Inc. and its subsidiaries (the “Company”) should be read in conjunction with the audited consolidated financial statements included in the Company's annual report on Form 10-K for the fiscal year ended June 30, 2013. The accompanying consolidated condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). These condensed statements do not include all of the information and disclosures required by GAAP for complete financial statements. In the opinion of management, the unaudited financial information for the interim periods presented reflects all adjustments, which are normal and recurring, necessary for a fair statement of the Company's consolidated condensed results of operations, comprehensive loss, financial position, and cash flows as of December 31, 2013, and for all periods presented. The results reported in these consolidated condensed financial statements for the three and six months ended December 31, 2013 are not necessarily indicative of the results that may be expected for the full fiscal year.

The Company operates its business in one operating segment.

Effective the second quarter of fiscal 2014, the Company changed how it reports its operations to use a 52-week fiscal year end with each year ending on June 30, compared to prior reporting using a 52-53 week fiscal year with each year ending on the Sunday closest to June 30. The Company's last fiscal year ended June 30, 2013 and the Company's second quarter of fiscal 2014 ended December 31, 2013. The second quarter of fiscal 2013 ended December 30, 2012.

The Company has incurred losses since fiscal 2006 and negative cash flows from operating activities since fiscal 2007. As of December 31, 2013, the Company had an accumulated deficit of $141.3 million. During the first half of fiscal 2014, the Company incurred a net loss of $8.9 million. The Company expects to incur a net loss as it continues to change its business model and improve operational efficiencies.

The Company has projected its cash on hand, short-term investment, and available borrowings under its credit facility will be sufficient to allow the Company to continue operations for the next 12 months. Significant changes from the Company’s current forecast, including but not limited to: (i) shortfalls from projected sales levels, (ii) unexpected increases in product costs, (iii) increases in operating costs, and/or (iv) changes in the historical timing of collecting accounts receivable could have a material adverse impact on the Company’s liquidity. This could force the Company to make further reductions in spending, extend payment terms with suppliers, liquidate assets where possible, and/or suspend or curtail planned programs. Any of these actions could materially harm the Company’s business, results of operations, and future prospects. The Company may seek debt, equity, or equity-based financing (such as convertible debt) when market conditions permit.

The Company's recurring losses and negative cash flows from operations raise substantial doubt about its ability to continue as a going concern. The accompanying consolidated condensed financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.

Principles of Consolidation

The accompanying consolidated condensed financial statements include the accounts of the Company and its wholly-owned subsidiaries, Overland Storage (Europe) Ltd., Overland Storage SARL, and Overland Storage GmbH. All significant intercompany accounts and transactions have been eliminated in consolidation.

Reclassifications

Certain prior year amounts have been reclassified to conform to the fiscal 2014 presentation.

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Short-term Investment

The Company's short-term investment is made up of a marketable security. This investment is classified as available-for-sale and is reported at fair value based on quoted prices using the specific identification method. Unrealized gains and losses are recorded in other comprehensive loss and included as a separate component of shareholders' equity (deficit). Realized gains and losses and declines in value judged to be other than temporary on marketable securities, if any, are included in other income in the consolidated condensed statements of operations.

Fair Value of Financial Instruments

The Company's financial instruments including cash, accounts receivable, accounts payable, and accrued liabilities are carried at cost, which management believes approximates fair value because of the short-term maturity of these instruments. The Company's short-term investment is measured at fair value using Level 1 inputs as the stock is traded on the TSX Venture Exchange. The carrying amount of the Company's borrowings under its credit facility approximates its fair value as the interest rate of the credit facility is substantially comparable to rates offered for similar debt instruments. The fair value of the Company's convertible notes is estimated at $6.5 million using an estimated interest rate of 12%, and is classified within Level 3 of the fair value hierarchy. At December 31, 2013, the carrying value of the convertible notes was $7.5 million.

The framework for measuring fair value provides a hierarchy that prioritizes the inputs to valuation techniques used in measuring fair value as follows:



Level 1 -	Quoted prices (unadjusted) in active markets for identical assets or liabilities,

Level 2 -	Inputs other than quoted prices included within Level 1 that are directly observable for the asset or liability or indirectly observable through corroboration with observable market data, and

Level 3 -	Unobservable inputs for the asset or liability only used when there is little, if any, market activity for the asset or liability at the measurement date.

NOTE 2 — SHORT-TERM INVESTMENT

Related Party

In July 2013, the Company entered into a supply agreement with Sphere 3D Corporation (“Sphere 3D”). As partial payment under the supply agreement, Sphere 3D issued 769,231 common shares with a value as of the date of issuance equal to approximately $0.5 million to the Company. Sphere 3D's shares are traded on the TSX Venture Exchange. The short-term investment is classified as available-for-sale marketable securities. See note 10 for additional related party disclosure.

The following summarizes short-term investment (in thousands):



	December 31, 2013
	Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Short-term investment — related party	$	481	$	4,236	$	—	$	4,717

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NOTE 3 — COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS

The following table summarizes inventories (in thousands):



	December 31, 2013		June 30, 2013
Raw materials	$	3,522	$	3,496
Work in process	848		857
Finished goods	5,801		6,001
	$	10,171	$	10,354

The following table summarizes other current assets (in thousands):



	December 31, 2013		June 30, 2013
Deferred cost - service contracts	$	988	$	1,192
Prepaid insurance and services	379		355
VAT receivable	87		155
Short-term deposits	83		119
Other	158		102
	$	1,695	$	1,923

The following table summarizes other assets (in thousands):



	December 31, 2013		June 30, 2013
Deferred cost – service contracts	$	456	$	702
Other	326		287
	$	782	$	989

The following table summarizes accrued liabilities (in thousands):



	December 31, 2013		June 30, 2013
Accrued expenses	$	3,455	$	3,955
Accrued third-party service contracts	951		1,048
Deferred income tax	986		—
	$	5,392	$	5,003

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The following table summarizes other long-term liabilities (in thousands):



	December 31, 2013		June 30, 2013
Deferred rent	$	494	$	782
Related party supply agreement	432		—
Accrued third-party service contracts	93		125
Other	—		3
	$	1,019	$	910

NOTE 4 — NET LOSS PER SHARE

Basic net loss per share is computed by dividing net loss applicable to common shareholders by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share is computed based on the weighted-average number of shares of common stock outstanding during the period increased by the weighted-average number of dilutive common stock equivalents outstanding during the period, using the treasury stock method. Dilutive common stock equivalents are comprised of options granted under the Company's stock option plans, employee stock purchase plan (“ESPP”) share purchase rights, convertible notes, and common stock purchase warrants. For all periods presented, there is no difference in the number of shares used to calculate basic and diluted shares outstanding due to the Company's net loss position.

Anti-dilutive common stock equivalents excluded from the computation of diluted net loss per share were as follows (in thousands):



	Three Months Ended		Six Months Ended
	December 31,		December 31,
	2013	2012	2013	2012
Restricted stock not yet vested and released	3,375	3,524	3,375	3,524
Options outstanding and ESPP share purchase rights	1,402	1,706	1,511	1,441
Common stock purchase warrants	14,168	12,637	14,168	12,637
Convertible notes	6,944	—	6,944	—
Convertible notes interest	2,452	—	2,452	—

NOTE 5 — INCOME TAXES

The Company recognizes the impact of an uncertain income tax position on its income tax return at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. The Company recognizes interest and penalties related to unrecognized tax benefits in its provision for income taxes. The Company had no material accrual for interest and penalties in its consolidated condensed balance sheets at December 31, 2013 and June 30, 2013, and recognized no interest or penalties in the consolidated condensed statements of operations for the three and six months ended December 31, 2013 and 2012.

The Company is subject to federal and state taxation in the United States and also in certain foreign tax jurisdictions. The Company's tax returns for fiscal 2010 and thereafter are subject to examination by the U.S. federal tax authorities, and the Company's tax returns for fiscal 2009 and thereafter are subject to examination by state tax authorities.

The Company's ability to use its net operating loss and research and development credit carryforwards may be substantially limited due to ownership change limitations that may have occurred or that could occur in the future, as required by Section 382 of the Internal Revenue Code of 1986, as amended, as well as similar state provisions. The Company has not completed a study to assess whether an ownership change has occurred or whether there have been multiple ownership changes since the Company

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became a “loss corporation” under the definition of Section 382. Due to the existence of the valuation allowance, it is not expected that any possible limitation will have an impact on the results of operations or financial position of the Company.

NOTE 6 — COMMITMENTS AND CONTINGENCIES

Lease

On October 15, 2013, the Company amended the lease for its corporate headquarters in San Diego, California. Under the terms of the amendment, the Company extended the expiration date of the lease from February 28, 2014 to March 31, 2019, reduced the rentable square footage under the lease, and reduced the Company's monthly base rent and share of facility expenses.

Warranty and Extended Warranty

The Company records a provision for estimated future warranty costs for both return-to-factory and on-site warranties. If future actual costs to repair were to differ significantly from estimates, the impact of these unforeseen costs or cost reductions would be recorded in subsequent periods.

Separately priced extended on-site warranties and service contracts are offered for sale to customers on all product lines. The Company contracts with third-party service providers to provide service relating to on-site warranties and service contracts. Extended warranty and service contract revenue and amounts paid in advance to outside service organizations are deferred and recognized as service revenue and cost of service, respectively, over the period of the service agreement. The Company had $1.4 million and $1.9 million in deferred costs related to deferred service revenue at December 31, 2013 and June 30, 2013, respectively.

In addition, the Company had $0.1 million and $0.2 million in deferred software revenue at December 31, 2013 and June 30, 2013, respectively, which is not included in the table below.

Changes in the liability for product warranty and deferred revenue associated with extended warranties and service contracts were as follows (in thousands):



	Product Warranty			Deferred Revenue
Liability at June 30, 2013	$	790		$	10,354
Settlements made during the period	(142		)	(5,943		)
Change in liability for warranties issued during the period	138			4,921
Change in liability for preexisting warranties	(187		)	—
Liability at December 31, 2013	$	599		$	9,332

Litigation

From time to time, the Company may be involved in various lawsuits, legal proceedings, or claims that arise in the ordinary course of business. Management does not believe any legal proceedings or claims pending at December 31, 2013 will have, individually or in the aggregate, a material adverse effect on its business, liquidity, financial position, or results of operations. Litigation, however, is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm the Company's business.

In August and October 2010, the Company filed patent infringement lawsuits in the United States District Court for the Southern District of California and with the United States International Trade Commission (“ITC”), respectively, against various parties. Both lawsuits claim infringement of two of the Company's U.S. Patents; Nos. 6,328,766 and 6,353,581.

In November 2011, the Company entered into a multi-year settlement and cross-licensing agreement with IBM pursuant to which the Company released all claims it had against IBM and Dell in connection with the patent infringement lawsuits the Company had filed in the United States District Court for the Southern District of California and at the ITC. In opinions issued

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by the ITC in November 2012 and May 2013, the ITC concluded or otherwise did not disturb findings that BDT’s customers directly infringe the six asserted claims of U.S. Patent No. 6,328,766, and that all but one of the asserted claims of U.S. Patent No. 6,353,581 are valid. The ITC also concluded that the six asserted claims of U.S. Patent No. 6,328,766 were invalid as anticipated, and that the accused BDT products did not infringe the asserted claims of U.S. Patent No. 6,353,581. In May 2013, the ITC terminated the investigation.

In June 2012, the Company filed five additional patent infringement lawsuits in the United States District Court for the Southern District of California against seven companies. In these lawsuits, the Company has asserted claims of infringement based on one or both of U.S. Patent Nos. 6,328,766 and 6,353,581 against the following defendants: Quantum Corporation (“Quantum”), based in San Jose, California; Spectra Logic Corporation (“Spectra Logic”), based in Boulder, Colorado; PivotStor, LLC, based in Irvine, California; Qualstar Corporation, based in Simi Valley, California; Tandberg Data GmbH, based in Germany; Tandberg Data Corp., based in Westminster, Colorado; and Venture Corporation Limited, based in Singapore. In October 2012, the Company voluntarily dismissed its claims against Venture Corporation. In February 2013, the Company filed a joint motion to dismiss its case against Tandberg Data GmbH and Tandberg Data Corp. without prejudice.

In August 2012, Quantum filed counterclaims against the Company in the United States District Court for the Southern District of California action alleging trademark infringement and unfair competition claims, and infringement of U.S. Patent Nos. 5,491,812, 6,542,787, 6,498,771 and 5,925,119 by its products. In April 2013, Quantum filed a complaint against the Company in the United States District Court for the Southern District of California alleging infringement of U.S. Patent No. 7,263,596 by the Company's products. Quantum is seeking monetary damages from the Company and injunctive relief.

In May 2013, Safe Storage LLC (“Safe Storage”), a Delaware limited liability company, filed a complaint against the Company in the United States District Court for the District of Delaware alleging infringement of U.S. Patent No. 6,978,346 by the Company's products. Safe Storage is seeking monetary damages from the Company and injunctive relief.

In June 2013, Spectra Logic filed a Petition for Inter Partes Review of the claims of U.S. Patent No. 6,328,766 with the United States Patent and Trademark Office. The petition has been assigned Case No. IPR2013-00357. In December 2013, the United States Patent and Trademark Office initiated an inter partes review proceeding involving U.S. Patent No. 6,328,766. The inter partes review proceeding is ongoing.

In February 2014, the District Court for the Southern District of California conditionally stayed our litigation against BDT, Spectra Logic and PivotStor pending the results of the inter partes review filed by Spectra Logic. The stay as to BDT and PivotStor is conditional on both of them agreeing to be bound by the results of the inter partes review at the United States Patent and Trademark Office.

NOTE 7 — INTANGIBLE ASSETS

Intangible assets, net, consist of customer contracts and trade names acquired in the June 2008 acquisition of SnapServer, which have been assigned an estimated useful life of six years. The intangible assets are being amortized on a straight-line basis over their estimated useful lives.

In the first quarter of fiscal 2014, the Company entered into a technology license agreement, with a related party, and recorded an intangible asset of $0.5 million. Amortization will commence upon shipment of the product, which is expected during the second half of fiscal 2014.

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The following table summarizes intangible assets (in thousands):



	December 31, 2013			June 30, 2013
Technology	$	2,427		$	1,928
Customer contracts and trade names	3,853			3,853
	6,280			5,781
Less: Accumulated amortization	(5,457		)	(5,129		)
	$	823		$	652

Amortization expense of intangible assets was $0.2 million during the second quarter of both fiscal 2014 and 2013. Amortization expense of intangible of intangible assets was $0.3 million during the first half of both fiscal 2014 and 2013. Estimated amortization expense for intangible assets is approximately $0.3 million for the remainder of fiscal 2014.

NOTE 8 — EQUITY (DEFICIT)

Restricted Stock

During the first half of fiscal 2014, the Company issued 472,804 shares of common stock in conjunction with vested restricted stock units. The restricted stock unit holders surrendered 216,367 restricted stock units to pay for minimum withholding taxes totaling $0.2 million. During the first half of fiscal 2013, the Company issued 562,124 shares of common stock in conjunction with vested restricted stock units, and the restricted stock unit holders surrendered 242,514 restricted stock units to pay for minimum withholding taxes totaling $0.4 million. Options and restricted stock units outstanding were approximately 5.0 million shares and 4.4 million shares as of December 31, 2013 and June 30, 2013, respectively.

Outside of 2009 Equity Incentive Plan

During the first half of fiscal 2014, the Company granted to an officer a restricted stock award to acquire 125,000 shares of common stock, and an option award to purchase 75,000 shares of common stock. These awards vest over three years. During the first half of fiscal 2013, the Company granted to an officer a restricted stock award to acquire 200,000 shares of common stock. This restricted stock award vests over three years.

2009 Equity Incentive Plan

During the first half of fiscal 2014, the Company granted to an officer a restricted stock award to acquire 1.1 million shares of common stock. This award vests over three years.

Employee Stock Purchase Plan

During the first half of fiscal 2014 and 2013, the Company issued 54,357 and 64,890, respectively, shares of common stock purchased through the Company's 2006 employee stock purchase plan.

Common Stock Exercises

During the first half of fiscal 2014 and 2013, the Company issued no and 27,751, shares of common stock, respectively, upon exercise of outstanding stock options.

Issuance of Common Stock for Convertible Notes

During the first half of fiscal 2014, the Company issued an aggregate of 8,247,896 shares of common stock at $1.30 per share in satisfaction of $10.7 million of the Company's outstanding convertible notes.

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During the first half of fiscal 2014, the Company issued an aggregate of 379,310 shares of common stock at $0.98 per share to the holders of its outstanding convertible notes as payment of interest on such notes, which was payable upon conversion of the convertible notes in November 2013.

NOTE 9 — DEBT

Credit Facility

In August 2011, the Company entered into a loan and security agreement, or credit facility, which allows for revolving cash borrowings up to $8.0 million. The proceeds of the credit facility may be used to fund the Company's working capital and to fund its general business requirements. The obligations under the credit facility are secured by substantially all assets of the Company other than 65% of the stock of our foreign subsidiaries, which are pledged under the Company's convertible notes. Borrowings under the credit facility bear interest at the prime rate (as defined in the credit facility) plus a margin of either 1.00% or 1.25%, depending on the Company's liquidity coverage ratio. The Company is also obligated to pay other customary facility fees and arrangement fees for a credit facility of this size and type. In August 2013, the credit facility was amended to extend the scheduled maturity date to August 7, 2015 and add a separate line of credit in the amount of $750,000 for letters of credit, foreign exchange contracts, and cash management. At December 31, 2013, the interest rate on the credit facility was 4.25%.

The credit facility requires the Company to comply with a liquidity coverage ratio and contains customary covenants, including covenants that limit or restrict the Company's and its subsidiaries' ability to incur liens and indebtedness, make certain types of payments, merge or consolidate, and make dispositions of assets. The credit facility specifies customary events of default (some of which are subject to applicable grace or cure periods) including, among other things, non-payment defaults, covenant defaults, cross-defaults to other material indebtedness, bankruptcy and insolvency defaults, and material judgment defaults. Upon the occurrence of an event of default under the credit facility, the lender may cease making loans, terminate the credit facility, and declare all amounts outstanding to be immediately due and deduct such amounts from the Company’s lockbox account on deposit with the bank. At December 31, 2013, the Company was in compliance with all covenants of the credit facility.

At December 31, 2013, the Company had $3.5 million outstanding on the credit facility, which was recorded as long-term debt, and remaining external borrowing capacity, subject to certain limitations of accounts receivable, of $4.5 million. No payments are due within the next 12 months. While the credit facility is recorded as long-term debt, it is a revolving line of credit and borrowings and payments are presented on a net basis in the consolidated statement of cash flows.

Convertible Notes

In February 2013, the Company entered into a note purchase agreement (the “NPA”) with the purchasers party thereto (the “Purchasers”), including certain affiliates of Cyrus Capital Partners, L.P. (the “Cyrus Purchasers”), which was amended in March 2013. The Company sold to the Purchasers convertible promissory notes (the “Initial Notes”) of the Company in an aggregate original principal amount of $13.25 million. On November 1, 2013, the Company amended and restated the NPA and agreed to sell up to an additional $7.0 million in convertible promissory notes (the “Additional Notes” and, together with the Initial Notes, the “Notes”) to the Cyrus Purchasers. The Company issued the Additional Notes in amounts of $3.0 million, $2.0 million, and $2.0 million on November 12, 2013, December 24, 2013, and January 17, 2014, respectively.

The Initial Notes are scheduled to mature in February 2017. The Additional Notes are scheduled to mature four years from date of issuance. Debt issuance costs of $0.3 million have been included in other assets and will be amortized over the term of the Notes. The Notes bear interest at a rate of 8% per annum, payable semi-annually.

On November 8, 2013, the Company issued 8,247,896 shares of common stock to the Purchasers in satisfaction of approximately $10.7 million of the Initial Notes. On November 8, 2013, the Cyrus Purchasers, the beneficial owners of Tandberg, became the sole holders of the outstanding Notes. See discussion of the Tandberg acquisition in Note 12 - Subsequent Events.

At December 31, 2013, the Notes' principal balance was $7.5 million and has been recorded as long-term debt. No payments of principal are due within the next 12 months.

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Through July 2015, the Company may, subject to certain limitations, pay interest in cash or in shares of common stock at its option. Subsequent to July 2015, if at anytime the Cyrus Purchasers hold 20% or more of the then outstanding common stock, the Cyrus Purchasers (and not the Company) will have the option to determine whether the applicable interest payment payable to the Cyrus Purchasers during such time is payable in cash or shares of common stock. The number of shares of common stock that may be issued as payment of interest on the Notes will be determined by dividing the amount of interest due to the holders of the Notes by the volume weighted average of the closing prices of one share of common stock as reported on the NASDAQ Capital Market for the 20 consecutive trading days up to and including the trading day on the third trading day prior to the valuation date, using the interest payment due date as the valuation date; provided the Company may not pay interest in shares of common stock at a price per share lower than, in the case of the Initial Notes, $0.98, and in the case of the Additional Notes, $0.90 (in each case as adjusted from time to time for items such as stock splits, combinations, reclassifications, or recapitalizations). In the event of a share price lower than, in the case of the Initial Notes, $0.98, and in the case of the Additional Notes, $0.90, the Company has the option to pay interest in a combination of shares of common stock and cash so long as the number of shares of common stock that the Company issues does not exceed the quotient obtained by dividing the interest payable at such time by, in the case of the Initial Notes, $0.98, and in the case of the Additional Notes, $0.90, and the difference between the amount of the interest paid in shares and the average closing price of the shares of common stock, determined as described above, will be payable in cash.

The Cyrus Purchasers may elect to convert all or a portion of the outstanding principal amount of such Purchaser's Note into shares of common stock (subject to certain limitations) in an amount equal to the principal amount of the Notes being converted divided by, in the case of the Initial Notes, $1.30, and in the case of the Additional Notes, $1.00, in each case subject to adjustment as set forth in the NPA, such as stock splits.

The Company may, at its option, convert the outstanding Initial Notes or Additional Notes, as applicable, into shares of common stock (subject to certain limitations) on the first trading day immediately following the date that the closing bid price of the common stock exceeds, in the case of the Initial Notes, $2.60, and in the case of the Additional Notes, $1.50, for 10 consecutive trading days.

If certain conditions are met with respect to ongoing litigation, the Company has an option to repay a portion of the Initial Notes prior to the maturity date. In addition, the Company has the option to prepay the Additional Notes in full or in part within 90 days following the consummation of the Tandberg acquisition (as described in Note 12 below).

The obligations under the Notes are secured by a pledge of 65% of the Company's stock in each of its foreign subsidiaries.

The NPA contains customary covenants, including covenants that limit or restrict the Company's ability to incur liens, incur indebtedness, or make certain restricted payments. Upon the occurrence of an event of default under the NPA, the Cyrus Purchasers may declare all amounts outstanding to be immediately due and payable. The NPA specifies a number of events of default (some of which are subject to applicable grace or cure periods) including, among other things, non-payment defaults, covenant defaults, cross-defaults to other material indebtedness, bankruptcy and insolvency defaults, and material judgment defaults. In the event of default, the interest rate shall automatically increase to 11%. The Company has also granted certain registration rights to the Cyrus Purchasers. At December 31, 2013, the Company was in compliance with all covenants contained in the NPA and the Notes.

NOTE 10 — RELATED PARTY

In July 2013, the Company entered into a supply agreement, and a technology license agreement, with Sphere 3D. As consideration for the transactions contemplated by the technology license agreement, the Company paid Sphere 3D $250,000 in cash and issued Sphere 3D 213,220 shares of its common stock, with a value at the time of issuance of approximately $250,000. As partial payment under the supply agreement, Sphere 3D issued 769,231 common shares with a value as of the date of issuance equal to approximately $0.5 million to the Company.

In connection with the July 2013 Sphere 3D transaction, Eric Kelly, the Company's President and Chief Executive Officer, was appointed chairman of the board of directors of Sphere 3D. Mr. Kelly was also awarded an option to purchase up to 850,000

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shares of common stock of Sphere 3D with an exercise price of approximately $0.63, which is believed to represent approximately 5% of Sphere 3D's outstanding shares at the time the award was granted.

At December 31, 2013, the Company had $175,000 and $432,000 in accounts receivable and other long-term liabilities, respectively, related to the Sphere 3D supply agreement. The Company recognized $237,000 in revenue related to the supply agreement during the three and six months ended December 31, 2013. No related party expense was recognized during the first half of fiscal 2014.

NOTE 11 — RECENT ACCOUNTING PRONOUNCEMENTS

From time to time, new accounting pronouncements are issued by the FASB that are adopted by the Company as of the specified effective date. If not discussed, the Company believes that the impact of recently issued standards, which are not yet effective, will not have a material impact on the Company's consolidated financial statements upon adoption.

In July 2013, the FASB, issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU No. 2013-11 provides that an entity is required to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. If a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. ASU No. 2013-11 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of this guidance affects presentation only and, therefore, it is not expected to have a material impact on the Company's consolidated financial results.

NOTE 12 — SUBSEQUENT EVENTS

Authorized Number of Shares of Common Stock

On January 17, 2014, the Company increased its authorized shares of common stock from 90,200,000 shares to 125,000,000 shares.

2009 Equity Incentive Plan

On January 17, 2014, the Company increased the number of shares of its common stock available for award grant purposes under the 2009 Equity Incentive Plan by 7,000,000 shares.

Acquisition

On January 21, 2014, the Company acquired Tandberg Data Holdings S.à r.l. (“Tandberg”), a privately held global leader of data storage and data protection solutions, for a purchase price of $49.0 million, which was paid in shares of the Company's common stock. The shareholders of Tandberg received 47,152,630 shares of the Company's common stock. Tandberg became a wholly-owned subsidiary of the Company, and the acquisition will be treated as a business combination for accounting purposes. The Company has included Tandberg's historical financial statements and the related proforma statements in the definitive proxy filed on December 19, 2013. The determination of the acquisition-date fair value of the total assets acquired and liabilities assumed is pending completion of a valuation.

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Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis contains forward-looking statements that involve risks, uncertainties, and assumptions that are difficult to predict. Words and expressions reflecting optimism, satisfaction, or disappointment with current prospects, as well as words such as “believes,” “hopes,” “intends,” “estimates,” “expects,” “projects,” “plans,” “anticipates,” and variations thereof, or the use of future tense, identify forward-looking statements, but their absence does not mean that a statement is not forward-looking. Such forward-looking statements are not guarantees of performance and our actual results could differ materially from those contained in such statements. Factors that could cause or contribute to such differences include, but are not limited to: our ability to maintain and increase sales volumes of our products; our ability to continue to aggressively control costs and operating expenses; our ability to achieve the intended cost savings and maintain quality with our manufacturing partner; our ability to generate cash from operations; the ability of our suppliers to provide an adequate supply of components for our products at prices consistent with historical prices; our ability to raise outside capital and to repay our debt as it comes due; our ability to introduce new competitive products and the degree of market acceptance of such new products; the timing and market acceptance of new products introduced by our competitors; our ability to maintain strong relationships with branded channel partners; our ability to maintain the listing of our common stock on the NASDAQ Capital Market; customers', suppliers', and creditors' perceptions of our continued viability; rescheduling or cancellation of customer orders; loss of a major customer; our ability to enforce our intellectual property rights and protect our intellectual property (including the outcome of our ongoing patent litigation); general competition and price measures in the market place; unexpected shortages of critical components; worldwide information technology spending levels; and general economic conditions. In evaluating such statements, we urge you to specifically consider various factors identified in this report, including the matters set forth under the heading “Risk Factors” in Item 1A of Part II of this report, and set forth in our annual report on Form 10-K for the fiscal year ended June 30, 2013 filed with the Securities and Exchange Commission ("SEC") on September 18, 2013 under the caption “Risk Factors” in Item 1A of Part I, any of which could cause actual results to differ materially from those indicated by such forward-looking statements.

We are a trusted global provider of unified data management and data protection solutions designed to enable small and medium enterprises (“SMEs”), distributed enterprises, and small and medium businesses (“SMBs”) to anticipate and respond to data storage requirements. Whether an organization's data is locally or globally based, our solutions consolidate and protect data for easy and cost-effective management of different tiers of information. We enable companies to expend fewer resources on information technology (“IT”), allowing them to focus on being more responsive to the needs of their customers.

We develop and deliver a comprehensive solution set of award-winning products and services for storing data throughout the organization and during the entire data lifecycle. Our SnapScale^™ clustered network attached storage (“NAS”) products allow customers to scale-out in capacity and performance as their storage needs grow. Our SnapServer^® products are unified NAS servers that integrate into businesses requiring simple, expandable block and file storage. Our SnapSAN^® products are storage area network (“SAN”) arrays designed to ensure primary and secondary data is accessible and protected regardless of its location. Our SnapScale^™, SnapServer^®, and SnapSAN^® solutions are available with backup, replication, and mirroring software in highly scalable configurations. These solutions provide simplified disk-based data protection and maximum flexibility to protect mission critical data for both continuous local backup and remote disaster recovery. Our NEO SERIES^® and REO SERIES^® libraries are tape and virtual tape solutions designed to meet the need for cost-effective, reliable data storage for long-term archiving and compliance requirements.

Our approach emphasizes long-term investment protection for our customers and reduces the complexities and ongoing costs associated with storage management. Moreover, most of our products are designed with a scalable architecture which enables companies to purchase additional storage as needed, on a just-in-time basis, and make it available instantly without downtime.

End users of our products include SMEs, SMBs, distributed enterprise companies such as divisions and operating units of large multi-national corporations, governmental organizations, and educational institutions. Our products are used in a broad range of industries including financial services, video surveillance, healthcare, retail, manufacturing, telecommunications, broadcasting, research and development, and many others.

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Overview

This overview discusses matters on which our management primarily focuses in evaluating our financial position and operating performance.

Generation of revenue. We generate the majority of our revenue from sales of our data protection products. The balance of our revenue is provided by selling maintenance contracts and rendering related services. The majority of our sales are generated from sales of our branded products through a worldwide channel, which includes systems integrators and value-added resellers.

We reported net revenue of $10.6 million for the second quarter of fiscal 2014, compared with $12.6 million for the second quarter of fiscal 2013. We reported net revenue of $21.2 million for the first half of fiscal 2014, compared with $24.3 million for the first half of fiscal 2013. We reported a net loss of $4.3 million, or $0.12 per share, for the second quarter of fiscal 2014 compared with a net loss of $4.3 million, or $0.15 per share, for the second quarter of fiscal 2013. We reported a net loss of $8.9 million, or $0.27 per share, for the first half of fiscal 2014 compared with a net loss of $9.1 million, or $0.33 per share, for the first half of fiscal 2013.

Acquisition. On November 1, 2013, we entered into a definitive agreement to acquire Tandberg Data Holdings S.à r.l. (“Tandberg”), a privately held global leader of data storage and data protection solutions in exchange for shares of our common stock. The acquisition was completed on January 21, 2014 and Tandberg became a wholly-owned subsidiary of the Company. The shareholders of Tandberg received, as a result of the acquisition, 47,152,630 shares of our common stock.

Liquidity and capital resources. At December 31, 2013, we had cash and a short-term investment of $4.9 million and $4.7 million, respectively, compared to cash of $8.8 million at June 30, 2013. In the first half of fiscal 2014, we incurred a net loss of $8.9 million. Our credit facility provides for an up to $8.0 million secured revolving loan and may be used to fund our working capital and our general business requirements. At December 31, 2013, we had a balance of $3.5 million recorded as long-term debt, and a remaining external borrowing capacity, subject to certain limitations of accounts receivable, of $4.5 million. Cash management and preservation continue to be a top priority. We expect to incur negative operating cash flows during fiscal 2014 as we continue to reshape our business model and further improve operational efficiencies.

Management has projected that cash on hand, short-term investment, and available borrowings under our credit facility will be sufficient to allow us to continue operations for the next 12 months. Significant changes from our current forecasts, including but not limited to: (i) shortfalls from projected sales levels, (ii) unexpected increases in product costs, (iii) increases in operating costs, and/or (iv) changes in the historical timing of collecting accounts receivable could have a material adverse impact on our liquidity. This could force us to make further reductions in spending, extend payment terms with suppliers, liquidate assets where possible, and/or suspend or curtail planned programs. Any of these actions could materially harm our business, results of operations, and future prospects. We may seek debt, equity, or equity-based financing (such as convertible debt) when market conditions permit.

As of December 31, 2013, we had working capital of $7.5 million, reflecting an increase in current assets of $0.1 million and a decrease in current liabilities of $0.7 million compared to June 30, 2013. The increase in current assets is primarily attributable to a $4.7 million increase in our short-term investment in Sphere 3D, offset by (i) a $3.9 million decrease in cash, (ii) a $0.3 million decrease in accounts receivable due to lower sales volumes primarily in our tape-based products sold in the Americas and EMEA regions, a (iii) a $0.2 million decrease in inventory, and (iv) a $0.2 million decrease in other current assets primarily related to deferred cost for service contracts. The decrease in current liabilities is primarily attributable to (i) a $0.6 million decrease in deferred revenue, (ii) a $0.4 million decrease in accrued payroll and employee compensation related to a 15% decrease in headcount, (iii) a $0.2 million decrease in accrued warranty, and (iv) a $0.2 million decrease in our stock appreciation rights valuation liability included in accrued payroll and employee compensation. These decreases were offset by an increase of $0.6 million in accounts payable and accrued liabilities related to deferred income tax of $1.0 million for our short-term investment in Sphere 3D, offset by a decrease in accrued liabilities related to operating activities.

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Recent Developments


•	On January 16, 2014, we appointed Randy Gast as our Chief Operating Officer. Mr. Gast joined the Company as Senior Vice President of Strategic Alliances and Client Services in August 2012. He has served as Senior Vice President of Worldwide Operations and Service since August 2012.


•	On January 17, 2014, we completed a private placement of $2.0 million of convertible notes.


•	On January 17, 2014, we increased our authorized shares of common stock from 90,200,000 shares to 125,000,000 shares, as well as increased the number of shares of our common stock available for award grant purposes under the 2009 Equity Incentive Plan by 7,000,000 shares.


•	On January 21, 2014, we acquired Tandberg Data Holdings S.à r.l. (“Tandberg”), a privately held global leader of data storage and data protection solutions, in exchange for shares of our common stock. The shareholders of Tandberg received, as a result of the acquisition, 47,152,630 shares of our common stock.

Critical Accounting Policies and Estimates

We describe our significant accounting policies in Note 1, “Operations and Summary of Significant Accounting Policies,” of the notes to the consolidated financial statements included in our annual report on Form 10-K for the fiscal year ended June 30, 2013; and we discuss our critical accounting policies and estimates in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations,” of that report. Unless otherwise described below, there have been no material changes in our critical accounting policies and estimates.

Results of Operations

The following table sets forth certain financial data as a percentage of net revenue:



	Three Months Ended				Six Months Ended
	December 31,				December 31,
	2013		2012		2013		2012
Net revenue	100.0	%	100.0	%	100.0	%	100.0	%
Cost of revenue	65.5		63.5		65.9		64.9
Gross profit	34.5		36.5		34.1		35.1
Operating expenses:
Sales and marketing	31.0		34.6		33.1		34.9
Research and development	12.7		12.6		12.5		13.1
General and administrative	33.1		21.9		28.9		23.2
	76.8		69.1		74.5		71.2
Loss from operations	(42.3	)	(32.6	)	(40.4	)	(36.1	)
Other income (expense), net	(3.1	)	(0.8	)	(3.7	)	(1.1	)
Loss before income taxes	(45.4	)	(33.4	)	(44.1	)	(37.2	)
Provision for (benefit from) income taxes	(4.8	)	0.5		(2.3	)	0.5
Net loss	(40.6	)%	(33.9	)%	(41.8	)%	(37.7	)%

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A summary of the sales mix by product follows:



	Three Months Ended				Six Months Ended
	December 31,				December 31,
	2013		2012		2013		2012
Tape-based products:
NEO Series^®	28.6	%	33.5	%	27.3	%	33.0	%
Disk-based products:
REO Series^®	0.8		1.4		0.7		1.2
SnapServer^®	22.7		17.9		23.4		17.4
	23.5		19.3		24.1		18.6
Service	38.0		38.2		40.1		40.6
Spare parts and other	9.9		9.0		8.5		7.8
	100.0	%	100.0	%	100.0	%	100.0	%

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The Second Quarter of Fiscal 2014 compared with the Second Quarter of Fiscal 2013

Net Revenue. Net revenue decreased to $10.6 million during the second quarter of fiscal 2014 from $12.6 million during the second quarter of fiscal 2013, a decrease of $2.0 million, or 15.9%. The decline was due to lower revenue from our branded products, primarily as a result of decreased sales volumes in our tape-based products sold in the Americas and EMEA. OEM net revenue, which is primarily made up of service revenue, accounted for 12.8% and 13.5% of net revenues in the second quarter of fiscal 2014 and 2013, respectively.

Product Revenue

Net product revenue decreased to $6.6 million during the second quarter of fiscal 2014 from $7.8 million during the second quarter of fiscal 2013. The decrease of approximately $1.2 million, or 15.4%, was associated with a decrease in sales of our NEO^® products of $1.2 million primarily related to a decrease in sales of our S-series and add-on drives.

Service Revenue

Net service revenue decreased to $4.0 million during the second quarter of fiscal 2014 from $4.8 million during the second quarter of fiscal 2013. The decrease of approximately $0.8 million, or 16.7%, was primarily due to decreased service revenue from our extended service contracts primarily related to lower tape-based product sales.

Gross Profit. Overall gross profit decreased to $3.7 million during the second quarter of fiscal 2014 compared to $4.6 million during the second quarter of fiscal 2013. Gross margin at 34.5% for the second quarter of fiscal 2014 decreased from 36.5% for the second quarter of fiscal 2013.

Product Revenue

Gross profit on our products during the second quarter of fiscal 2014 was $1.2 million compared to $1.4 million during the second quarter of fiscal 2013. The decrease of $0.2 million, or 14.3%, was primarily due to decreased sales volumes of tape-based products. Gross margin on product revenue at 18.9% for the second quarter of fiscal 2014 increased from 18.6% for the second quarter of fiscal 2013.

Service Revenue

Gross profit on our services during the second quarter of fiscal 2014 was $2.5 million compared to $3.1 million during the second quarter of fiscal 2013. The decrease of $0.6 million, or 19.4%, was primarily due to a decrease in our extended service contracts due to a decrease in tape-based product sales. Gross margin on our services at 59.9% for the second quarter of fiscal 2014 decreased from 65.4% for the second quarter of fiscal 2013.

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Share-based Compensation Expense. During the second quarter of fiscal 2014 and 2013, we recorded share-based compensation expense of approximately $0.8 million and $1.3 million, respectively. Share-based compensation expense for the third quarter of fiscal 2014 is expected to be approximately $1.0 million.

The Company recorded the following compensation expense related to its share-based compensation awards (in thousands):



	Three Months Ended
	December 31,
	2013			2012
Cost of product sales	$	30		$	33
Sales and marketing	(68		)	262
Research and development	80			81
General and administrative	794			875
	$	836		$	1,251

Sales and Marketing Expense. Sales and marketing expense in the second quarter of fiscal 2014 decreased to $3.3 million from $4.4 million during the second quarter of fiscal 2013. The decrease of $1.1 million, or 25.0%, was primarily due to a decrease of $0.5 million in employee and related expenses associated with a decrease in average headcount, a decrease of $0.2 million in public relations and advertising expense, including contractor fees, and a decrease of $0.3 million in share-based compensation primarily related to the departure of an officer.

Research and Development Expense. Research and development expense in the second quarter of fiscal 2014 decreased to $1.4 million from $1.6 million during the second quarter of fiscal 2013. The decrease of $0.2 million, or 12.5%, was primarily due to a decrease in employee and related expenses associated with a decrease in average headcount.

General and Administrative Expense. General and administrative expense in the second quarter of fiscal 2014 increased to $3.5 million from $2.8 million during the second quarter of fiscal 2013. The increase of $0.7 million, or 25.0%, was primarily a result of an increase of $0.8 million in legal and advisory expenses primarily related to our acquisition of Tandberg in January 2014, offset by a $0.1 million decrease in share-based compensation.

Interest Expense. Interest expense in the second quarter of fiscal 2014 increased to $269,000 from $46,000 during the second quarter of fiscal 2013. The increase was related to interest expense for the convertible notes we sold in February 2013 and November 2013.

Other Income (Expense), Net. During the second quarter of fiscal 2014, we incurred other expense, net, of $62,000 compared to $47,000 of expense, net, during the second quarter of fiscal 2013. The change was primarily due to an increase in realized foreign currency exchange losses during the second quarter of fiscal 2014 due to currency fluctuations.

The First Half of Fiscal 2014 compared with the First Half of Fiscal 2013

Net Revenue. Net revenue decreased to $21.2 million during the first half of fiscal 2014 compared to $24.3 million during the first half of fiscal 2013, a decrease of $3.1 million, or 12.8%. The decline was primarily due to a decrease of $1.4 million from our branded channel, and a decrease of $1.4 million in service revenue. The decrease in net revenue was attributable to decreased sales volumes primarily in our tape-based products sold in the Americas and EMEA regions. Our sole OEM customer represented approximately 12.5% of net revenue in the first half of fiscal 2014 compared to 12.6% of net revenue in the first half of fiscal 2013.

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Product Revenue

Net product revenue decreased to $12.7 million during the first half of fiscal 2014 compared to $14.4 million during the first half of fiscal 2013. The decrease of $1.7 million, or 11.8%, was primarily associated with a decrease of $2.2 million in tape-based products sold in the Americas and EMEA regions, offset by an increase of $0.6 million in disk-based products sold in the Americas and EMEA regions.

Service Revenue

Net service revenue decreased to $8.5 million in the first half of fiscal 2014 compared to $9.9 million during the first half of fiscal 2013. The decrease of $1.4 million, or 14.1%, was primarily due to a decrease in our extended service contracts primarily related to lower tape-based product sales in EMEA and the Americas regions. As a percentage of total revenue, service revenue remained relatively constant at 40.1% for the first half of fiscal 2014 compared to 40.7% for the first half of fiscal 2013.

Gross Profit. Gross profit in the first half of fiscal 2014 decreased to $7.2 million compared to $8.5 million in the first half of fiscal 2013. Gross margin decreased to 34.1% in the first half of fiscal 2014 compared to 35.1% in the first half of fiscal 2013.

Product Revenue

Gross profit on our products was constant at $2.0 million for the first half of fiscal 2014 and the first half of fiscal 2013. Gross margin on our products was 15.7% for the first half of fiscal 2014 compared to 14.1% for the first half of fiscal 2013.

Service Revenue

Gross profit on our services was $5.2 million during the first half of fiscal 2014 compared to $6.5 million in the first half of fiscal 2013. The decrease of $1.3 million was primarily due to a decrease in our extended service contracts. Gross margin on service at 61.5% for the first half of fiscal 2014 decreased from 65.8% for the first half of fiscal 2013.

Share-based Compensation. During the first half of fiscal 2014 and 2013, we recorded share-based compensation expense of approximately $1.7 million and $2.5 million, respectively.

The following table summarizes share-based compensation by income statement caption (in thousands):



	Six Months Ended
	December 31,
	2013		2012
Cost of product sales	$	48	$	68
Sales and marketing	173		512
Research and development	144		160
General and administrative	1,381		1,764
	$	1,746	$	2,504

Sales and Marketing Expenses. Sales and marketing expenses decreased to $7.0 million during the first half of fiscal 2014 compared to $8.5 million during the first half of fiscal 2013. The decrease of approximately $1.5 million, or 17.6%, was primarily a result of a decrease of $0.7 million in employee and related expenses associated with an decrease in average headcount, a decrease of $0.4 million in public relations and advertising expense, and a decrease of $0.3 million in share-based compensation expense related to the departure of an officer.

Research and Development Expenses. Research and development expenses decreased to $2.7 million during the first half of fiscal 2014 compared to $3.2 million during the first half of fiscal 2013. The decrease of approximately $0.5 million, or 15.6%,

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was primarily a result of a decrease of $0.5 million in employee and related expenses associated with a decrease in average headcount.

General and Administrative Expenses. General and administrative expenses increased to $6.1 million during the first half of fiscal 2014 compared to $5.6 million for the first half of fiscal 2013. The increase of approximately $0.5 million, or 8.9%, was primarily a result of an increase of $1.0 million in legal and advisory expenses primarily related to our acquisition of Tandberg in January 2014 and our on-going patent infringement lawsuits, offset by a $0.4 million decrease in share-based compensation primarily related to the departure of an officer.

Interest Expense. Interest expense increased to $0.6 million during the first half of fiscal 2014 compared to $0.1 million during the first half of fiscal 2013. The increase of approximately $0.5 million was related to interest expense for the convertible notes we sold in February 2013 and November 2013.

Liquidity and Capital Resources

At December 31, 2013, we had cash and a short-term investment of $4.9 million and $4.7 million, respectively, compared to cash of $8.8 million at June 30, 2013. In the first half of fiscal 2014, we incurred a net loss of $8.9 million. Our credit facility provides for an up to $8.0 million secured revolving loan and may be used to fund our working capital and our general business requirements. At December 31, 2013, we had a balance of $3.5 million recorded as long-term debt, and a remaining external borrowing capacity, subject to certain limitations of accounts receivable, of $4.5 million. Cash management and preservation continue to be a top priority. We expect to incur negative operating cash flows during fiscal 2014 as we continue to reshape our business model and further improve operational efficiencies.

As a result of our recurring losses from operations and negative cash flows, the report from our independent registered public accounting firm regarding our consolidated financial statements for the year ended June 30, 2013 includes an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern.

During the first half of fiscal 2014, we used net cash in operating activities of $8.0 million, compared to $6.4 million in the first half of fiscal 2013. The use of cash during the first half of fiscal 2014 was primarily a result of our net loss of $8.9 million

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offset by $1.9 million in non-cash items, which were share-based compensation, deferred income tax benefit, depreciation and amortization. In addition, we had decreases in accounts receivable, inventory, and accrued liabilities due to lower sales.

Net cash used in investing activities was $0.7 million during the first half of fiscal 2014 and first half of fiscal 2013. During the first half of fiscal 2014 and 2013, capital expenditures totaled $0.5 million and $0.7 million, respectively. In the first half of fiscal 2014, such expenditures were primarily associated with the implementation of a new enterprise resource planning system and equipment for quality assurance testing. In the first half of fiscal 2013, such expenditures were associated with machinery and equipment to support new product introductions. During the first half of fiscal 2014, intangible assets totaled $250,000 and related to a technology license agreement.

Net cash provided by financing activities was $4.8 million during the first half of fiscal 2014, compared to net cash used of $0.3 million during the first half of fiscal 2013. During the first half of fiscal 2014, we received gross proceeds of $5.0 million from the sale of our convertible notes, offset by $0.2 million paid for taxes for net settlement of restricted stock units. During the first half of fiscal 2013, $0.4 million was paid for taxes for net settlement of restricted stock units, offset by proceeds received of $145,000 from ESPP purchases.

Inflation

Inflation has not had a significant impact on our operations during the periods presented. Historically, we have been able to pass on to our customers increases in raw material prices caused by inflation. If at any time we cannot pass on such increases, our margins could suffer.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements or significant guarantees to third parties that are not fully recorded in our consolidated condensed balance sheet or fully disclosed in the notes to our consolidated condensed financial statements.

Recently Issued Accounting Pronouncements

See Note 11 to our consolidated condensed financial statements for information about recent accounting pronouncements.


Item 3.	Quantitative and Qualitative Disclosures about Market Risk.

Market risk represents the risk of loss that may impact our financial position, results of operations, or cash flows due to adverse changes in financial and commodity market prices and rates. We are exposed to market risk from changes in foreign currency exchange rates as measured against the U.S. dollar. These exposures are directly related to our normal operating and funding activities. Historically, we have not used derivative instruments or engaged in hedging activities.

Foreign Currency Risk. We conduct business on a global basis and essentially all of our products sold in international markets are denominated in U.S. dollars. Historically, export sales have represented a significant portion of our sales and are expected to continue to represent a significant portion of sales. Our wholly-owned subsidiaries in the United Kingdom, France, and Germany incur costs that are denominated in local currencies. As exchange rates vary, these results may vary from expectations when translated into U.S. dollars, which could adversely impact overall expected results. The effect of exchange rate fluctuations on our results of operations during the first half of fiscal 2014 and 2013 resulted in losses of $224,000 and $189,000, respectively, to our consolidated condensed financial statements.


Item 4.	Controls and Procedures.

Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rules 13a-15

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(e) and 15d-15(e) under the Exchange Act of 1934. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the fiscal quarter ended December 31, 2013 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.

We are from time to time involved in various lawsuits, legal proceedings, or claims that arise in the ordinary course of business. We do not believe any such legal proceedings or claims will have, individually or in the aggregate, a material adverse effect on our business, liquidity, results of operations, or financial position. Litigation, however, is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business.

In August 2010, we filed a patent infringement lawsuit in the United States District Court for the Southern District of California against BDT AG, BDT Products, Inc., and BDT-Solutions GmbH. In October 2010, we filed an amended complaint for patent infringement in that court naming the following defendants: BDT AG; BDT Products, Inc.; BDT-Solutions GmbH & Co. KG; BDT Automation Technology (Zhuhai FTZ) Co., Ltd.; BDT de México, S. de R.L. de C.V.; IBM; and Dell. Also in October 2010, we filed a complaint for patent infringement with the United States International Trade Commission (“ITC”) against the same defendants. Both lawsuits claimed infringement of two of our U.S. Patents; Nos. 6,328,766 and 6,353,581. The complaints broadly claimed infringement by BDT's products, and they specifically identify BDT's FlexStor II^® product line as infringing our patents. The Southern District of California case was stayed to allow the ITC case to move forward first. The ITC instituted the case on November 18, 2010 (Investigation No. 337-TA-746). The trial for such case began on August 29, 2011 and ended on September 7, 2011. In July 2013, the court issued an order lifting the stay of our case against BDT in the United States District Court for the Southern District of California.

In November 2011, we entered into a multi-year settlement and cross-licensing agreement with IBM pursuant to which we released all claims we had against IBM and Dell in connection with the patent infringement lawsuits we had filed in the United States District Court for the Southern District of California and at the ITC. In opinions issued by the ITC in November 2012 and May 2013, the ITC concluded or otherwise did not disturb findings that BDT’s customers directly infringe the six asserted claims of U.S. Patent No. 6,328,766, and that all but one of the asserted claims of U.S. Patent No. 6,353,581 are valid. The ITC also concluded that the six asserted claims of U.S. Patent No. 6,328,766 were invalid as anticipated, and that the accused BDT products did not infringe the asserted claims of U.S. Patent No. 6,353,581. In May 2013, the ITC terminated the investigation.

In June 2012, we filed five additional patent infringement lawsuits in the United States District Court for the Southern District of California against seven companies. In these lawsuits, we have asserted claims of infringement based on one or both of U.S. Patent Nos. 6,328,766 and 6,353,581 against the following defendants: Quantum Corporation (“Quantum”), based in San Jose, California; Spectra Logic Corporation (“Spectra Logic”), based in Boulder, Colorado; PivotStor, LLC, based in Irvine, California; Qualstar Corporation, based in Simi Valley, California; Tandberg Data GmbH, based in Germany; Tandberg Data Corp., based in Westminster, Colorado; and Venture Corporation Limited, based in Singapore. In October 2012, we voluntarily dismissed our claims against Venture Corporation. In February 2013, we filed a joint motion to dismiss our case against Tandberg Data GmbH and Tandberg Data Corp. without prejudice.

In August 2012, Quantum filed counterclaims against us in the United States District Court for the Southern District of California action alleging trademark infringement and unfair competition claims, and infringement of U.S. Patent Nos. 5,491,812; 6,542,787; 6,498,771; and 5,925,119 by our products. In April 2013, Quantum filed a complaint against us in the United States

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District Court for the Southern District of California alleging infringement of U.S. Patent No. 7,263,596 by our products. Quantum is seeking monetary damages from us and injunctive relief.

In May 2013, Safe Storage LLC (“Safe Storage”), a Delaware limited liability company, filed a complaint against us in the United States District Court for the District of Delaware alleging infringement of U.S. Patent No. 6,978,346 by our products. Safe Storage is seeking monetary damages from us and injunctive relief.


Item 1A.	Risk Factors.

An investment in our company involves a high degree of risk. In addition to the risk factor below and the other information included or incorporated by reference in this report, you should carefully consider each of the following risk factors in evaluating our business and prospects as well as an investment in our company. The risks and uncertainties described in Item 1A of Part II of our annual report on Form 10-K for the fiscal year ended June 30, 2013 are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the risks actually occur, our business and financial results could be harmed. In that case, the trading price of our common stock could decline.

Our investment in Sphere 3D is subject to a variety of risks which could reduce its value.

We hold 769,231 shares of common stock of Sphere 3D Corporation (“Sphere 3D”), which had a value as of December 31, 2013 of approximately $4.7 million, representing 14.9% of our total assets as of such date. The value of our investment in Sphere 3D could decrease substantially or entirely for a number of reasons, including Sphere 3D's limited operating history, that Sphere 3D may not be able to achieve or maintain revenues or profitability, the limited trading of Sphere 3D's stock on the TSX Venture Exchange and continued significant volatility of its trading price, our lack of control over Sphere 3D's management and operating decisions, the timing and nature of any exit transaction, the fact that the common stock of Sphere 3D is not listed on any U.S. stock exchange, and the fact that the shares of common stock of Sphere 3D owned by us have not been registered under U.S. securities laws, which could make it more difficult to sell our such shares. These factors could cause the value of our investment to decrease significantly, which could cause our financial condition to suffer as a result.


Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.

On November 12, 2013 and December 24, 2013 we issued and sold $3.0 million and $2.0 million, respectively, of convertible promissory notes (the “Notes”) pursuant to an amended and restated note purchase agreement, dated as of November 1, 2013 (the “NPA”), by and among the Company and the purchasers party thereto, all of which were accredited investors. The Notes are convertible into shares of common stock (subject to certain limitations) in an amount equal to the principal amount of the Notes being converted divided by $1.00, subject to adjustment as set forth in the NPA. In addition, the Company may, subject to certain limitations, pay interest on the Notes in cash or in shares of common stock at its option.

The Notes were issued pursuant to the exemptions from registration provided by Section 4(2) of the Securities Act of 1933, as amended, or the Securities Act, and/or Regulation D and/or Regulation S promulgated thereunder. The shares issuable upon conversion of the Notes and any shares that we may issue as payment of interest on the Notes will be restricted in accordance with Rule 144 under the Securities Act in the event they are not registered under the Securities Act. The issuance of the Notes did not involve any public offering; the Company has made and will make no solicitation in connection with the private placement other than communications with the purchasers; the Company obtained representations from the purchasers regarding their investment intent, knowledge and experience; the purchasers either received or had access to adequate information about the Company in order to make informed investment decisions; the Company reasonably believed that the purchasers are capable of evaluating the merits and risks of their investment; and the shares potentially issuable under the NPA are issuable with restricted securities legends.

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Item 3.	Defaults Upon Senior Securities.

Not applicable.


Item 4.	Mine Safety Disclosures.

Not applicable.


Item 5.	Other Information.

Not applicable.


Item 6.	Exhibits.



10.1	Fourth Amendment to Lease dated October 15, 2013 between the Company and Overtape (CA) QRS 15-14, Inc. (successor-in-interest to LBA Overland, LLC, the successor-in-interest to LBA-VIF One, LLC).

10.2	Acquisition Agreement dated November 1, 2013 (incorporated by reference to the Company's Form 8-K filed November 1, 2013).

10.3	Amended and Restated Note Purchase Agreement, dated November 1, 2013 (incorporated by reference to the Company's Form 8-K filed November 1, 2013).

10.4	Amended and Restated Registration Rights Agreement, dated November 1, 2013 (incorporated by reference to the Company's Form 8-K filed November 1, 2013).

31.1	Certification of Eric L. Kelly, President and Chief Executive Officer, pursuant to Rule 13a-14(a) or 15d-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2	Certification of Kurt L. Kalbfleisch, Senior Vice President and Chief Financial Officer, pursuant to Rule 13a-14(a) or 15d-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by Eric L. Kelly, President and Chief Executive Officer, and Kurt L. Kalbfleisch, Senior Vice President and Chief Financial Officer.

101.INS	XBRL Instance Document.

101.SCH	XBRL Taxonomy Extension Schema.

101.CAL	XBRL Taxonomy Extension Calculation Linkbase.

101.DEF	XBRL Taxonomy Extension Definition Linkbase.

101.LAB	XBRL Taxonomy Extension Label Linkbase.

101.PRE	XBRL Taxonomy Extension Presentation Linkbase.

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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.



		OVERLAND STORAGE, INC.

Dated:	February 13, 2014	By:	/s/ Eric L. Kelly
			Eric L. Kelly President and Chief Executive Officer (Principal Executive Officer)



		OVERLAND STORAGE, INC.

Dated:	February 13, 2014	By:	/s/ Kurt L. Kalbfleisch
			Kurt L. Kalbfleisch Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	8th grade Good

Overland Storage (OVRL) Inactive 10-Q2014 Q2 Quarterly report

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