Item 1. Business.
This report contains certain 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. 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 Part I, Item 1A
Item 1A. Risk Factors.
An investment in our company involves a high degree of risk. In addition to 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 below 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 following risks actually occur, our business and financial results could be harmed. In that case the trading price of our common stock could decline.
Our cash and other sources of liquidity may not be adequate to fund our operations for the next 12 months. If we raise additional funding through sales of equity or equity-based securities, your shares will be diluted. If we need additional funding for operations and we are unable to raise it, we may be forced to liquidate assets and/or curtail or cease operations.
We have projected that cash on hand, combined with 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 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 to the historical timing of collecting accounts receivable could have a material adverse impact on our ability to access the level of funding necessary to continue our operations at current levels. If any of these events occur or if we are not able to secure additional funding, we may be forced 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.
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 fiscal year ended June 30, 2011 includes an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern.
We may seek debt, equity or equity-based financing (such as convertible debt) when market conditions permit. Such financing may not be available on favorable terms, or at all. If we need additional funding for operations and are unable to raise it through debt or equity financings, we may be forced to liquidate assets and/or curtail or cease operations. In addition, such financing may not be available on favorable terms, or at all. If we raise additional funds by selling additional shares of our capital stock, or securities convertible into shares of our capital stock, the ownership interest of our existing shareholders will be diluted. The amount of dilution could be increased by the issuance of warrants or securities with other dilutive characteristics, such as anti-dilution clauses or price resets.
We urge you to review the additional information about our liquidity and capital resources in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this report. If we cease to continue as a going concern due to lack of available capital or otherwise, you may lose your entire investment in our company.
We have a history of net losses. We expect to continue to incur net losses for some time and we may not achieve or maintain profitability.
We have incurred significant operating losses in our last six fiscal years and we anticipate continued losses during fiscal 2012. As of June 30, 2011, we had an accumulated deficit of $96.6 million. To return to profitability we will need to maintain or increase revenue, increase gross profit margins and improve our operating model. We may also need to implement additional cost reduction efforts across our operations as discussed below.
Our financial condition and the “going concern” opinion from our independent registered public accounting firm may negatively impact our business.
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, 2011 includes an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern. Such report, and our financial condition and history of net losses, could cause current or potential customers to defer new orders with us or to select other suppliers, and may cause suppliers to require terms that are unfavorable to us.
We may need to implement additional cost reduction efforts across our operations.
During the second quarter of fiscal 2010, we reduced our worldwide workforce by 6.4%, or 15 employees, in connection with our realignment around core initiatives. During the fourth quarter of fiscal 2010, we further reduced our worldwide workforce by an additional 18.8%, or 42 employees, in connection with changes in our business model and a restructuring of our workforce. There can be no assurance that our cost reduction efforts will be successful and we may need to implement additional cost reduction initiatives, such as further reductions in the cost of our workforce and/or suspending or curtailing planned programs, either of which could materially harm our business, results of operations and future prospects.
We rely on indirect sales channels to market and sell our branded products. Therefore, the loss of, or deterioration in, our relationship with one or more of our distributors or resellers could negatively affect our operating results.
We sell all of our branded products through our network of distributors, VARs and DMRs, who in turn sell our products to end users. In fiscal 2011 and 2010, we had no distributors that accounted for more than 10% of our sales. The long-term success of any of our distributors or resellers is difficult to predict, and we have no purchase commitments or long-term orders from any of them to assure us of any baseline sales through these channels. Most of our distributors and resellers also carry competing product lines that they may promote over our products. A distributor or reseller might not continue to purchase our products or market them effectively, and each determines the type and amount of our products that it will purchase from us and the pricing of the products that it sells to end user customers. Our operating results could be adversely affected by a number of factors, including, but not limited to:
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a change in competitive strategy that adversely affects a distributor’s or reseller’s willingness or ability to stock and distribute our products;
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the reduction, delay or cancellation of orders or the return of a significant amount of our products;
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the loss of one or more of our distributors or resellers; and
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any financial difficulties of our distributors or resellers that result in their inability to pay amounts owed to us.
If our suppliers fail to meet our manufacturing needs, it would delay our production and our product shipments to customers and negatively affect our operations.
Our products have a large number of components and subassemblies produced by outside suppliers. We depend greatly on these suppliers for items that are essential to the manufacture of our products, including tape drives, printed circuit boards and integrated circuits. We work closely with our regional, national and international suppliers, which are carefully selected based on their ability to provide quality parts and components that meet both our technical specifications and volume requirements. For certain items, we qualify only a single source, which magnifies the risk of shortages and decreases our ability to negotiate with that supplier on the basis of price. From time to time, we have been unable to obtain as many drives as we have needed due to drive shortages or quality issues from certain of our suppliers. If our suppliers fail to meet our manufacturing needs, it would delay our production and our product shipments to customers and negatively affect our operations.
We have granted security interests over certain of our assets in connection with various debt arrangements.
We have granted security interests over certain of our assets in connection with our Credit Facility and we may grant additional security interests to secure future borrowings. If we are unable to satisfy our obligations under these arrangements, we could be forced to sell certain assets that secure these loans, which could have a material adverse effect on our ability to operate our business. In the event we are unable to maintain compliance with covenants set forth in these arrangements or if these arrangements are otherwise terminated for any reason, it could have a material adverse affect on our ability to access the level of funding necessary to continue operations at current levels. If any of these events occur, management may be forced to make further reductions in spending, further 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.
Our success depends on our ability to anticipate rapid technological changes and develop new and enhanced products.
As an advanced technology company, we are subject to numerous risks and uncertainties characterized by rapid technological change and intense competition. Our future success will depend on our ability to anticipate changes in technology, and to develop, introduce, manufacture and achieve market acceptance of new and enhanced products on a timely and cost-effective basis.
Development schedules for technology products are inherently uncertain. We may not meet our product development schedules, and development costs could exceed budgeted amounts. Our business, results of operations, financial position and liquidity may be materially and adversely affected if the products or product enhancements that we develop are delayed or not delivered due to developmental problems, quality issues or component shortage problems, or if our products or product enhancements do not achieve market acceptance or are unreliable. We or our competitors will continue to introduce products embodying new technologies, such as new sequential or random access mass storage devices. In addition, new industry standards may emerge. Such events could render our existing products obsolete or not marketable, which would have a material adverse effect on our business, results of operations, financial position and liquidity.
Our disk-based products involve many significant risks and may fail to achieve or maintain market acceptance.
The success of our Snap Server® family of disk-based products is uncertain and subject to significant risks that could have a material adverse effect on our business, results of operations, financial position and liquidity. We must commit significant resources to sustain these products and will continuously need to update and upgrade them to stay competitive. Any delay in the commercial release of new or enhanced disk-based products could result in a significant loss of potential revenue and may adversely impact the market price of our common stock. Furthermore, if our disk-based products do not achieve market acceptance or success, then the association of our brand name with these products may adversely affect our reputation and sales of other products, diluting the value of our brand name.
Our business has been highly dependent on sales to our one OEM customer, and we are currently in a transition with our OEM customer.
HP has historically been our largest customer, accounting for 18.8% and 22.5% of sales in fiscal 2011 and 2010, respectively. No other customer accounted for more than 10% of sales in any year during the two-year period ended June 30, 2011. During the fourth quarter of fiscal 2011, we fulfilled all our obligations under the agreement for supply of tape libraries; however, we will continue to provide spares and services under the agreement.
We face intense competition and price pressure, and many of our competitors have substantially greater resources than we do.
The worldwide storage market is intensely competitive. A number of manufacturers of tape and disk-based storage solutions compete for a limited number of customers. In addition, barriers to entry are relatively low in these markets. Some of our competitors have substantially greater financial and other resources, larger research and development staffs, and more experience and capabilities in manufacturing, marketing and distributing products. Ongoing pricing pressure could result in significant price erosion, reduced profit margins and loss of market share, any of which could have a material adverse effect on our business, results of operations, financial position and liquidity.
Our business is highly dependent on the continued market acceptance and usage of tape-based systems for data backup and recovery.
We have historically derived a majority of our revenue from products that use magnetic tape drives for backup and recovery of digital data. Our tape-based storage solutions now compete directly with other storage technologies, such as hard disk drives, and may face competition in the future from other emerging technologies. The prices of hard disk drives continue to decrease as their capacity and performance increase. We expect our tape-based products to face increased competition from these alternative technologies and come under increasing pricing pressure. If our strategy to compete in disk-based markets does not succeed, it could have a material adverse effect on our business, results of operations, financial position and liquidity.
If our revenue base continues to decline, we may choose to discontinue or exit some or a substantial portion of our current operations.
Our management team continually reviews and evaluates our product portfolio, operating structure and markets to assess the future viability of our existing products and market positions. We may determine that the infrastructure and expenses necessary to sustain an existing product offering are greater than the potential contribution margin that we would realize. As a result, we may determine that it is in our interest to exit or divest one or more existing product offerings, which could result in costs incurred for exit or disposal activities and/or impairments of long-lived assets. Moreover, if we do not identify other opportunities to replace discontinued products or operations, our revenues would decline, which could lead to further net losses and adversely impact the market price of our common stock.
Our ability to compete depends in part on our ability to protect our intellectual property rights.
We rely on a combination of patent, copyright, trademark, trade secret and other intellectual property laws to protect our intellectual property rights. However, these rights may not prevent competitors from developing products that are substantially equivalent or superior to our products. To the extent that we have or obtain patents, such patents may not afford meaningful protection for our technology and products. Others may challenge our patents and, as a result, our patents could be narrowed, invalidated or declared unenforceable. The patents that are material to our business will begin to expire in November 2015. In addition, our current or future patent applications may not result in the issuance of patents in the United States or foreign countries. The laws of certain foreign countries may not protect our intellectual property to the same extent as U.S. laws. Furthermore, competitors may independently develop similar products, duplicate our products or, if patents are issued to us, design around these patents.
In order to protect or enforce our patent rights, we may initiate interference proceedings, oppositions, or patent litigation against third parties, such as infringement suits. Such enforcement efforts could be expensive and divert management’s time and attention from other business concerns. The patent position of information technology firms in particular is highly uncertain, involves complex legal and factual questions, and continues to be the subject of much litigation. No consistent policy has emerged from the U.S. Patent and Trademark Office or the courts regarding the breadth of claims allowed or the degree of protection afforded under information technology patents.
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.; Dell; and IBM. Also in October 2010, we filed a complaint for patent infringement with the United States International Trade Commission against the same defendants. Both lawsuits claim infringement of two of our United States patents, Nos. 6,328,766 and 6,353,581. The complaints broadly claim infringement by BDT’s products, and they specifically identify BDT’s FlexStor® II product line as infringing our patents. The complaints also claim infringement by Dell and IBM products that are manufactured by BDT based on the FlexStor® II. The Southern District of California case has been stayed to allow the International Trade Commission case to move forward first. The International Trade Commission 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. The Initial Determination from the Administrative Law Judge is due on November 23, 2011.
We could incur charges for excess and obsolete inventory.
The value of our inventory may be adversely affected by factors that affect our ability to sell the products in our inventory. Such factors include changes in technology, introductions of new products by us or our competitors, the current or future economic downturns, or other actions by our competitors. If we do not effectively forecast and manage our inventory, we may need to write off inventory as excess or obsolete, which adversely affects cost of sales and gross profit. We have previously experienced, and may in the future experience, reductions in sales of older generation products as customers delay or defer purchases in anticipation of new products that we or our competitors may introduce. We have established reserves for slow moving or obsolete inventory. These reserves, however, may prove to be inadequate, which would result in additional charges for excess or obsolete inventory.
Our warranty reserves may not adequately cover our warranty obligations.
We have established reserves for the estimated liability associated with our product warranties. However, we could experience unforeseen circumstances where these or future reserves may not adequately cover our warranty obligations. For example, the failure or inadequate performance of product components that we purchase could increase our warranty obligations beyond these reserves.
The failure to attract, retain and motivate key personnel could have a significant adverse impact on our operations.
We have experienced significant changes in our senior management. In January 2010, our Board of Directors appointed Eric L. Kelly, who has served as our Chief Executive Officer since January 2009 and on our Board of Directors since November 13, 2007, as our President. In February 2010, we terminated the employment of Ravi Pendekanti, our former Vice President of Business Development and Solutions. In September 2009, Christopher Gopal joined us as our Vice President of Worldwide Operations; and in February 2010, Geoff Barrall joined us as our Chief Technology Officer and Vice President of Engineering. Mr. Gopal’s employment with us ended in January 2011. These changes may be a distraction to other senior management, business operations, commercial partners and customers. Additionally, we have experienced a prolonged period of operating losses and declines in our stock price and cash position, which have affected and may continue to affect employee morale and retention. We reduced our workforce by 6.4% in October 2009 and by 18.8% in April 2010. Additional turnover, particularly among senior management, may also create distractions as we search for replacement personnel, which could result in significant recruiting, relocation, training and other costs, and can cause operational inefficiencies as replacement personnel become familiar with our business and operations. In addition, manpower in certain areas may be constrained, which could lead to disruptions over time. We cannot guarantee that we will successfully attract or retain the management we need, or be able to maintain an optimal
workforce size. Any inability to attract, retain or motivate such personnel or to address manpower constraints could materially adversely affect our results of operations, financial position or cash flows. We do not currently maintain any key-man insurance for any of our employees.
We face risks related to the continuing economic downturn.
The continuing economic downturn in the U.S. and global financial markets, and in the U.S. and global economies, has had, and may continue to have, a material and adverse impact on our business and our financial condition. Businesses may further reduce or postpone spending on IT infrastructure in response to tighter credit, negative financial news and declines in income or asset values. We believe that such reduction in, or postponement of, spending has had and may continue to have a material adverse effect on the demand for our products. We cannot predict the length or severity of the current economic downturn, or the timing or severity of future economic or industry downturns. The continuing uncertainty in the capital markets may also severely restrict our ability to access the capital markets, which would limit our ability to react to changing economic and business conditions. A prolonged recession or continued or further decline in the global economy would materially adversely affect our results of operations, financial position or cash flows.
Our financial results may fluctuate substantially for many reasons, and past results should not be relied on as indications of future performance.
The markets that we serve are volatile and subject to market shifts that we may be unable to anticipate. A slowdown in the demand for workstations, mid-range computer systems, networks and servers could have a significant adverse effect on the demand for our products in any given period. In the past, we have experienced delays in the receipt of purchase orders and, on occasion, anticipated purchase orders have been rescheduled or have not materialized due to changes in customer requirements. Our customers may cancel or delay purchase orders for a variety of reasons, including, but not limited to, the rescheduling of new product introductions, changes in our customers’ inventory practices or forecasted demand, general economic conditions affecting our customers’ markets, changes in our pricing or the pricing of our competitors, new product announcements by us or others, quality or reliability problems related to our products, or selection of competitive products as alternate sources of supply. In particular, our ability to forecast sales to distributors, VARs and DMRs is especially limited because these customers typically provide us with relatively short order lead times or are permitted to change orders on short notice. Because a large portion of our sales is generated by our European channel, our first fiscal quarter (July through September) results of operations are often impacted by seasonally slow European orders, reflecting the summer holiday period in Europe. None of our customers is obligated to purchase a specific amount of our products.
Our financial results have fluctuated and will continue to fluctuate quarterly and annually based on, among others, the following factors:
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changes in customer mix (e.g., OEM vs. branded);
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changes in product mix;
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fluctuations in average selling prices;
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currency exchange fluctuations;
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increases in costs and expenses associated with the introduction of new products; and
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increases in the cost of or limitations on the availability of materials.
We therefore believe that our revenue and operating results will continue to fluctuate, and that period-to-period comparisons are not necessarily meaningful and should not be relied on as indications of future performance. Our revenue and operating results may fail to meet the expectations of public market analysts or investors, which could have a material adverse effect on the price of our common stock. In addition, portions of our expenses are fixed and difficult to reduce if our revenues do not meet our expectations. These fixed expenses magnify the adverse effect of any revenue shortfall.
We plan to replace our Enterprise Resource Planning (“ERP”) System within the next several years. This will be expensive and may be disruptive to our business.
Our ERP system is 14 years old, and we plan to replace it within the next several years. Transitioning to a new ERP system will be expensive and time consuming, and our business and results of operations may be materially and adversely affected if problems occur during the transition. In addition, we have modified our current ERP system significantly during its term of use and it is possible that we will experience a significant system failure before we replace it. Any such failure may materially and adversely affect our business, liquidity, results of operations and financial position.
Our international operations are important to our business and involve unique risks.
Sales to customers outside of the United States represent a significant portion of our total sales and we expect them to continue to do so. Sales to customers outside the United States are subject to various risks, including, but not limited to:
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the imposition of governmental controls mandating compliance with various foreign and U.S. export laws;
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currency exchange fluctuations;
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weak economic conditions in foreign markets;
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political and economic instability;
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trade restrictions, tariffs and taxes;
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longer payment cycles typically associated with international sales; and
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difficulties in staffing and managing international operations.
Furthermore, we may be unable to comply with changes in foreign laws, rules and regulations applicable to us in the future, which could have a material adverse effect on our business, results of operations, financial position and liquidity.
We are subject to exchange rate risk in connection with our international operations.
We do not currently engage in foreign currency hedging activities and, therefore, we are exposed to some level of currency risk. While essentially all of our sales in international markets are denominated in U.S. dollars, 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 when translated into U.S. dollars may vary from expectations and adversely impact overall expected results. A weaker U.S. dollar would result in an increase to revenue and expenses upon consolidation, and a stronger U.S. dollar would result in a decrease to revenue and expenses upon consolidation. Exchange rate transactions resulted in a net loss of $0.5 million during fiscal 2011.
We have made a number of acquisitions in the past and we may make acquisitions in the future. The failure to successfully integrate acquisitions and successfully complete product development and launch of the related products could harm our business, financial condition and operating results.
We have in the past and may in the future make acquisitions of complementary businesses, products or technologies as we implement our business strategy. Mergers and acquisitions involve numerous risks, including liabilities that we may assume from the acquired company, difficulties in completion of in-process product development and assimilation of the operations and personnel of the acquired business, the diversion of management’s attention from other business concerns, risks of entering markets in which we have no direct prior experience, and the potential loss of key employees of the acquired business.
Future mergers and acquisitions by us also may result in dilutive issuances of our equity securities and the incurrence of debt, amortization expense and potential impairment charges related to intangible assets. Any of these factors could adversely affect our business, liquidity, results of operations and financial position.
The market price of our common stock is volatile.
The market price of our common stock has experienced significant fluctuations since it commenced trading in February 1997, and may continue to fluctuate significantly in the future. Many factors could cause the market price of our common stock to fluctuate, including, but not limited to:
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our ability to meet our working capital needs;
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announcements concerning us, our competitors, our customers or our industry;
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changes in earnings estimates by analysts;
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purchasing decisions of HP and other significant customers;
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quarterly variations in operating results;
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the introduction of new technologies or products by us or our competitors;
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changes in product pricing policies by us or our competitors;
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the terms of any financing arrangements we enter into; and
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changes in general economic conditions.
In addition, stock markets generally have experienced extreme price and volume volatility in recent years. This volatility has had a substantial effect on the market prices of securities of many smaller public companies for reasons frequently unrelated or disproportionate to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock.
We may not be able to continue to meet the continued listing requirements for the NASDAQ Capital Market. If our common stock is delisted from the NASDAQ Capital Market, our business, financial condition, results of operations and stock price could be adversely affected, and the liquidity of our stock and our ability to obtain financing could be impaired.
On December 15, 2009, we received written notification from the NASDAQ Stock Market, LLC (“NASDAQ”) that because we had not regained compliance with the minimum market value of publicly held shares of $15 million requirement set forth in NASDAQ Listing Rule 5450(b)(1)(C) by the December 14, 2009 expiration of the 90-day compliance period for this requirement, our common stock would be delisted from the NASDAQ Global Market unless we requested an appeal of this determination to a NASDAQ Hearings Panel (“Panel”). We requested an appeal of the determination and met with the Panel on January 20, 2010. On March 3, 2010, we received written notification from the Panel that it would continue the listing of our common stock on the NASDAQ Global Market subject to our demonstrating compliance with all continued listing standards of the NASDAQ Global Market on or before June 14, 2010. Prior to June 14, 2010, our management determined to apply to NASDAQ to transfer the listing of our common stock from the NASDAQ Global Market to the NASDAQ Capital Market. On June 14, 2010, we were notified that NASDAQ approved our application to transfer the listing of our common stock to the NASDAQ Capital Market, effective at the opening of trading on June 16, 2010. We are currently in compliance with all of the listing standards for listing on the NASDAQ Capital Market, but we cannot provide any assurance that we will continue to be in compliance in the future.
In addition, on December 8, 2009, we effected a one-for-three reverse stock split of our common stock to regain compliance with the minimum bid price of $1.00 per share requirement set forth in NASDAQ Listing Rule 5450(a)(1). Though the bid price of our common stock has remained above $1.00 per share since the reverse split, we cannot guarantee that it will remain at or above $1.00 per share. If the bid price drops below $1.00 per share, our common stock could become subject to delisting again and we may seek shareholder
approval for an additional reverse split. A second reverse split could produce negative effects and we cannot provide any assurance that it would result in a long-term or permanent increase in the bid price of our common stock. For example, a second reverse split could make it more difficult for us to comply with other listing standards of NASDAQ, including requirements related to the minimum number of shares that must be in the public float, the minimum market value of publicly held shares and the minimum number of round lot holders. In addition, investors might consider the increased proportion of unissued authorized shares of common stock to issued shares of common stock to have an anti-takeover effect under certain circumstances by allowing for dilutive issuances which could prevent certain shareholders from changing the composition of our Board of Directors.
Although we are currently in compliance with the standards for listing on the NASDAQ Capital Market, we were not in compliance with all of such listing standards during portions of 2009 and 2010, and we may not be able to continue to meet the continued listing requirements for the NASDAQ Capital Market. Any delisting of our common stock from the NASDAQ Capital Market could adversely affect our ability to attract new investors, decrease the liquidity of our outstanding shares of common stock, reduce our flexibility to raise additional capital, reduce the price at which our common stock trades and increase the transaction costs inherent in trading such shares with overall negative effects for our shareholders. In addition, delisting of our common stock could deter broker-dealers from making a market in or otherwise seeking or generating interest in our common stock, and might deter certain institutions and persons from investing in our securities at all. For these reasons and others, delisting could adversely affect our business, financial condition and results of operations.
Item 1B.
Item 1B. Unresolved Staff Comments.
We have no unresolved comments from the SEC.
Item 2.
Item 2. Properties.
We own no real property and we currently lease all facilities used in our business. Our headquarters is located in San Diego, California, where we leased a 158,585 square foot facility in a light industrial complex as of June 30, 2010. On July 1, 2010, we modified our San Diego headquarters lease and reduced our facility by one building, or 67,285 square feet, which proportionally reduced our monthly base rent and share of facility expenses. The lease expires in February 2014 and may be renewed for one additional five-year period. This San Diego facility houses manufacturing and administrative functions.
We lease a 20,777 square foot facility in San Jose, California. The lease expires in May 2017 and can be renewed for one additional five-year period. The San Jose facility houses research and development, sales and marketing, and administrative functions.
We lease a 17,000 square foot facility located in Wokingham, England, which houses sales, technical support and repair services, and administration functions. The lease expires in January 2018. We also maintain small sales offices located close to Paris, France; Munich, Germany; and in Singapore.
Item 3.
Item 3. 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, either individually or in the aggregate, a material adverse effect on our results of operations, financial position or cash flows. However, litigation 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 December 2009, Crossroads Systems, Incorporated (“Crossroads”) filed a lawsuit against us and several other companies in the United States District Court for the Western District of Texas (the “Complaint”). The Complaint was served on us in December 2009, and alleged that our products infringe upon United States Patent
Nos. 6,425,035 and 7,051,147. The Court had scheduled a hearing on issues of claim construction for June 3, 2010. Although we were prepared to vigorously defend against Crossroads’ lawsuit, in advance of the claim construction briefing, the parties reached a settlement of the lawsuit, and the Court entered an Order of Dismissal of the lawsuit on May 25, 2010.
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.; Dell; and IBM. Also in October 2010, we filed a complaint for patent infringement with the United States International Trade Commission against the same defendants. Both lawsuits claim infringement of two of our United States patents, Nos. 6,328,766 and 6,353,581. The complaints broadly claim infringement by BDT’s products, and they specifically identify BDT’s FlexStor® II product line as infringing our patents. The complaints also claim infringement by Dell and IBM products that are manufactured by BDT based on the FlexStor® II. The Southern District of California case has been stayed to allow the International Trade Commission case to move forward first. The International Trade Commission 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. The Initial Determination from the Administrative Law Judge is due on November 23, 2011.
Item 4.
Item 4. (Removed and Reserved).
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.
Our common stock trades on the NASDAQ Capital Market under the symbol “OVRL.” As of September 7, 2011, there were approximately 35 shareholders of record. On December 8, 2009, we effected a one-for-three reverse stock split of our outstanding shares of common stock. The following table sets forth the range of high and low bid prices for our common stock for the past two fiscal years as reported by NASDAQ. All amounts in the table have been adjusted to give effect to the reverse stock split.
The above quotations reflect inter-dealer prices, without retail markup, markdown or commission and may not necessarily represent actual transactions. We have not paid any cash dividends on our common stock for our two most recent fiscal years and do not anticipate paying any cash dividends in the foreseeable future.
Item 6.
Item 6. (Removed and Reserved).
Item 7.
Item 7. 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. 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 Part I, Item 1A of this report, any of which could cause actual results to differ materially from those indicated by such forward-looking statements. Forward-looking statements speak only as of the date of this report and we undertake no obligation to publicly update any forward-looking statements to reflect new information, events or circumstances after the date of this report. Per share amounts herein have been adjusted to give effect to the December 8, 2009 one-for-three reverse stock split.
We are a trusted global provider of unified data management and data protection solutions designed to enable SMEs, corporate departments and SMBs, to anticipate and respond to change. Whether an organization’s data is distributed around the corner or across continents, our solutions consolidate and categorize data for easy and cost-effective management of different tiers of information over time. We enable companies to expend fewer resources on 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 moving and storing data throughout the organization and during the entire data lifecycle. Our Snap Server® product is a complete line of network attached storage and storage area network solutions designed to ensure primary and secondary data is accessible and protected regardless of its location. Our Snap Server® solutions are available with backup, replication and mirroring software in fixed capacity or 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® of virtual tape libraries, tape backup and archive systems are 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. See “Business” in Part I, Item 1 of this report for more information about our business, products and operations.
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, selling spare parts, and earning royalties on our licensed technology. The majority of our sales are generated through our branded channel, which includes systems integrators and VARs, with the remainder from our private label arrangement with our OEM, HP. During fiscal 2011, we experienced decreased revenues related to our OEM channel while our branded channel remained relatively constant.
Business Transition. During the fourth quarter of fiscal 2011, we fulfilled all our obligations under the HP agreement for supply of tape libraries; however, we will continue to provide spares and services under the agreement. HP product revenue, including spares, accounted for 10.3% and 18.3% of sales in fiscal 2011 and 2010, respectively. HP total revenue accounted for 18.8% and 22.5% of net revenues in fiscal 2011 and 2010, respectively.
Due in large part to the overall decline in HP revenue, we reported net revenue of $70.2 million for fiscal 2011, compared with $77.7 million for fiscal 2010. The decline in net revenue resulted in a net loss of $14.5 million, or $0.94 per share, for fiscal 2011 compared with a net loss of $13.0 million, or $2.04 per share, for fiscal 2010.
Liquidity and capital resources. At June 30, 2011, we had a cash balance of $10.2 million, compared to $8.9 million at June 30, 2010. In fiscal 2011, we incurred a net loss of $14.5 million. During the third quarter of fiscal 2011, we sold an aggregate of 8,653,045 shares of our common stock and warrants to purchase up to 3,807,331 shares of common stock in a private placement for a total issuance price of approximately $15.3 million and net proceeds of approximately $13.8 million. Cash management and preservation continue to be a top priority. We expect to incur negative operating cash flows during the remainder of calendar year 2011 as we continue to reshape our business model and further improve operational efficiencies.
Management has projected that cash on hand, combined with 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 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 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.
As of June 30, 2011, we had working capital of $8.7 million, reflecting decreases in current assets and current liabilities of $2.4 million and $8.7 million, respectively, during fiscal 2011. The decrease in current assets is primarily attributable to cash used in operating activities and reduced sales, resulting in lower inventory balances. The decrease in current liabilities is primarily attributable to a $5.6 million decrease in accounts payable and accrued liabilities primarily related to operating activities, a $4.4 million reduction in our current liabilities associated with our non-OEM accounts receivable financing arrangements and a $0.7 million reduction in debt related to the repayment of our note payable to Anacomp Inc. (“Anacomp”). These decreases were offset by a $2.0 million increase in accrued payroll and employee compensation related to a $2.2 million liability recorded for an equity instrument modification in the fourth quarter of fiscal 2011 offset by a $0.2 million decrease in accrued payroll related to timing of payment dates. See “Liquidity and Capital Resources” below for a description of these arrangements.
Industry trends. We estimate that the cost of managing digital assets is four times the cost of acquiring storage devices. Furthermore, many SMEs and SMBs are seeking to implement tiered storage for primary and secondary data utilizing a combination of low cost SATA (Serial ATA) drives and high performance SAS (Serial Attached SCSI) drives. IDC estimates that the total networked attached storage (“NAS”) market will grow at approximately 12.6% through 2014, and the growth rate for NAS storage systems in price bands up to $15,000, where most of our Snap Server® solutions lie, is estimated to be 17.4%. According to IDC, tape storage still constitutes approximately 7.3% of the total storage revenue in the global storage market. Sales of tape automation appliances represented 37.7% and 46.6% of our revenue during fiscal 2011 and 2010, respectively.
Recent Developments
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In July 2011, we launched our OverlandCare™ service offerings for our line of Snap Server® NAS, SnapSAN™, NEO Series® tape products and REO Series® VTL solutions.
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In August 2011, we terminated our MCF Financing Agreement pursuant to its terms.
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In August 2011, we entered into the Credit Facility that provides for an $8.0 million secured revolving loan. The proceeds of the Credit Facility may be used to fund our working capital and to fund our general business requirements. The Credit Facility is scheduled to mature August 8, 2013.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial position and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of consolidated financial statements requires that we make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent liabilities. On an on-going basis, we evaluate our estimates, including, but not limited to, those related to revenue recognition, share-based compensation, bad debts, inventories, intangible and other long-lived assets, warranty obligations and income taxes. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Critical accounting policies are those policies that, in management’s view, are most important in the portrayal of our financial condition and results of operations. The footnotes to our consolidated financial statements also include disclosure of significant accounting policies. The methods, estimates and judgments that we use in applying our accounting policies have a significant impact on the results that we report in our financial statements. These critical accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are inherently uncertain. Our critical accounting policies and estimates that require the most significant judgment are discussed further below.
Revenue Recognition
We recognize revenue from sales of products when persuasive evidence of an arrangement exists, the price is fixed or determinable, collectability is reasonably assured and delivery has occurred. Under this policy, revenue on direct product sales (excluding sales to distributors) is recognized upon shipment of products to our customers. These customers are not entitled to any specific right of return or price protection, except for any defective product that may be returned under our warranty policy. Generally, title and risk of loss transfer to the customer when the product leaves our dock. Product sales to distribution customers are subject to certain rights of return, stock rotation privileges and price protection. Because we are unable to estimate our exposure for returned product or price adjustments, revenue from shipments to these customers is not recognized until the related products are in turn sold to the ultimate customer by the distributor. For products in which software is more than an incidental component, we recognize revenue in accordance with current authoritative guidance for software revenue recognition.
In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2009-13, Multiple-Deliverable Revenue Arrangements and ASU No. 2009-14, Software: Certain Revenue Arrangements That Include Software Elements. The new standards change the requirements for establishing separate units of accounting in multiple element arrangements and require the allocation of arrangement consideration to each deliverable to be based on the relative selling price. We adopted these standards effective the beginning of the first quarter of fiscal 2011. As a result of the adoption of these standards, sales of products which contain both hardware and software components, and for which we had previously concluded that the software was more than incidental are no longer within the scope of software revenue recognition guidance as the hardware and software components function together to deliver the product’s essential functionality. For any multiple element agreement, we allocate the relative fair value to each component. If in an arrangement we have fair value for undelivered elements but not the delivered element in an
arrangement, we defer the fair value of the undelivered element(s) and the relative fair value is allocated to the delivered element(s). Undelivered elements typically include services. Revenue from extended warranty and product service contracts is initially deferred and recognized ratably over the contract period.
We have various royalty arrangements with independent service providers that sell our product and also sell and provide service on our product. These independent service providers pay a royalty fee for service contracts in place on our product. The royalty fee is calculated by us for the units covered in the quarter, and agreed to by the service provider, based upon the monthly fee for each unit covered by the independent service provider.
We have various licensing agreements relating to our Variable Rate Randomizer (“VR2®”) technology with third parties. The licensees pay us a royalty fee for sales of their products that incorporate our VR2® technology. The licensees provide us with periodic reports that include the quantity of units, subject to royalty, sold to their end users. We record the royalty when reported to us by the licensee, generally in the period during which the licensee ships the products containing VR2® technology.
Allowance for Doubtful Accounts
We estimate our allowance for doubtful accounts based on an assessment of the collectability of specific accounts and the overall condition of the accounts receivable portfolio. When evaluating the adequacy of the allowance for doubtful accounts, we analyze specific trade and other receivables, historical bad debts, customer credits, customer concentrations, customer credit-worthiness, current economic trends and changes in customers’ payment terms and/or patterns. If the financial condition of our customers were to deteriorate, impairing their ability to make additional payments, then we may need to make additional allowances. Likewise, if we determine that we could realize more of our receivables in the future than previously estimated, we would adjust the allowance to increase income in the period we made the determination. We review the allowance for doubtful accounts on a quarterly basis and record adjustments as considered necessary. Generally, our allowance for doubtful accounts is based on specific identification. If we fail to identify an account as doubtful, or if we identify an account as uncollectible that is later collected, our results could vary.
Share-based Compensation
Share-based compensation expense can be significant to our results of operations, even though no cash is used for such expense. In determining period expense associated with unvested options, we estimate the fair value of each option at the date of grant. We use the Black-Scholes option pricing model to determine the fair value of the award. This model requires the input of highly subjective assumptions, including the expected volatility of our stock and the expected term the average employee will hold the option prior to the date of exercise. In addition, we estimate pre-vesting forfeitures for share-based awards that are not expected to vest. We primarily use historical data to determine the inputs and assumptions to be used in the Black-Scholes pricing model. Changes in these inputs and assumptions could occur and could materially affect the measure of estimated fair value and make it difficult to compare the results in future periods to our current results.
A 10% change in our share-based compensation for the year ended June 30, 2011 would have affected our net loss by $0.3 million.
Inventory Valuation
We record inventories at the lower of cost or market. We assess the value of our inventories periodically based upon numerous factors including, among others, expected product or material demand, current market conditions, technological obsolescence, current cost and net realizable value. If necessary, we adjust our inventory for obsolete or unmarketable inventory by an amount equal to the difference between the cost of the inventory and the estimated market value. If actual market conditions are less favorable than we project, we may need to record additional inventory adjustments and adverse purchase commitments.
Impairment of Long-lived Assets
We test for recoverability of long-lived assets whenever events or changes in circumstances indicate the carrying value may not be recoverable. When the carrying value is not considered recoverable, an impairment loss is recognized for the amount by which the carrying value of a long-lived asset exceeds its fair value, with a corresponding reduction in the carrying value of the related assets. Such impairment charges may be material. Fair value is generally determined based on the estimated future discounted cash flows over the remaining useful life of the asset or asset group using a discount rate determined by management to be commensurate with the risk inherent in our current business model.
The assumptions supporting the cash flow analysis, including the discount rates, are determined using management’s best estimates as of the date of the impairment review. If these estimates or their related assumptions change in the future, or if our future results are significantly different than forecasted, we may be required to further evaluate our long-lived assets for recoverability and record impairment charges for these assets, which could adversely affect our results of operations.
Warranty Obligations
We provide for estimated future costs of warranty obligations in accordance with current accounting rules. For return-to-factory and on-site warranties, we accrue for warranty costs at the time revenue is recognized based on contractual rights and on the historical rate of claims and costs to provide warranty services. If we experience an increase in warranty claims above historical experience or our costs to provide warranty services increase, we may be required to increase our warranty accrual. Any such unforeseen increases may have an adverse impact on our gross margins in the periods in which they occur. Similarly, if we experience a decrease in warranty claims or our costs to provide services decline, we may be required to decrease our warranty accrual, which may have a favorable impact on our gross margins in the periods in which they occur.
Results of Operations
The following table sets forth certain financial data as a percentage of net revenue:
A summary of the sales mix by product follows:
Fiscal 2011 Compared with Fiscal 2010
Net Revenue. Net revenue decreased to $70.2 million during fiscal 2011 from $77.7 million during fiscal 2010, a decrease of $7.5 million, or 9.7%. The decline was primarily in our OEM revenue related to decreased revenue from HP, which represented approximately 18.8% of net revenue in fiscal 2011 compared with 22.5% of net revenue in fiscal 2010. In our branded channel, the decrease in net revenue was attributable to decreased volumes in our APAC and EMEA channels primarily due to the discontinuance of our ARCvault® and Ultamus® products offset by increases in units of Snap Server® products.
Product Revenue
Net product revenue decreased to $45.7 million during fiscal 2011 from $53.6 million during fiscal 2010, a decrease of $7.9 million, or 14.7%.
Net product revenue from our OEM customer, HP, decreased to $7.2 million during fiscal 2011 from $14.2 million during fiscal 2010. The decrease of $7.0 million, or 49.3%, was primarily associated with the fulfillment of our obligations under the product supply portion of the agreement and includes $0.5 million of previously deferred revenue associated with obligations under the agreement. We will continue to provide spares and services under the existing agreement.
Net product revenue from Overland branded products, excluding service revenue, decreased to $38.5 million during fiscal 2011 from $39.4 million during fiscal 2010. The decrease of $0.9 million, or 2.3%, was primarily associated with decreases of $2.4 million from ARCvault® products and $0.5 million from Ultamus® products due to the discontinuance of these two products, as well as a decrease of $0.9 million from REO® products. These decreases were partially offset by an increase of $2.7 million from Snap Server® products and $0.2 million from NEO® products. We began selling the NEO® S product in the second quarter of fiscal 2010.
Service Revenue
Net service revenue was relatively constant at $24.2 million during fiscal 2011 compared to $23.6 million during fiscal 2010.
Royalty Fees
Net royalty fees decreased to $0.3 million during fiscal 2011 from $0.5 million during fiscal 2010. The decrease of $0.2 million, or 40.0%, is primarily associated with lower VR2® technology royalties. VR2® technology royalties during fiscal 2011 totaled $0.2 million compared with $0.3 million during fiscal 2010.
Gross Profit. Overall gross profit was relatively constant at $21.2 million during fiscal 2011 compared to $21.4 million during fiscal 2010. Gross margin increased to 30.2% during fiscal 2011 from 27.5% during fiscal 2010 primarily related to the increase in higher margin branded product revenue as a percentage of total revenue.
Product Revenue
Gross profit on product revenue during fiscal 2011 was $7.5 million compared to $8.3 million during fiscal 2010. The decrease of $0.8 million, or 9.6%, was primarily due to the 14.7% decrease in net product revenue. Gross margin on product revenue at 16.5% for fiscal 2011 increased from 15.5% for fiscal 2010 primarily as a result of increased sales of higher margin products and an improved product mix.
Service Revenue
Gross profit on service revenue during fiscal 2011 was $13.3 million compared to $12.6 million during fiscal 2010. The increase of $0.7 million, or 5.5%, was primarily due to our transition of a significant portion of service repair from a third party vendor to our own personnel, during the third quarter of fiscal 2011, which reduced our payments to third party vendors. Gross margin on service revenue at 55.0% for fiscal 2011 increased from 53.4% for fiscal 2010.
Sales and Marketing Expense. Sales and marketing expense in fiscal 2011 decreased to $16.4 million from $18.0 million during fiscal 2010. The decrease of $1.6 million, or 8.9%, was primarily a result of (i) a decrease of $1.1 million in employee and related expenses, including travel costs, associated with a decrease in the average headcount by seven employees, primarily due to the streamlining of our sales force, (ii) a decrease of $0.5 million in public relations and advertising expense, including contractor fees, due to restructuring and reductions in marketing programs and bringing previously outsourced projects in house and (iii) a decrease of $0.3 million in severance costs associated with the fiscal 2010 restructurings. These decreases were slightly offset by a $0.3 million increase in share-based compensation expense primarily associated with options granted to an executive officer in February 2010.
Research and Development Expense. Research and development expense in fiscal 2011 increased to $7.7 million from $5.8 million during fiscal 2010. The increase of $1.9 million, or 32.8%, is primarily a result of (i) an increase of $1.5 million in employee and related expenses, including travel costs, associated with an increase in average headcount by seven employees associated with the restructuring of our research and development department, including the addition of a chief technology officer, (ii) an increase of $0.3 million in outside contractor fees and (iii) an increase of $0.2 million in share-based compensation expense primarily associated with options granted to an executive officer in March 2010. These increases were offset by a $0.1 million decrease in development expense associated with the timing of new product development.
General and Administrative Expense. General and administrative expense in fiscal 2011 increased to $12.7 million from $11.9 million during fiscal 2010. The increase of $0.8 million, or 6.7%, is primarily a result of (i) an increase of $1.1 million in share-based compensation expense primarily associated with options granted to executive officers in February 2010, (ii) an increase of $0.7 million in executive bonuses, (iii) an increase of $0.4 million in outside contractor expenses, principally for financial and accounting services, (iv) an increase of $0.2 million in investor relation expenses and (v) an increase of $0.1 million in fees associated with the termination of our Financing Agreement with Faunus Group International (“FGI”). These increases were partially offset by (i) a decrease of $1.0 million in legal fees and (ii) a decrease of $0.3 million in severance expense associated with a
former executive officer, (iii) a decrease of $0.3 million in employee related expenses, including travel costs, associated with a decrease in average headcount by four employees and (iv) a decrease of $0.1 million in audit, tax and consulting fees related to our transition to a new public accounting firm.
Interest Expense. We incurred interest expense of $1.1 million and $1.5 million during fiscal 2011 and 2010, respectively. In fiscal 2009, we entered into two non-OEM accounts receivable financing agreements. Under the non-OEM accounts receivable financing agreements we recorded interest expense of $1.1 million, including $0.1 million in amortization of debt issuance costs, compared to $1.3 million, including $0.1 million in amortization of debt issuance costs, in fiscal 2010. Interest expense associated with our note payable to Anacomp totaled $3,000 during fiscal 2011 compared to interest expense associated with our notes payable to Anacomp and Adaptec, which totaled $0.2 million during fiscal 2010. We are no longer a party to these financing agreements.
Other Income (expense), net. During fiscal 2011, we incurred other income (expense), net, of $2.5 million of income compared with $1.0 million of income during fiscal 2010. The increase of $1.5 million, or 150.0%, was primarily due to the receipt of $3.0 million from various institutional investors in consideration for a minority ownership interest in any amounts we receive from litigation awards or settlements arising from our patent infringement lawsuit against BDT, Dell and IBM and our complaint for patent infringement with the United States International Trade Commission against the same defendants. This increase was offset by (i) a decrease of approximately $1.0 million in realized currency exchange gains due to foreign currency fluctuations and (ii) a decrease of $0.5 million related to the prior year liquidation of our auction rate securities (“ARS”).
Provision for (benefit from) Income Taxes. During fiscal 2011, we recognized income tax expense of $0.3 million compared to a benefit from income taxes of $1.8 million in fiscal 2010. The income tax expense in fiscal 2011 primarily related to earnings in our foreign operations. The net benefit in fiscal 2010 primarily related to our net operating loss carry back recognized pursuant to amended Internal Revenue Code Section 172(b)(1)(H).
Liquidity and Capital Resources
At June 30, 2011, we had a cash balance of $10.2 million, compared to $8.9 million at June 30, 2010. In fiscal 2011, we incurred a net loss of $14.5 million. During the third quarter of fiscal 2011, we sold an aggregate of 8,653,045 shares of our common stock and warrants to purchase up to 3,807,331 shares of common stock in a private placement for a total issuance price of approximately $15.3 million and net proceeds of approximately $13.8 million. In August 2011, we entered into a credit facility that provides for an $8.0 million secured revolving loan and may be used to fund our working capital and our general business requirements. Cash management and preservation continue to be a top priority. We expect to incur negative operating cash flows during the remainder of calendar 2011 as we continue to reshape our business model and further improve operational efficiencies.
As of June 30, 2011, we had working capital of $8.7 million, reflecting decreases in current assets and current liabilities of $2.4 million and $8.7 million, respectively, during fiscal 2011. The decrease in current assets is primarily attributable to cash used in operating activities and reduced sales, resulting in lower inventory balances. The decrease in current liabilities is primarily attributable to a $5.6 million decrease in accounts payable and accrued liabilities primarily related to operating activities, a $4.4 million reduction in our current liabilities associated with our non-OEM accounts receivable financing arrangements and a $0.7 million reduction in debt related to the repayment of our note payable to Anacomp. These decreases were offset by a $2.0 million increase in accrued payroll and employee compensation related to a $2.2 million liability recorded for the Stock Appreciation Rights (“SAR”) awards in June 2011 offset by a $0.2 million decrease in accrued payroll related to timing of payment dates.
Management has projected that cash on hand, combined with 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 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 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.
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, 2011 includes an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern.
During fiscal 2011, we used cash in operating activities of $10.9 million, compared to $10.5 million in fiscal 2010. The use of cash during fiscal 2011 was primarily a result of our net loss of $14.5 million offset by overall decreases in operating assets and liabilities. The decreases primarily consisted of (i) a decrease in inventory, (ii) a decrease in accounts payable and accrued liabilities, and (iii) a decrease in accounts receivable due to lower sales.
We used cash in investing activities of $0.5 million during fiscal 2011, compared to $1.7 million cash generated from investing activities in fiscal 2010. During fiscal 2011, we acquired intangible assets consisting of existing technology (acquired technology) for $150,000. During fiscal 2011 and 2010, capital expenditures totaled $0.3 million for each year. Such expenditures were associated with machinery and equipment to support new product introductions. During fiscal 2010, we liquidated our ARS for $2.0 million.
We generated cash from our financing activities of $12.7 million during fiscal 2011, compared to $12.2 million during fiscal 2010. In November 2010, we sold 3,376,000 shares of our common stock to certain institutional investors at $1.25 per share for gross proceeds of $4.2 million and net proceeds of $4.0 million. In March 2011, we sold an aggregate of 8,653,045 shares of our common stock and warrants to purchase up to 3,807,331 shares of common stock in a private placement for a total issuance price of approximately $15.3 million and net proceeds of approximately $13.8 million. During fiscal 2011, we made payments totaling $0.7 million against the Anacomp note, and repayments of $4.4 million for amounts funded under our non-OEM accounts receivable financing agreements. Cash generated from financing activities in fiscal 2010 primarily relates to the sale of 794,659 shares of Series A Convertible Preferred Stock and warrants for a total issuance price of $11.9 million and net proceeds of approximately $10.9 million, and the sale of 2,070,000 shares of our common stock through a public offering of common stock at $2.10 per share resulting in gross proceeds of approximately $4.3 million and net proceeds of approximately $3.7 million, offset by payments under the notes payable to Anacomp and Adaptec, which totaled $2.7 million during fiscal 2010. During fiscal 2010, $0.3 million of cash generated by financing activities related to net funding activity from accounts receivable pledged to MCF and FGI.
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 balance sheet or fully disclosed in the notes to our consolidated financial statements.
Contractual Obligations
The following schedule summarizes our contractual obligations to make future payments at June 30, 2011 (in thousands):
(1) Represents contractual lease obligations under non-cancellable operating leases on our San Diego, California; San Jose, California; Wokingham, England; and Paris, France facilities.
(2) Represents purchase orders for inventory and non-inventory items entered into prior to June 30, 2011, with purchase dates extending beyond July 1, 2011. Some of these purchase obligations may be cancelled.
(3) Liabilities associated with uncertain tax provisions, currently estimated at $0.1 million (including interest) are not included in the table above as we cannot reasonably estimate when, if ever, an amount would be paid to a government agency. Ultimate settlement of these liabilities is dependent on factors outside of our control, such as examinations by each agency and expiration of statutes of limitation for assessment of additional taxes.
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.
Recently Issued Accounting Pronouncements
See Note 1 to our consolidated financial statements.
Item 7A.
Item 7A. 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 fiscal 2011 and 2010 resulted in a loss of $0.5 million for fiscal 2011 and a gain of $0.5 million for fiscal 2010.
Item 8.
Item 8. Financial Statements and Supplementary Data.
Our consolidated financial statements and supplementary data required by this item are set forth at the pages indicated in Item 15(a)(1) and 15(a)(2), respectively.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Not applicable.
Item 9A.
Item 9A. 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(e) and 15d-15(e) under the Exchange Act. 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 annual report.
Internal Control Over Financial Reporting
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over our financial reporting. In order to evaluate the effectiveness of internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act, management has conducted an assessment, including testing, using the criteria in Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Our system of internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Based on our evaluation under the framework in Internal Control-Integrated Framework, our Chief Executive Officer and Chief Financial Officer concluded that our internal control over financial reporting was effective as of June 30, 2011.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions and that the degree of compliance with the policies or procedures may deteriorate.
This annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report on internal control over financial reporting was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this annual report.
This report on internal control over financial reporting shall not be deemed to be filed for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities of that section, and is not incorporated by reference into any of our filings, whether made before or after the date hereof, regardless of any general incorporation language in such filing.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the fiscal year ended June 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information.
Not applicable.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The following table sets forth the name, age, and position of the directors of the Company. The table also sets forth the year in which each director was first elected to the Board. Directors are elected each year, and all directors serve one-year terms. As of September 7, 2011, directors are as follows:
Each of the above-listed committee members served for all of fiscal 2011, except Mr. Shottan and Mr. De Perio and who were appointed to the Board of Directors in February and April 2011, respectively.
During fiscal 2011, Michael Norkus served on the Audit Committee, the Compensation Committee and the Nominating and Governance Committee until his resignation from the Board of Directors and these committees in February 2011.
There are no family relationships between any of the directors or executive officers of our company, and there are no arrangements or understandings between any of the directors and any other person pursuant to which such director was or is selected as a director.
We have a standing audit committee as defined in Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended. The members of the Audit Committee are Robert A. Degan, Nora M. Denzel and Shmuel Shottan.
In addition to being independent under NASDAQ Marketplace Rule 5605(a)(2), all members of the Audit Committee must meet the additional independence standards for audit committee members set forth in Rule 10A-3(b)(1) of the Exchange Act and NASDAQ Marketplace Rule 5605(c)(2)(A). The Board of Directors has determined that each of Ms. Denzel and Mr. Degan qualifies as an audit committee financial expert as defined in Item 407(d)(5) of Regulation S-K under the Exchange Act.
Biographical Information of Directors
Robert A. Degan has been a private investor since January 2000. From November 1998 to December 1999, Mr. Degan served as General Manager of the Enhanced Services & Migration Business Unit (formerly, Summa Four, Inc.) of Cisco Systems, Inc., an Internet networking company. From July 1998 to November 1998, Mr. Degan was Chairman, President and Chief Executive Officer of Summa Four, Inc., and from January 1997 to July 1998, he served as its President and Chief Executive Officer and as a director. Mr. Degan retired from the board of directors of CaminoSoft Corp. in December 2007, FlexiInternational Software, Inc. in July 2006 and Gensym Corporation in May 2005. Mr. Degan was formerly on the research staff at Massachusetts Institute of
Technology. Mr. Degan’s significant experience as a director and CEO of Summa Four, along with his experience from his career in related industries and as a board member of other public technology companies, provides the Board of Directors with financial and operational expertise and analytical skills relevant to the storage industry.
Nora M. Denzel has served as the Senior Vice President of payroll services at Intuit, Inc., a provider of business and financial management software, since February 2008. From February 2006 to January 2008, Ms. Denzel served as an independent consultant to technology companies. From August 2000 to February 2006, she held several executive level positions in technology with HP, a global manufacturer of computing, communications and measurement products and services, including: Senior Vice President/General Manager Software Global Business Unit (May 2002 to February 2006); Senior Vice President Adaptive Enterprise (June 2004 to May 2005); and Vice President Storage Organization (August 2000 to May 2002). Prior to HP, she served as Senior Vice President of Product Operations from February 1997 to August 2000 at Legato Systems, Inc. Her initial corporate experiences were at IBM, where she began her career as a software engineer and then served in several marketing, engineering, and executive level positions, including the business line manager of IBM’s portfolio of storage management software products. Ms. Denzel also serves on the board and advisory boards of several privately-held organizations. Ms. Denzel’s current experience at Intuit and prior experience at HP, together with her prior consulting work for technology companies, provides her with valuable knowledge of technology companies and of companies with a global presence. She is able to provide the Board of Directors with current working knowledge of business and economic trends that affect the storage industry.
Joseph A. De Perio has served as a Portfolio Manager, Activist Investments and Private Equity of Clinton Group, Inc. since October 2010. From December 2007 to September 2010, Mr. De Perio was a Vice President at Millennium Management, L.L.C. From June 2006 to December 2007, Mr. De Perio served as Vice President, Activist Investments and Long/Short Equity and Private Equity of the Clinton Group. Mr. De Perio was a Private Equity Associate at Trimaran Capital Partners from May 2004 to June 2006 and an analyst and associate in the mergers and acquisitions department at CIBC World Markets from July 2000 to May 2004. Mr. De Perio has been a board member of Viking Systems, Inc., a developer, manufacturer and marketer of visualization solutions for complex, minimally invasive surgery, since June 2011. Mr. De Perio was selected as a director of the Company pursuant to the terms of a Stock Purchase Agreement between the Company and Clinton Magnolia Master Fund, Ltd.
Eric L. Kelly has served as our Chief Executive Officer since January 2009, our President since January 2010 and a member of our Board of Directors since November 2007. From April 2007 to January 2009, Mr. Kelly served as President of Silicon Valley Management Partners Inc., a management consulting and M&A advisory firm, which he co-founded in April 2007. From July 2004 to August 2006, Mr. Kelly was Vice President and General Manager of storage systems solutions at Adaptec, Inc.. From August 2002 to July 2004, he served as President and CEO of Snap Appliance, Inc., which was acquired by Adaptec in July 2004. The Snap division of Adaptec was acquired by us in June 2008. From March 2000 to June 2002, Mr. Kelly served as President, Network Systems Division of Maxtor Corporation. Prior to Maxtor, he served as the Chief Operating Officer of Isyndicate, Inc. From July 1998 to January 2000 he was the Enterprise Vice President for Dell Computer Corporation. From 1980 to 1998 he served in executive or managerial roles with Netpower Incorporated, Diamond Multimedia Systems Incorporated, Conner Peripherals Incorporated, Marq Technologies Incorporated and IBM. Mr. Kelly’s position as President and Chief Executive Officer of the Company provides the Board of Directors with unique insight and direct access to strategic and operational information about the Company. His significant experience in the storage industry, including his involvement in Snap Appliance, allows him to draw on experiences and knowledge from across the storage industry and enables him to identify best practices and strategic initiatives for the Company.
Scott McClendon has served as Executive Chairman of the Board since May 2011, and has served as Chairman of the Board since March 2001. From November 2006 to August 2007, Mr. McClendon served as our interim President and Chief Executive Officer and as our President and Chief Executive Officer from October 1991 to March 2001, when he was named our Chairman of the Board, and continued as an executive officer and employee until June 2001. Mr. McClendon has been a business consultant since June 2001. Mr. McClendon was
employed by HP for over 32 years in various positions in engineering, manufacturing, sales and marketing. He last served as the general manager of the San Diego Technical Graphics Division and site manager of HP in San Diego, California. Mr. McClendon is Chairman and a director of Procera Networks, Inc., a network equipment company. Mr. McClendon’s significant experience with HP, his prior tenure as our President and Chief Executive Office and current experience as Chairman and director of Procera provide him with a unique set of managerial, operational and strategic skills, which provides the Board of Directors insights into the Company’s challenges, opportunities and operations.
Shmuel Shottan has served as Chief Technology Officer of BlueArc Corporation, a supplier of enterprise NAS since September 2001 and Senior Vice President of Engineering of BlueArc from September 2001 to April 2006. Prior to BlueArc, Mr. Shottan was a General Partner of Quantum Technology Ventures, a $100 million corporate venture fund. From 1995 to March 1999, Mr. Shottan served as Senior Vice President and Chief Technical Officer for Snap Appliance which was sold to Quantum Corporation in March 1999. From March 1999 to February 2000, Mr. Shottan served as Senior Vice President of Engineering and Chief Strategy Officer for the Snap Division of Quantum. Prior to Snap, Mr. Shottan served as Vice President of Engineering and Chief Technical Officer of Parallan Computer, Inc. from 1993 to 1995. Before joining Parallan, Mr. Shottan held engineering positions at various companies since 1980. Mr. Shottan’s significant experience at BlueArc and other technology companies provides the Board of Directors with valuable insight directly related to technology developments in the storage industry. His engineering background and storage experience makes him particularly well suited to understanding our technology and allows him to provide valuable perspective to the Board of Directors on new product initiatives.
Executive Officers of the Registrant
The executive officers, their ages, positions held and biographical information as of September 7, 2011, are as follows:
Name
Age
Position Held
Eric L. Kelly
President and Chief Executive Officer
Geoff Barrall
Vice President, Engineering and Chief Technology Officer
Kurt L. Kalbfleisch
Vice President of Finance, Chief Financial Officer and Secretary
Jillian Mansolf
Vice President of Worldwide Sales and Marketing
Eric L. Kelly is our President and Chief Executive Officer and a director. See the description of his business experience above under Biographical Information of Directors.
Geoff Barrall, PhD, joined us as our Chief Technology Officer and Vice President of Engineering in February 2010. Prior to joining us, Dr. Barrall served as the Chief Executive Officer of Data Robotics, Inc. from April 2005 to December 2010, the maker of the world’s first data storage robot and a company he founded in 2005. Dr. Barrall has founded five companies including BlueArc, a supplier of enterprise NAS, as well as several information technology and consulting services firms. Dr. Barrall is a current member of the board of directors of Nexsan Corporation, a provider of disk-based storage systems. In addition to his roles at Data Robotics and BlueArc, he also served on the board of directors of Tacit Networks, Inc. and was an executive consultant to the senior team at Brocade Communications Systems, Inc. His storage experience also includes sitting on the boards of advisors for Data Domain, Inc. and NeoPath Networks, Inc. As a designer, Dr. Barrall has more than a dozen data storage-related patents to his credit.
Kurt L. Kalbfleisch has served as our Chief Financial Officer since February 2008, as our Vice President of Finance since July 2007, and as our Secretary since October 2009. He served as our Interim Chief Financial Officer from August 2007 to February 2008. Mr. Kalbfleisch has been an employee of our company since December 1993 and has served in key management roles in our finance department during that time. Prior to joining our company, Mr. Kalbfleisch worked as a manufacturing budget analyst for McDonnell Douglas Corporation, a major aerospace manufacturer and defense contractor, from July 1989 to December 1993.
Jillian Mansolf has served as our Vice President of Worldwide Sales and Marketing since joining us in July 2009. From August 2007 to June 2009, Ms. Mansolf served as Senior Vice President of Worldwide Sales and Marketing for Data Robotics-The Makers of Drobo. From May 2006 to July 2007 she was Vice President of Worldwide Marketing & Product Management for Motion Computing, Inc., a creator of tablet personal computers. From November 2002 to July 2004, Ms. Mansolf was Vice President of Worldwide Sales and Channel Marketing for Snap Appliance, Inc., a designer and manufacturer of NAS and SAN software and hardware products through the acquisition by Adaptec in July 2004. She then served in such role at Adaptec until March 2005. From December 2001 to November 2002 she was Vice President of Worldwide Sales and Marketing for Maxtor Corporation, a manufacturer of hard, external and portable drives. Prior to that time, Ms. Mansolf held key positions for Dell from 1997 to 2001 serving first as a Director of Marketing for Workstation Products and Services from June 1997 to April 1998 and later as an Area Vice President for the Large Corporate Accounts Division from May 1998 to December 2001. Prior to her tenure with Dell, she held sales management positions with Netpower Incorporated and Tandon Computer Corporation.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our directors, executive officers and beneficial owners of more than 10% of our common stock to file reports of ownership and changes in ownership with the SEC. Based solely on copies of these reports provided to us and written representations that no other reports were required, we believe that these persons met all of the applicable Section 16(a) filing requirements during fiscal 2011, with the exception of one late Form 4 filing related to one transaction for each of Ms. Mansolf and Messrs. Kelly, Kalbfleisch and Barrall.
Code of Business Conduct and Ethics
We have adopted the Overland Storage, Inc. Code of Business Conduct and Ethics, which applies to our directors, executive officers and employees. A copy of the Code of Business Conduct and Ethics is publicly available on our website at www.overlandstorage.com. If we make any substantive amendments to the Code of Business Conduct and Ethics or grant any waiver from a provision of the code applying to our principal executive officer or our principal financial or accounting officer, we will disclose the nature of such amendment or waiver on our website or in a report on Form 8-K.
Item 11.
Item 11. Executive Compensation.
Summary Compensation Table for Fiscal Year 2011
The following table summarizes the total compensation paid to or earned by our principal executive officer and our two other most highly compensated executive officers (referred to as our “named executive officers”) for the Company’s 2011 and 2010 fiscal years.
(1) The amounts shown in the “Bonus” column represent discretionary bonuses awarded by the Compensation Committee for the fiscal year.
(2) The amounts shown in these columns do not reflect compensation actually received by the named executive officer. These amounts represent the fair value on the grant date of the awards granted to these officers during fiscal 2011 and 2010. These values have been determined under the principles used to calculate the grant date fair value of equity awards for purposes of our financial statements. For a more detailed discussion on the valuation model and assumptions used to calculate the fair value of these awards in each fiscal year, see Note 8 to the consolidated financial statements included herein.
(3) The amounts shown in the “Non-Equity Incentive Plan” column represent bonuses awarded for fiscal 2011 pursuant to the terms of the Company’s Executive Bonus Plan and as established by the Compensation Committee for the fiscal year.
(4) The amounts shown in this column for each named executive officer reflect premiums we paid on the officer’s behalf for health insurance, term life insurance and certain out-of-pocket medical and wellness expenses we paid on the officer’s behalf.
(5) This amount includes sales commissions of $94,490 earned in fiscal 2011.
(6) This amount includes sales commissions of $82,509 earned in fiscal 2010.
Outstanding Equity Awards at End of Fiscal Year 2011
The following table provides information about the holdings of stock and option awards by our named executive officers outstanding at the end of fiscal year 2011.
(1) This award was originally granted as a stock option and was amended and reissued on June 29, 2011 as a stock appreciation rights (“SAR”) award. The purpose of the amendment and reissuance is to provide that, upon exercise, the SAR will be settled in cash or stock, at the discretion of the Company. No other terms of the award changed.
(2) This option vests in equal monthly installments over a thirty-six month period following the grant date.
(3) This SAR award vests in equal monthly installments over a thirty-six month period following the grant date.
(4) This stock unit award vests in full on October 8, 2011.
(5) This stock unit award vests in six equal installments, with the first installment vesting six months after July 15, 2011 and an additional installment vesting at the end of each six-month period thereafter.
(6) Amounts listed represent the aggregate market value of the unvested restricted stock unit awards held by the named executive officers based on the closing price of a share of our common stock of $2.75 on the last trading day of fiscal 2011.
(7) Options granted before December 2009 are reported in the table above as adjusted to reflect our December 8, 2009 one-for-three reverse stock split.
Employment, Severance and Change in Control Agreements
Eric L. Kelly. We entered into an employment agreement with Mr. Kelly, our President and Chief Executive Officer, on June 24, 2009, which was amended and restated on June 29, 2011 (the “Kelly Agreement”). The Kelly Agreement provides for Mr. Kelly to earn a base salary of $400,000, which has been his base salary since his appointment as Chief Executive Officer on January 27, 2009. Mr. Kelly is eligible to receive an annual bonus based upon the achievement of financial and management objectives reasonably established by the Board of Directors or an authorized committee of the Board of Directors. His annual bonus target is 100% of the greater of $400,000 or his base salary as of the end of the applicable fiscal quarter or year in which the bonus is earned, and he has the opportunity to earn an annual bonus of up to 150% of the target bonus. If the Company terminates Mr. Kelly’s employment without cause or he resigns for good reason, or if he dies or becomes disabled, before the end of a fiscal quarter or year, he will be eligible to receive a prorated amount of the target bonus for the fiscal quarter or year in which his employment terminates. For purposes of the Kelly Agreement, the terms “cause” and “good reason” are defined in the agreement, and a termination of employment by the Company without cause includes a termination by the Company at the end of the term then in effect. To the extent that any travel, lodging or auto expense reimbursements are taxable to Mr. Kelly, the Company will provide him with a tax restoration payment so that he will be put in the same after-tax position as if such reimbursements had not been subject to tax. The Kelly Agreement has a three-year term and automatically renews for additional one-year terms. The Company may unilaterally modify Mr. Kelly’s cash compensation at any time, subject to Mr. Kelly’s right to terminate his employment for good reason.
The Kelly Agreement also provides that if the Company terminates Mr. Kelly’s employment without cause or if Mr. Kelly resigns from employment for good reason, then the Company will be obligated to pay him an aggregate severance payment equal to the sum of (i) 150% of the greater of his base salary then in effect or his original base salary, (ii) a portion of his target bonus prorated based on the number of days he was employed during the period on which the target bonus is based, (iii) an amount equal to the premiums he would be required to pay to continue health insurance coverage under the Company’s insurance plans for himself and his eligible dependents under COBRA for 18 months following the date of his termination, and (iv) an amount necessary for him to continue life, accident, medical and dental insurance benefits for himself and his eligible dependents in amounts substantially similar to those which he received immediately prior to the date of his termination for a period of 18 months following his termination (reduced by the amount of any reimbursement for COBRA premiums as described in clause (iii) above). The severance payment will be made in equal monthly installments over 18 months in accordance with the Company’s regular payroll practices. In addition, Mr. Kelly will be entitled to accelerated vesting for any unvested portion of his then outstanding stock options and any other equity-based awards that would otherwise have vested during the 12-month period following his termination. In the case of vested stock options, he will be permitted to exercise such options in whole or in part at any time within one year of the date of his termination, subject to earlier termination upon the expiration of the maximum term of the applicable options under the applicable plan or upon a change in control. The severance benefits described above are contingent upon Mr. Kelly providing the Company with a general release of all claims.
Kurt L. Kalbfleisch. We entered into an employment and severance agreement with Mr. Kalbfleisch, our Vice President of Finance, Chief Financial Officer and Corporate Secretary on September 29, 2009, which was amended and restated on June 29, 2011 (the “Kalbfleisch Agreement”). The Kalbfleisch Agreement provides for
Mr. Kalbfleisch to earn a base salary of $266,000 which was effective in May 2011. Prior to that time Mr. Kalbfleisch earned a base salary of $240,000. Mr. Kalbfleisch is eligible to receive an annual bonus based upon the achievement of financial and management objectives reasonably established by the Board of Directors or an authorized committee of the Board of Directors.
If the Company terminates Mr. Kalbfleisch’s employment without cause or he resigns his employment for good reason before the end of a fiscal quarter or year, he will be eligible to receive a prorated amount of the target bonus for the fiscal quarter or year in which his employment terminates. For purposes of the Kalbfleisch Agreement, the terms “cause” and “good reason” are defined in the agreement, and a termination of employment by the Company without cause includes a termination by the Company at the end of the term then in effect. The Kalbfleisch Agreement has a three-year term and automatically renews for additional one-year terms. The Company may unilaterally modify Mr. Kalbfleisch’s cash compensation at any time, subject to Mr. Kalbfleisch’s right to terminate his employment for good reason.
The Kalbfleisch Agreement provides that if the Company terminates Mr. Kalbfleisch’s employment without cause or if Mr. Kalbfleisch resigns from employment for good reason, the Company will be obligated to pay him an aggregate severance payment equal to the sum of (i) the greater of his annual base salary then in effect or his original base salary of $266,000, (ii) a portion of any target bonus prorated based on the number of days he was employed during the period on which the target bonus is based, (iii) an amount equal to the premiums he would be required to pay to continue health insurance coverage under the Company’s insurance plans for himself and his eligible dependents under COBRA for 12 months following the date of his termination, and (iv) an amount necessary for him to continue life, accident, medical and dental insurance benefits for himself and his eligible dependents in amounts substantially similar to those which he received immediately prior to the date of his termination for a period of 12 months following his termination (reduced by the amount of any reimbursement for COBRA premiums as described in clause (iii) above). The severance payment will be made in equal monthly installments over the 12 months following termination of employment. In addition, Mr. Kalbfleisch will be entitled to accelerated vesting for any unvested portion of his then outstanding stock options and any other equity-based awards that would otherwise have vested during the 12-month period following his termination. In the case of vested stock options, he will be permitted to exercise such options in whole or in part at any time within one year of the date of his termination, subject to earlier termination upon the expiration of the maximum term of the applicable options under the applicable plan or upon a change in control. If such a termination of employment occurs within two years following a change in control of the Company, then the severance benefits will generally be the same as described above except that the cash severance will paid in a single lump sum on the sixtieth day after termination of employment and Mr. Kalbfleisch will be entitled to accelerated vesting for any unvested portion of his then outstanding stock options and any other equity-based awards. The severance benefits described above are contingent upon Mr. Kalbfleisch providing the Company with a general release of all claims.
Jillian Mansolf. As our Vice President of Worldwide Sales and Marketing, Ms. Mansolf is an at-will employee and her employment may be terminated by us for any reason, with or without notice. Prior to May 2011, Ms. Mansolf earned an annual salary of $238,000, was eligible for quarterly commission earnings of up to $25,500 for a total compensation package equal up to $340,000 annually. Ms. Mansolf currently earns an annual salary of $250,000 and is eligible for quarterly commission earnings of $25,500, for a total annual compensation package of up to $352,000. Ms. Mansolf is also eligible to receive an annual bonus based upon the achievement of financial and management objectives reasonably established by the Board of Directors or an authorized committee of the Board of Directors. Ms. Mansolf’s offer letter provides that if her employment is terminated by the Company without cause she is eligible to receive severance benefits consisting of six months of base salary plus earned commissions and twelve months of continued health benefits coverage.
Retention Agreements. The following describes the severance arrangements we have with our named executive officers in the case of a change of control. For these purposes, the terms “cause,” “good reason” and “change in control” are defined in each executive’s retention agreement.
Eric L. Kelly. On June 24, 2009, we entered into a retention agreement with Mr. Kelly, which provides that he will receive a lump sum severance payment if, within 60 days before or two years following a change of control of the Company, his employment is terminated by the Company without cause or he resigns for good reason. The severance payment will equal 150% of the sum of Mr. Kelly’s base salary at the time of the consummation of the change of control or termination date or $400,000, whichever is higher, plus any annual target bonus. The retention agreement provides that (i) if Mr. Kelly elects to continue insurance coverage as provided by COBRA, we will reimburse him for an amount equal to the premiums he would be required to pay to continue health insurance coverage under our company’s insurance plans for himself and his eligible dependents under COBRA for 18 months following the date of his termination, and (ii) we will reimburse him for an amount necessary for him to continue life, accident, medical and dental insurance benefits for himself and his eligible dependents in amounts substantially similar to those which he received immediately prior to the date of his termination for a period of 18 months following his termination (reduced by the amount of any reimbursements for COBRA premiums as described in clause (i) above). We are required to reimburse Mr. Kelly for the estimated costs of these benefits in one lump sum payment on his termination date. In addition, Mr. Kelly will be entitled to accelerated vesting for any unvested portion of his then outstanding stock options and any other equity-based awards. In the case of vested stock options, he will be permitted to exercise such options in whole or in part at any time within one year of the date of his termination, subject to earlier termination upon the expiration of the maximum term of the applicable options under the applicable plan or upon a change of control. The consideration payable to Mr. Kelly under the retention agreement is contingent upon him providing us a general release of claims.
The retention agreement provides limited protection to Mr. Kelly from the possible imposition of excise taxes under the Internal Revenue Code and any corresponding state tax provisions. If there is a change of control of our company on or before December 31, 2011, and if, as a result, Mr. Kelly becomes subject to a federal or state golden parachute excise tax, we are required to provide Mr. Kelly an excise tax restoration payment so that Mr. Kelly will be in the same after-tax position as if the excise tax was not imposed. The amount of the excise tax restoration payment may not exceed $600,000 for a change of control that occurs in 2011. No excise tax payment will be owed to Mr. Kelly with respect to a change of control that occurs after December 31, 2011.
We agreed to the excise tax restoration provisions of Mr. Kelly’s retention agreement in large part because Mr. Kelly’s compensation for service as a director of our company prior to his service as our Chief Executive Officer is taken into account for computing the “base amount” for calculation of excess parachute payments. In general, Mr. Kelly will be subject to excise taxes for compensation contingent upon a change of control if the amount of such compensation, which includes amounts attributed to the acceleration of stock options, equals or exceeds three times his base amount. For any change of control of our company that occurs after 2009, Mr. Kelly’s prior compensation as a director will be averaged with his compensation as our Chief Executive Officer, and such averaging would result in him having a base amount which is substantially less than his current compensation level. Our Compensation Committee determined that providing Mr. Kelly with the limited excise tax restoration benefit described above was essential to ensuring that the incentive compensation that Mr. Kelly may earn will fulfill its intended purpose.
Jillian Mansolf. We entered into a retention agreement with Ms. Mansolf effective July 13, 2009. This agreement generally provides that Ms. Mansolf will receive a lump sum severance payment if, within two years of the consummation of a change of control of our company, her employment is terminated without cause or she resigns with good reason. These severance payments are based on Ms. Mansolf’s base salary and target commission at the time of the consummation of the change of control or the termination date, whichever is higher, plus her target bonus for the year before the consummation of the change of control. The agreement provides that, upon a qualifying termination in connection with a change of control, Ms. Mansolf is entitled to receive an amount equal to her annual base salary, target commissions plus target bonus. If any portion of any payment under the retention agreements would constitute an “excess parachute payment” within the meaning of Section 280G of the Internal Revenue Code, then that payment will be reduced to an amount that is one dollar less than the threshold for triggering the tax imposed by Section 4999 of the Internal Revenue Code. The
agreement also provides that if Ms. Mansolf elects to continue health insurance coverage as provided by COBRA, we would reimburse her for the amount of the premiums incurred by her for 12 months following the termination date.
Equity Awards Granted in Fiscal 2011
The “Stock Awards” column of the “Summary Compensation Table for Fiscal Year 2011” above reflects the grant-date fair value (as determined for accounting purposes) of restricted stock unit (“RSU”) awards granted to the named executive officers during fiscal 2011. Each of these awards was granted under our 2009 Equity Incentive Plan (“2009 Plan”). The 2009 Plan is administered by the Compensation Committee, which has authority to interpret the plan provisions and make all required determinations under the plan. Awards granted under the 2009 Plan are generally only transferable to a beneficiary of a named executive officer upon his or her death. However, the Compensation Committee may establish procedures for the transfer of awards to other persons or entities, provided that such transfers comply with applicable securities laws and, with limited exceptions, are not made for value.
Each RSU represents a contractual right to receive one share of our common stock upon vesting of the unit. The number of RSUs subject to each award granted to the named executive officers during fiscal 2011 and the vesting schedules for these awards are reported in the “Outstanding Equity Awards at End of Fiscal Year 2011” table above. In each case, vesting of the RSUs is generally contingent on the executive’s continued employment with the Company through the vesting date, subject to accelerated vesting on certain terminations of employment under the employment and retention agreements described above. The RSUs will vest in full in the event of the executive’s death or disability. In addition, with respect to the RSUs granted to the named executive officers in June 2011, if the executive’s employment is terminated by the Company without cause or by the executive for good reason, the RSUs subject to the award will vest pro-rata based on the number of months of the executive’s employment through the date of termination. If, however, a change in control of the Company occurs and the executive’s employment is terminated by the Company without cause or by the executive for good reason within 60 days before or two years after the change in control, the units will fully vest. The named executive officers do not have the right to vote or dispose of the RSUs.
Executive Bonus Plan
In September 2010, the Compensation Committee approved an Executive Bonus Plan (“Bonus Plan”), which provides bonus opportunities for selected employees of the Company, including each of the Company’s executive officers. Each participant in the Bonus Plan is assigned a target bonus percentage that is expressed as a percentage of the participant’s base salary for the applicable bonus period (“Bonus Period”). Bonuses are payable based upon the Company’s attainment of one or more performance goal(s) for revenue, gross profit, operating income, operating expenses and/or earnings per share as approved by the Compensation Committee for the applicable Bonus Period. The Compensation Committee may establish minimum, target and/or maximum performance goals for one or more of these performance metrics. The Compensation Committee establishes target bonus amounts for each Bonus Period and also establishes the percentage of the total bonus that will be determined based on Company performance and the percentage of the total bonus that will be determined based on individual performance and, as applicable, the performance goals that will be used to determine a participant’s individual performance for the Bonus Period. The Bonus Plan is effective for fiscal 2011 and future fiscal years unless and until otherwise determined by the Compensation Committee.
For fiscal 2011, the Compensation Committee established performance goals for the Company’s revenue growth, gross operating profit and net income for the first half of fiscal 2011, and for the Company’s revenue growth and operating expenses for the second half of fiscal 2011. The named executive officers’ target bonuses for fiscal 2011 (expressed as a percentage of the executive’s annual base salary) were as follows: Mr. Kelly-100%; Mr. Kalbfleisch-50%; and Ms. Mansolf-10%. (Ms. Mansolf’s participation in the Bonus Plan is in addition to her opportunity to be awarded sales commissions under her employment agreement as described above.) The bonuses awarded to each named executive officer under the Bonus Plan for fiscal 2011 are reported in the Non-Equity Incentive Plan Compensation column of the “Summary Compensation Table for Fiscal 2011” above.
401(k) Plan
In February 1994, we adopted our On-Track 401(k) Savings Plan that covers all of our eligible employees who are at least 21 years old. Our 401(k) plan is intended to qualify under Section 401 of the Internal Revenue Code so that employee contributions and income earned on such contributions are not taxable to employees until withdrawn. Employees may elect to defer up to 60% of their eligible compensation (not to exceed the statutorily prescribed annual limit) in the form of elective deferral contributions to our 401(k) plan. However, our named executive officers qualify as highly compensated employees and may only elect to defer up to 8.5% of their eligible compensation (not to exceed the statutorily prescribed annual limit) in the form of elective deferral contributions to our 401(k) plan. Our 401(k) plan also has a catch up contribution feature for employees aged 50 or older (including those who qualify as highly compensated employees) who can defer amounts over the statutory limit that applies to all other employees. In October 2008, we suspended the matching by the Company of contributions made by participants under the plan.
Director Compensation Table
The following table provides compensation information for each individual who served on our Board of Directors during fiscal 2011 and was not employed by us or one of our subsidiaries (“non-employee directors”). See “Summary Compensation Table for Fiscal 2011” above for information related to the compensation of Mr. Kelly who was a director in fiscal 2011 and who also served as an executive officer during the fiscal year.
(1) The amounts shown in this column do not reflect compensation actually received by the non-employee director. These amounts represent the fair value on the grant date of the awards granted to the directors during fiscal 2011. These values have been determined under the principles used to calculate the grant date fair value of equity awards for purposes of our financial statements. For a more detailed discussion on the valuation model and assumptions used to calculate the fair value of these awards, see Note 8 to the consolidated financial statements.
(2) At fiscal 2011 end, the number of shares subject to outstanding option awards for each director were as follows: Mr. De Perio-0; Mr. Degan-63,088; Ms. Denzel-34,422; Mr. McClendon-70,421; Mr. Norkus-22,422; and Mr. Shottan-0. The number of shares subject to outstanding stock awards were as follows: Mr. De Perio-22,728; Mr. Degan-22,728; Ms. Denzel-22,728; Mr. McClendon-701,771; Mr. Norkus-0; and Mr. Shottan-22,728.
(3) Mr. De Perio was appointed to the Board of Directors in April 2011.
(4) Mr. Shottan was appointed to the Board of Directors in February 2011.
(5) Mr. Norkus resigned from the Board of Directors in February 2011.
Overview of Non-Employee Director Compensation and Procedures
We compensate non-employee directors through cash and equity-based compensation. Each non-employee director receives an annual retainer of $40,000 payable quarterly. The Executive Chairman of the Board of Directors receives an additional $10,000 retainer annually. No additional fees are paid for attendance at meetings of the Board of Directors or committees. We also reimburse expenses incurred by non-employee directors to attend meetings.
In addition to the above fees, each non-employee director receives an annual grant of RSUs with a value of $50,000 (based on the value of our common stock on the grant date). These RSU awards generally vest one year from the grant date and are payable upon vesting in shares of our common stock on a one-for-one basis. The annual RSU awards replace the annual grants of options to non-employee directors provided under the director compensation program implemented in January 2010.
In May 2011, Ms. Denzel and Messers. De Perio, Degan, McClendon, and Shottan each received an award of 22,728 RSUs which will vest in full on June 14, 2012.
In May 2011, Mr. McClendon was appointed Executive Chairman of the Board of Directors. Prior to May 2011, Mr. McClendon served as the Chairman of the Board. In June 2011, at the same time grants of RSUs were made to each of the named executive officers as described above, Mr. McClendon received an award of 679,043 RSUs in connection with his duties as Executive Chairman. The RSU award vests in six equal installments, with the first installment vesting six months after July 15, 2011 and an additional installment vesting at the end of each six-month period thereafter, and would vest in full in the event of a change in control of the Company or Mr. McClendon’s death or disability. The RSUs may also vest on a pro-rata basis upon certain terminations of Mr. McClendon’s service on the Board of Directors.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The following table sets forth certain information regarding the beneficial ownership of Common Stock of the Company as of September 7, 2011 (except as otherwise indicated) by each person who is known by us to own more than 5% of our shares of common stock, each named executive officer, each director and all of our directors and executive officers as a group.
Unless otherwise indicated in the footnotes to this table and subject to community property laws where applicable, we believe that each of the shareholders named in this table has sole voting and investment power with respect to the shares indicated as beneficially owned.
* Less than 1%
+ Except as otherwise indicated, the address for each beneficial owner is 9112 Spectrum Center Boulevard, San Diego, CA, 92123.
(1) With respect to 5% shareholders, includes shares of common stock which could be acquired upon exercise of outstanding warrants. See footnotes (3), (4), (6) and (12) for a description of shares which could be acquired upon exercise of outstanding warrants by each of Special Situations Fund, Clinton Group, Inc., Stephens Investment Management LLC and Columbus Capital Management, LLC, respectively. With respect to executive officers and directors, includes shares of common stock which could be acquired upon exercise of stock options which are either currently vested and exercisable or will vest and become exercisable within 60 days of September 7, 2011, with respect to Ms. Mansolf and Messrs. Kelly and McClendon, shares of common stock which could be acquired upon exercise of outstanding warrants within 60 days of September 7, 2011, and with respect to Ms. Mansolf and Messrs. Kelly and Kalbfleisch, shares of common stock which will be issued upon the vesting of stock units within 60 days of September 7, 2011.
(2) Based on 23,068,649 shares of common stock outstanding on September 7, 2011 and calculated in accordance with Rule 13d-3 promulgated under the Exchange Act.
(3) According to a Form 4 filed on July 14, 2011, the number of shares of common stock currently owned (“Shares”) and the number of shares of common stock acquirable within 60 days pursuant to warrants (“Warrant Shares”) includes 1,312,798 Shares and 2,457,092 Warrant Shares held directly by Special Situations Fund III Q.P., L.P., 938,752 Shares and 1,755,064 Warrant Shares held directly by Special Situations Private Equity Fund, L.P., 131,437 Shares and 245,708 Warrant Shares held directly by Special Situations Technology Fund, L.P. and 807,412 Shares and 1,509,356 Warrant Shares held directly by Special Situations Technology Fund II, L.P. MGP Advisors Limited (“MGP”) is the general partner of the Special Situations Fund III, QP, L.P. AWM Investment Company, Inc. (“AWM”) is the general partner of MGP and the investment adviser to the Special Situations Fund III, QP, L.P., the Special Situations Technology Fund, L.P., the Special Situations Technology Fund II, L.P. and the Special Situations Private Equity Fund, L.P. Austin W. Marxe and David M. Greenhouse are the principal owners of MGP and AWM. Through their control of MGP and AWM, Messrs. Marxe and Greenhouse share voting and investment control over the portfolio securities of each of the funds listed above.
(4) The number of Shares and the number of Warrant Shares include 2,832,861 Shares and 1,246,458 Warrant Shares held directly by Clinton Magnolia Master Fund, Ltd. (“CMAG”) Clinton Group, Inc. (“CGI”) is the investment manager of CMAG and consequently has voting control and investment discretion over securities held by CMAG. CGI and George Hall, as chief investment officer and president of CGI, may be deemed to beneficially own any securities owned by CGI and CMAG. Each of CGI and Mr. Hall disclaim beneficial ownership of these securities.
(5) Based on the Schedule 13G filed with the SEC on April 7, 2011, Marathon Capital Management, LLC has sole voting power with respect to 328,000 shares and sole disposal power with respect to 3,007,836 shares.
(6) Based on the Schedule 13G filed with the SEC on February 11, 2011, the number of Shares include warrants for the purchase of 351,011 shares of common stock held directly by Orphan Fund, L.P. (“Orphan Fund”) and warrants for the purchase of 526,520 shares of common stock held directly by Stephens Industry II, L.P. (“Industry Fund”). Stephens Investment Management, LLC (“SIM”) serves as general partner and investment manager for Orphan Fund and Industry Fund. SIM and Paul Stephens, Brad Stephens and Bart Stephens, as managing members and owners of SIM, may be deemed to beneficially own the securities owned by Orphan Fund and Industry Fund, insofar as they may be deemed to have the power to direct the voting or disposition of such securities. Each of SIM and Messrs. Stephens disclaim beneficial ownership as to such securities, except to the extent of its or his pecuniary interest therein.
(7) Includes 333 shares of common stock held by Mr. Degan’s wife.
(8) Includes 49,309 shares of common stock owned by Mr. Kelly through his family trust.
(9) Represents shares of common stock owned by Ms. Mansolf through her family trust.
(10) Represents 147,297 shares of common stock owned by Mr. McClendon through his family trust, 33,333 shares through his self-directed IRA and 333 shares held by his wife.
(11) Mr. De Perio was elected to our Board of Directors pursuant to the terms of a Stock Purchase Agreement between the Company and CMAG and is the nominee of, and is employed by, CGI. CGI is the investment manager of CMAG. Pursuant to the Purchase Agreement, CMAG acquired 2,832,861 shares of common stock and warrants exercisable to purchase 1,246,458 shares of common stock for total consideration of $5.0 million.
(12) Based on the Schedule 13G filed with the SEC on June 9, 2011, the number of shares beneficially held include 1,602,120 shares held by Columbus Capital Partners, L.P. (“CCP”) and 202,180 shares held by Columbus Capital Offshore Fund, Ltd. (“CCOF”). These shares include warrants to purchase 235,620 shares held by CCP and warrants to purchase 28,380 shares held by CCOF. Columbus Capital Management, LLC (“CCM”) is the general partner to CCP and the investment manager to CCOF. CCM has shared voting and dispositive power with Matthew Ockner, the managing member of CCM.
We are aware of no arrangements, including any pledge by any person of our common stock, the operation of which may at a subsequent date result in a change of control of our company.
Equity Compensation Plan Information
The following table provides information about our equity compensation plans as of the last day of fiscal 2011.
(1) Of the aggregate number of shares that remained available for future issuance reported in column (c), 2,013,034 were available under the 2009 Plan and 755,062 were available under the 2006 Employee Stock Purchase Plan. The 2009 Plan permits the granting of the following types of incentive awards: stock options, stock appreciation rights, restricted shares, and stock units. Subject to any accelerated vesting that may apply in the circumstances, the unvested portion of a named executive officer’s outstanding awards will immediately terminate upon a termination of the named executive officer’s employment.
(2) These figures represent options to purchase 98 shares of our common stock granted under our 2001 Supplemental Stock Option Plan (the “2001 Plan”) and options to purchase 501,712 shares of our common stock granted to certain employees (including Ms. Mansolf) as an inducement to their commencing employment with our company (the “Inducement Options”). The 2001 Plan is administered by the Compensation Committee and provides for grants of stock options to employees and consultants who are not officers or directors of our company. Our ability to grant new awards under the 2001 Plan terminated in November 2003. The Inducement Options were not granted under a plan and are administered by the Compensation Committee. The 2001 Plan options and the Inducement Options are generally subject to the same terms as options granted during fiscal 2011 under the 2009 Plan as described above under “Equity Awards Granted in Fiscal 2011.” Each of the 2001 Plan options has a ten-year term and the Inducement Options have a six-year term and is subject to earlier termination on a termination of the optionee’s employment or a change in control of our company. These options generally may not be transferred by the optionee.
(3) The weighted-average exercise prices do not reflect shares subject to outstanding awards of restricted stock units.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Indemnification of Our Executive Officers and Directors
Our executive officers and directors are entitled to be indemnified under our articles of incorporation and bylaws to the fullest extent permitted under California law. We have also entered into indemnification agreements with each of our executive officers and directors.
Director Independence
The Board of Directors, upon the recommendation of the Nominating and Governance Committee, has affirmatively determined that Ms. Denzel and Messrs. Degan, McClendon, De Perio and Shottan are independent directors within the meaning of NASDAQ Marketplace Rule 5605(a)(2). Mr. Kelly does not meet the independence requirements under NASDAQ Marketplace Rule 5605(a)(2) because he is our President and Chief Executive Officer. In the course of determining whether Ms. Denzel and Messrs. Degan, McClendon, De Perio and Shottan were independent under NASDAQ Marketplace Rule 5605(a)(2), the Board of Directors considered the following transactions, relationships and arrangements not required to be disclosed in “Certain Relationships and Related Party Transactions”:
•
Although Mr. McClendon served as our Interim President and Chief Executive Officer from November 2006 through August 2007, he is not automatically disqualified from being an independent director under NASDAQ Marketplace Rule 5605(a)(2) because he served in these interim positions more than three years prior to our Board’s determination of his independence and for less than one year.
•
Although Mr. De Perio was elected to our Board of Directors pursuant to the terms of the Purchase Agreement and is the nominee of, and is employed by, one of our shareholders, he is not automatically disqualified from being an independent director under NASDAQ Marketplace Rule 5605(a)(2). In April 2011, the Board of Directors, upon the recommendation of the Nominating and Governance Committee, found that Mr. De Perio had no relationship with our company which, in the opinion of the Board of Directors, would interfere with his exercise of independent judgment in carrying out the responsibilities of a director. In making this determination, the Board of Directors found that ownership of our securities by Mr. De Perio’s employer does not preclude a finding of independence.
Item 14.
Item 14. Principal Accounting Fees and Services.
The following table summarizes the aggregate fees billed to the Company by its independent registered public accounting firm, Moss Adams LLP (in thousands):
(1) Audit fees consist of fees billed for professional services rendered in connection with the audit of our consolidated annual financial statements and review of the interim consolidated financial statements included in quarterly reports, which were provided by Moss Adams in connection with statutory and regulatory filings or engagements.
(2) Audit-related fees consist of fees billed for assurance and related services that are reasonably related to the performance of the audit or review of our consolidated financial statements and are not reported under audit fees.
(3) Tax fees consist of fees billed for professional services rendered for tax compliance, tax advice and tax planning (domestic and international). These services include assistance regarding federal, state and international tax compliance, acquisitions and international tax planning. There were no such services rendered to us by Moss Adams during fiscal years 2010 or 2011.
(4) All other fees consist of fees for products and services other than the services reported above. There were no such services rendered to us by Moss Adams during fiscal years 2010 or 2011.
Pre-Approval Policies and Procedures
As a matter of policy, all audit and non-audit services provided by our independent registered public accounting firm are approved in advance by the Audit Committee, which considers whether the provision of non-audit services is compatible with maintaining such firm’s independence. All services provided by Moss Adams during fiscal years 2010 and 2011 were pre-approved by the Audit Committee. The Audit Committee has considered the role of Moss Adams in providing services to us for fiscal year 2011 and has concluded that such services are compatible with their independence as our auditors.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements. The following consolidated financial statements of Overland Storage, Inc. and reports of independent registered public accounting firms are included in a separate section of this report:
(a)(2) Financial Statement Schedules.
Schedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the consolidated financial statements or notes thereto.
(a)(3) Exhibits
+ Portions of this exhibit have been omitted pursuant to a request for confidential treatment and the non-public information has been filed separately with the SEC.
++ Certain schedules and similar attachments have been omitted pursuant to Item 601(b)(2) of Regulation S-K. A copy of the omitted schedules and similar attachments will be provided supplementally to the SEC upon request.
* Management contract or compensation plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints Eric L. Kelly and Kurt L. Kalbfleisch, jointly and severally, as his attorney-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this annual report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Overland Storage, Inc.
We have audited the accompanying consolidated balance sheets of Overland Storage, Inc. (the “Company”) as of July 3, 2011, and June 27, 2010, and the related consolidated statements of operations, shareholders’ equity and comprehensive loss, and cash flows for the periods then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Overland Storage, Inc. as of July 3, 2011 and June 27, 2010, and the results of their operations and their cash flows for the periods then ended, in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company’s recurring losses and negative operating cash flows raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans concerning these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Moss Adams LLP
San Diego, California
September 13, 2011
OVERLAND STORAGE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
See accompanying notes to consolidated financial statements.
OVERLAND STORAGE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
See accompanying notes to consolidated financial statements.
OVERLAND STORAGE, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND
COMPREHENSIVE LOSS
(in thousands)
See accompanying notes to consolidated financial statements.
OVERLAND STORAGE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying notes to consolidated financial statements.
OVERLAND STORAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1-OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
General
Overland Storage, Inc. (“Overland” or the “Company”) was incorporated on September 8, 1980 under the laws of the State of California. For more than 30 years, Overland has delivered data protection solutions designed for backup and recovery to ensure business continuity. Historically, the Company has focused on delivering a portfolio of tape automation solutions including loader and library systems designed for small and medium-sized business computing environments.
The Company operates and reports using a 52-53 week fiscal year with each quarter ending on the Sunday closest to the calendar quarter. For ease of presentation, the Company’s fiscal years are considered to end on June 30. For example, references to fiscal 2011 and 2010 refer to the fiscal years ended July 3, 2011 and June 27, 2010, respectively. Fiscal 2011 and 2010 each contained 52 weeks.
The Company has incurred losses for its last six fiscal years and negative cash flows from operating activities for its last five fiscal years. As of June 30, 2011, the Company had an accumulated deficit of $96.6 million. During fiscal 2011, the Company incurred a net loss of $14.5 million. Through calendar 2011, the Company expects to incur a net loss as it continues to change its business model and improve operational efficiencies.
The Company’s balance of cash increased by $1.3 million to $10.2 million compared with the balance at June 30, 2010. In November 2010, the Company sold to various institutional investors for $3.0 million a minority ownership interest in any amounts it receives from litigation awards or settlements arising from its patent infringement lawsuit.
The Company has projected that cash on hand, combined with 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’s recurring losses and negative cash flows from operations raise substantial doubt about its ability to continue as a going concern. The accompanying consolidated 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 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.
Management Estimates and Assumptions
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenue and expenses during the reporting period. Estimates have been prepared on the basis of the most current and best available information and actual results could differ from those estimates.
Revenue Recognition
Revenue from sales of products is recognized when persuasive evidence of an arrangement exists, the price is fixed or determinable, collectability is reasonably assured and delivery has occurred. Under this policy, revenue on direct product sales, excluding sales to distributors, is recognized upon shipment of products to customers. These customers are not entitled to any specific right of return or price protection, except for any defective product that may be returned under the Company’s warranty policy. Title and risk of loss transfer to the customer when the product leaves the Company’s dock. Product sales to distribution customers are subject to certain rights of return, stock rotation privileges and price protection. Because the Company is unable to estimate its exposure for returned product or price adjustments, revenue from shipments to these customers is not recognized until the related products are in turn sold to the ultimate customer by the distributor. For products for which software is more than an incidental component, the Company recognizes revenue in accordance with current authoritative guidance for software revenue recognition.
In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2009-13, Multiple-Deliverable Revenue Arrangements and ASU No. 2009-14, Software: Certain Revenue Arrangements That Include Software Elements. The new standards change the requirements for establishing separate units of accounting in multiple element arrangements and require the allocation of arrangement consideration to each deliverable to be based on the relative selling price. The Company adopted these standards effective the beginning of the first quarter of fiscal 2011. As a result of the adoption of these standards, sales of products which contain both hardware and software components, and for which the Company had previously concluded that the software was more than incidental are no longer within the scope of software revenue recognition guidance as the hardware and software components function together to deliver the product’s essential functionality. For any multiple element agreement, the Company allocates the relative fair value to each component. If the Company has fair value for undelivered elements but not the delivered element in an arrangement, the Company defers the fair value of the undelivered element(s) and the relative fair value is allocated to the delivered element(s). Undelivered elements typically include services. Revenue from extended warranty and product service contracts is initially deferred and recognized ratably over the contract period.
The Company has various royalty arrangements with independent service providers that sell its product and also sell and provide service on that product. These independent service providers pay a royalty fee for service contracts on the Company’s product. The royalty fee is calculated by Overland for the units covered in the quarter, and agreed to by the service provider, based upon the monthly fee for each unit covered by the independent service provider.
The Company has various licensing agreements relating to its Variable Rate Randomizer (VR2®) technology with third parties. The licensees pay a royalty fee for sales of their products that incorporate the VR2® technology. The licensees provide the Company with periodic reports that include the number of units, subject to royalty, sold to their end users. The Company records the royalty when reported to it by the licensee, generally in the period during which the licensee ships the products containing VR2® technology.
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 all 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.
Changes in the liability for product warranty and deferred revenue associated with extended warranties and service contracts were as follows (in thousands):
Shipping and Handling
Amounts billed to customers for shipping and handling are included in product sales and costs incurred related to shipping and handling are included in cost of revenue.
Advertising Costs
Advertising costs are expensed as incurred. Advertising expenses were $0.6 million and $0.5 million for fiscal years 2011 and 2010, respectively.
Research and Development Costs
Research and development costs are expensed as incurred. Software development costs are expensed until technological feasibility has been established, at which time any additional costs are capitalized. Because the Company believes its current process for developing software is essentially completed concurrently with the establishment of technological feasibility, which occurs upon the completion of a working model, no costs were capitalized during fiscal 2011 or 2010.
Segment Data
The Company reports segment data based on the management approach. The management approach designates the internal reporting that is used by management for making operating and investment decisions and evaluating performance as the source of the Company’s reportable segments. The Company uses one measurement of profitability and does not disaggregate its business for internal reporting. The Company has determined that it operates in one segment providing data storage solutions for mid-range businesses and distributed enterprises. The Company discloses information about products and services, geographic areas and major customers.
Information about Products and Services
The following table summarizes net revenue by product (in thousands):
Information about Geographic Areas
The Company markets its products domestically and internationally, with its principal international market being Europe. Revenue is attributed to the location to which the product was shipped. Long-lived assets are based on location of domicile.
The following table summarizes net revenue and long-lived assets by geographic area (in thousands):
Cash and Cash Equivalents
Highly liquid investments with insignificant interest rate risk and original maturities of three months or less, when purchased, are classified as cash equivalents. Cash equivalents are composed of money market funds. The carrying amounts approximate fair value due to the short maturities of these instruments.
Accounts Receivable and Allowance for Doubtful Accounts
The Company records accounts receivable at invoice amount and does not charge interest thereon. The Company estimates its allowance for doubtful accounts based on an assessment of the collectability of specific accounts and the overall condition of the accounts receivable portfolio. When evaluating the adequacy of the allowance for doubtful accounts, the Company analyzes specific trade and other receivables, historical bad debts, customer credits, customer concentrations, customer credit-worthiness, current economic trends and changes in customers’ payment terms and/or patterns. The Company reviews the allowance for doubtful accounts on a quarterly basis and records adjustments as considered necessary. Customer accounts are written-off against the allowance for doubtful accounts when an account is considered uncollectible.
Inventories
Inventories are stated at the lower of cost or market using the first-in-first-out method. The Company assesses the value of its inventories periodically based upon numerous factors including, among others, expected product or material demand, current market conditions, technological obsolescence, current cost and net realizable value. If necessary, the Company adjusts its inventory for obsolete or unmarketable inventory by an amount equal to the difference between the cost of the inventory and the estimated market value.
Property and Equipment
Property and equipment are recorded at cost. The Company also capitalizes qualifying internal use software costs incurred during the application development stage. Depreciation expense is computed using the straight-line method. Leasehold improvements are depreciated over the shorter of the remaining estimated useful life of the asset or the term of the lease. Estimated useful lives are as follows:
Expenditures for normal maintenance and repair are charged to expense as incurred, and improvements are capitalized. Upon the sale or retirement of property or equipment, the asset cost and related accumulated depreciation are removed from the respective accounts and any gain or loss is included in the results of operations.
Long-lived Assets
The Company evaluates the recoverability of long-lived assets, including property and equipment and certain identifiable intangible assets, in accordance with current accounting rules. The Company tests for recoverability whenever events or changes in circumstances indicate the carrying value may not be recoverable. The Company’s consideration includes, but is not limited to, the following events or changes as potential indicators of non-recoverability:
•
Significant underperformance relative to historical or projected future operating results.
•
Significant changes in the manner of use of the assets or the strategy for the Company’s overall business.
•
Significant decrease in the market value of the assets.
•
Significant negative industry or economic trends.
When the carrying value is not considered recoverable, an impairment loss for the amount by which the carrying value of a long-lived asset exceeds its fair value is recognized, with an offsetting reduction in the carrying value of the related asset. If the Company’s future results are significantly different than forecasted, the Company may be required to further evaluate its long-lived assets for recoverability and such analysis could result in an impairment charge in a future period. In fiscal 2011 and 2010, there were no impairments recognized.
Deferred Rent
Rent expense is recorded on a straight-line basis over the term of the lease. The difference between rent expense and amounts paid under the lease agreements is recorded in other liabilities in the accompanying consolidated balance sheet.
Foreign Currency Translation
The financial statements of foreign subsidiaries, for which the functional currency is the local currency, are translated into U.S. dollars using the exchange rate at the balance sheet date for assets and liabilities and a weighted-average exchange rate during the year for revenue, expenses, gains and losses. Translation adjustments are recorded as accumulated other comprehensive income within shareholders’ equity. Gains or losses from foreign currency transactions are recognized currently in income. Such transactions resulted in a loss of $0.5 million for fiscal 2011 and a gain of $0.5 million for fiscal 2010.
Income Taxes
The Company provides for income taxes utilizing the asset and liability approach of accounting for income taxes. Under this approach, deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. The provision for income taxes generally represents income taxes paid or payable for the current year plus the change in deferred taxes during the year. Deferred taxes result from differences between the financial and tax bases of the Company’s assets and liabilities and are adjusted for changes in tax rates and tax laws when changes are enacted. Valuation allowances are recorded to reduce deferred tax assets when a judgment is made that it is considered more likely than not that a tax benefit will not be realized. A decision to record a valuation allowance results in an increase in income tax expense or a decrease in income tax benefit. If the valuation allowance is released in a future period, income tax expense will be reduced accordingly.
The calculation of tax liabilities involves dealing with uncertainties in the application of complex global tax regulations. The impact of an uncertain income tax position is recognized 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. If the estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result.
Comprehensive Loss
Comprehensive loss and its components encompasses all changes in equity other than those with stockholders and includes net loss, foreign currency translation adjustments and unrealized gains on available-for-sale securities, and are disclosed as a separate component of stockholders’ equity.
Concentration of Credit Risks
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of trade accounts receivable, which are generally not collateralized and accounts receivable pledged as collateral. To reduce credit risk, the Company performs ongoing credit evaluations of its customers and maintains allowances for potential credit losses and sales returns.
The following table summarizes certain financial data for the customer who accounted for 10% or more of sales. No other customer accounted for 10% or more of sales in any of the two years presented.
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 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):
As discussed in Note 7, the Company recorded a beneficial conversion feature of $144,000 for the February 2010 issuance of Series A Convertible Preferred Stock. This amount has been included as an increase to the net loss for common shareholders when computing loss per share for the fiscal year ended June 30, 2010.
Share-based Compensation
The Company accounts for stock option grants and similar equity instruments granted to employees and non-employee directors under the fair value method. Share-based compensation award types include stock options, restricted stock units, and Stock Appreciation Rights (“SAR”) awards. The Company uses the Black-Scholes option pricing model to estimate the fair value of its options on the measurement date, which generally is the date of grant except for the liability-classified SAR awards. The cost is recognized over the requisite service period (usually the vesting period) for the estimated number of instruments for which service is expected to be rendered.
Compensation expense associated with option awards with graded vesting is recognized pursuant to an accelerated method. Compensation expense associated with restricted stock awards is recognized over the vesting period using the straight-line method.
The Company has not recognized, and does not expect to recognize in the near future, any tax benefit related to share-based compensation cost as a result of the full valuation allowance of the Company’s net deferred tax assets and its net operating loss carryforwards.
The Company recorded the following compensation expense related to its share-based compensation awards (in thousands):
Fair Value of Financial Instruments
Financial instruments including cash and cash equivalents, accounts receivable (pledged and non-pledged), accounts payable, accrued liabilities and a note payable, are carried at cost, which management believes approximates fair value because of the short-term maturity of these instruments. The carrying amount of the Company’s note payable in the prior fiscal year approximated its fair value as the interest rate of the note payable was substantially comparable to rates offered for similar debt instruments. The note payable was paid in full during the first quarter of fiscal 2011.
Recently Issued Accounting Pronouncements
In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. ASU No. 2011-05 provides two options for presenting other comprehensive income (“OCI”), which previously has typically been placed near the statement of equity. The amendments require an OCI statement to be included with the income statement, which together will make a statement of total comprehensive income or separate from the income statement, but the two statements will have to appear consecutively within a financial report. The provisions of ASU No. 2011-05 are effective for fiscal quarters and years beginning on or after December 15, 2011. The Company will retroactively opt one of the two presentation options in its Quarterly Report filed on Form 10-Q for the quarterly period ended March 31, 2012.
From time to time, new accounting pronouncements are issued by the FASB that are adopted by the Company as of the specified effective date. Unless otherwise discussed, management 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.
NOTE 2-COMPANY RESTRUCTURINGS
Restructurings
In fiscal October 2009, the Company reduced its worldwide workforce by 6.4%, or 15 employees, in accordance with the Company’s realignment around core initiatives. Severance costs, including COBRA premiums, related to the terminated employees of $422,000 were recorded in the first quarter of fiscal 2010. Severance charges are included in cost of goods sold, sales and marketing expense, research and development expense and general and administrative expense in the accompanying consolidated statement of operations.
In April 2010, the Company reduced its worldwide workforce by 18.8%, or 42 employees. Severance costs, including COBRA premiums, related to the terminated employees of $220,000 were recorded in the fourth quarter of fiscal 2010. Severance charges are included in cost of goods sold, sales and marketing expense, research and development expense and general and administrative expense in the accompanying consolidated statement of operations.
The following table summarizes the activity and balances of accrued restructuring charges through fiscal 2011 (in thousands):
NOTE 3-COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS
The following table summarizes inventories (in thousands):
The following table summarizes other current assets (in thousands):
The following table summarizes property and equipment (in thousands):
Depreciation and amortization expense for property and equipment was $0.4 million and $0.6 million in fiscal 2011 and 2010, respectively.
The following table summarizes other assets (in thousands):
The following table summarizes accrued liabilities (in thousands):
The following table summarizes other long-term liabilities (in thousands):
As of the end of fiscal 2011, the balances of accounts receivable consist entirely of accounts receivable trade balances, net of allowance for doubtful accounts. As of the end of fiscal 2010, the balances of accounts receivable and accounts receivable pledged as collateral consist entirely of accounts receivable trade balances, net of allowance for doubtful accounts, including amounts due from MCF and FGI related to customer remittances that had not been remitted to the Company as of the balance sheet date. In August 2011, the Company terminated the MCF Financing Agreement pursuant to its terms. In April 2011, the Company terminated the FGI Financing Agreement pursuant to its terms.
The following table summarizes the changes in allowance for doubtful accounts (in thousands):
NOTE 4-INTANGIBLE ASSETS
Intangible assets consist of the following (in thousands):
Intangible assets, net, primarily consist of the intangible assets acquired in the June 2008 acquisition of Snap Server. The identifiable intangible assets acquired in the Snap Server acquisition consist of existing technology (acquired technology), which has been assigned an estimated useful life of four years, and customer contracts and trade names, 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 2011, the Company purchased intangible assets for $150,000. The identifiable intangible assets acquired consist of existing technology (acquired technology), which has been assigned an estimated useful life of three years. The intangible assets are being amortized on a straight-line basis over their estimated useful lives.
Amortization expense of intangible assets was $1.1 million during fiscal 2011 and 2010. Estimated amortization expense for intangible assets will be $1.1 million in fiscal 2012 and $0.7 million in each of fiscal 2013 and fiscal 2014.
NOTE 5-DEBT
The components of the Company’s outstanding debt are as follows (in thousands):
MCF Financing Agreement
In November 2008, the Company entered into a domestic non-OEM accounts receivable financing agreement (the “MCF Financing Agreement”) with Marquette Commercial Finance (“MCF”). Under the terms of the MCF Financing Agreement, the Company could offer to sell its accounts receivable to MCF each month during the term of the MCF Financing Agreement, up to a maximum amount outstanding at any time of $9.0 million in gross receivables submitted, or $6.3 million in net amounts funded based upon a 70.0% advance rate. The MCF Financing Agreement could be terminated by either party with 30 days written notice. The Company was not obligated to offer accounts in any month, and MCF had the right to decline to purchase any offered accounts (invoices). Net amounts funded by MCF as of June 30, 2011 and 2010, based upon a 70.0% advance rate, were $0 and $2.6 million, respectively.
The MCF Financing Agreement provided for the sale, on a revolving basis, of accounts receivable generated by specified debtors. The purchase price paid by MCF reflects a discount that is generally 2.5%, but could be increased in certain circumstances, including situations when the time elapsed between placement of the account with MCF and receipt of payment from the debtor exceeds certain thresholds. The Company continued to be responsible for the servicing and administration of the receivables purchased.
The Company accounted for the sale of receivables under the MCF Financing Agreement as a secured borrowing with a pledge of the subject receivables as collateral, in accordance with the authoritative guidance for accounting for transfers and servicing of financial assets and extinguishments of liabilities. The caption “Accounts receivable pledged as collateral” on the accompanying consolidated balance sheet in the amount of $0 million and $6.2 million as of June 30, 2011 and 2010, respectively, includes $0 and $3.7 million, respectively, of gross receivables that were designated as “sold” to MCF. Such receivable served as collateral for short-term debt in the amount of $0 and $2.6 million, excluding accrued interest, as of June 30, 2011 and 2010, respectively.
As of June 30, 2011, the Company was in compliance with the dilution covenant. In August 2011, the Company terminated the MCF Financing Agreement pursuant to its terms.
FGI Financing Agreement
In March 2009, the Company entered into a foreign non-OEM accounts receivable financing agreement (the “FGI Financing Agreement”) with Faunus Group International (“FGI”). Under the terms of the FGI Financing Agreement, the Company could offer to sell its foreign non-OEM accounts receivable to FGI each month during the term of the FGI Financing Agreement, up to a maximum amount outstanding at any time of $5.0 million in gross accounts receivable submitted, or $3.75 million in net amounts funded based upon a 75.0% advance rate. FGI became responsible for the servicing and administration of the accounts receivable purchased. The Company would pay FGI a monthly collateral management fee equal to 1.09% of the average monthly balance of accounts purchased by FGI. In addition, FGI would charge the Company interest on the daily net funds employed at a rate equal to the greater of (i) 7.5% or (ii) 3.0% above FGI’s prime rate. The Company was not obligated to offer accounts in any month and FGI has the right to decline to purchase any accounts. Net amounts funded by FGI as of June 30, 2011 and 2010, based upon a 75.0% advance rate, were $0 and $1.9 million, respectively.
The Company accounted for the sale of accounts receivable under the FGI Financing Agreement as a secured borrowing with a pledge of the subject receivables as collateral, in accordance with the authoritative guidance for accounting for transfers and servicing of financial assets and extinguishments of liabilities. The caption “Accounts receivable pledged as collateral” on the accompanying consolidated balance sheet in the amount of $0 and $6.2 million as of June 30, 2011 and 2010, respectively, included $0 and $2.5 million of gross accounts receivable that were designated as “sold” to FGI and that served as collateral for short-term debt in the amount of $0 and $1.9 million as of June 30, 2011 and 2010, respectively.
In April 2011, the Company terminated the FGI Financing Agreement pursuant to its terms and paid the $100,000 termination fee to FGI pursuant to the terms of such agreement. FGI had a security interest in substantially all of the Company’s assets during the term of such agreement.
Note Payable to Anacomp
In April 2009, the Company entered into a secured promissory note with Anacomp, Inc. (“Anacomp”), one of the Company’s authorized service providers. The Anacomp note represented a conversion of accounts payable owed by the Company to Anacomp that accumulated primarily during the third quarter of fiscal 2009, during which time the Company was negotiating an extension and other terms under its agreement with Anacomp. The Anacomp note, as amended and restated to reflect the actual accounts payable due, was in the amount of $2.3 million and accrued simple interest at 12.0% per annum. The Anacomp note was paid in full in the first quarter of fiscal 2011.
NOTE 6-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 following is a summary of the changes in the amount of unrecognized tax benefits (in thousands):
At June 30, 2011, $0.1 million of the unrecognized tax benefits, excluding interest, are presented as a component of long-term liabilities in the accompanying consolidated balance sheet and $0.3 million is presented as a reduction of the related deferred tax asset for which there is full valuation allowance. The entire amount of unrecognized tax benefits at June 30, 2011 will affect the effective tax rate if recognized. However, the portion that would be recognized as an increase to deferred tax assets may result in a corresponding increase in the valuation allowance at the time of recognition resulting in no net effect to the effective tax rate, depending upon the Company’s assessment of the likelihood of realization of the tax benefits at the time they are recognized.
The Company believes it is reasonably possible that, within the next twelve months, the amount of unrecognized tax benefits may remain unchanged. 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 on its consolidated balance sheet at fiscal years ended June 30, 2011 and 2010 and recognized no interest and/or penalties in the consolidated statement of operations for the fiscal year ended June 30, 2011.
During fiscal 2011, the Company’s liability for unrecognized tax benefits remained unchanged from the prior year due to the expiration of the statute of limitation for certain years. The full amount was recognized as a tax benefit in the Company’s financial statements.
The Company is subject to federal and state taxation in the United States and also in certain foreign tax jurisdictions. Generally, the Company’s tax returns for fiscal 2008 and forward are subject to examination by the U. S. federal tax authorities and fiscal 2007 and forward are subject to examination by state tax authorities.
In December 2009, Section 172(b)(1)(H) of the Internal Revenue Code (Section 172(b)(1)(H)) was amended to allow all taxpayers to elect to carry back an applicable net operating loss (NOL) for a period of three, four or five years. This election traditionally provided that an NOL for any taxable year could be carried back to each of the two years preceding the taxable year of the NOL. For the Company, the first applicable tax year available to carry back NOLs under Section 172(b)(1)(H) is its fiscal year ended June 30, 2008. The Company elected to carry back its fiscal 2008 NOL of $20.2 million to the fifth, fourth and third preceding years as allowed under Section 172(b)(1)(H). As a result, the Company recognized a discrete tax benefit in the third quarter of fiscal 2010 of approximately $2.0 million. No additional NOL carryback opportunity was available during fiscal 2011.
The Company’s ability to use its net operating loss (NOL) and research and development (R&D) 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 (the Code), as well as similar state provisions. These ownership changes may limit the amount of NOL and R&D credit carryforwards that can be utilized annually to offset future taxable income and tax, respectively. In general, an “ownership change” as defined by Section 382 of the Code results from a transaction or series of transactions over a three-year period resulting in an ownership change of more than 50.0% of the outstanding stock of a company by certain stockholders or public groups.
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 became a “loss corporation” under the definition of Section 382. If the Company has experienced an ownership change, utilization of the NOL or R&D credit carryforwards would be subject to an annual limitation under Section 382 of the Code, which is determined by first multiplying the value of the Company’s stock at the time of the ownership change by the applicable long-term, tax-exempt rate, and then could be subject to additional adjustments, as required. Any limitation may result in expiration of a portion of the NOL or R&D credit carryforwards before utilization. Further, until a study is completed and any limitation known, no positions related to limitations are being considered as an uncertain tax position or disclosed as an unrecognized tax benefit. Any carryforwards that expire prior to utilization as a result of such limitations will be removed from deferred tax assets with a corresponding reduction of the valuation allowance. 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.
The components of loss before income taxes were as follows (in thousands):
The provision for income taxes includes the following (in thousands):
A reconciliation of income taxes computed by applying the federal statutory income tax rate of 34.0% to loss before income taxes to the total income tax provision reported in the accompanying consolidated statements of operations is as follows (in thousands):
Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets and liabilities are shown below. A full valuation allowance has been recorded, as realization of such assets is uncertain. Deferred income taxes comprised (in thousands):
At June 30, 2011, the Company has federal and state net operating loss carryforwards of $106.9 million and $73.9 million, respectively. These amounts include share-based compensation deductions of $1.0 million that will be recorded to contributed capital when realized. The remaining federal net operating loss will begin expiring in 2023, unless previously utilized. State net operating loss carryforwards generally begin to expire in 2016, unless previously utilized.
At June 30, 2011, the Company had federal and California research and development tax credit carryforwards totaling $0.6 million and $2.2 million, respectively. The California research credit may be carried forward indefinitely. The federal research credit will begin expiring in 2025, unless previously utilized. In addition, the Company has foreign tax credit carryforwards totaling $0.3 million, which will begin expiring in 2015, unless previously utilized. The Company has federal alternative minimum tax credit carryforwards totaling $0.2 million which can be carried forward indefinitely.
NOTE 7-EQUITY
Sale of Common Stock
In March 2011, in a private placement transaction, the Company sold an aggregate of 8,653,045 shares of its common stock along with warrants to purchase up to 3,807,331 shares of common stock for a total issuance price of approximately $15.3 million and net proceeds of approximately $13.8 million. The purchase price for one share of common stock and a warrant to purchase 0.44 shares of common stock was $1.765. Each warrant has an initial exercise price of $1.71 per share of common stock. The warrants are immediately exercisable and have a five year term. In connection with the offering and as partial compensation for the placement agent’s services, the Company issued to the placement agent a warrant initially exercisable to purchase up to 259,591 shares of common stock at an exercise price of $1.71 per share of common stock and with other terms also substantially the same as the warrants issued to the purchasers. The Company has evaluated the warrants issued in the private placement transaction and has concluded that the equity classification is appropriate as all warrants are considered to be indexed to the Company’s equity and there are no settlement provisions that would result in classification as a debt instrument.
As part of the March 2011 sale of common stock, the number of shares of common stock issuable upon exercise of the warrants issued in February 2010 was further adjusted from 7,307,186 shares to 8,368,135 shares and the per share strike price of such warrants was proportionately decreased from $2.253 to $1.967, each as a result of the weighted-average anti-dilution provisions in the warrants. The Company has concluded that these warrants should continue to be classified as a component of equity.
In November 2010, the Company sold an aggregate of 3,376,000 shares of its common stock to certain institutional investors at $1.25 per share for gross proceeds of approximately $4.2 million and net proceeds of approximately $4.0 million. As part of this sale of common stock, the number of shares of common stock issuable upon exercise of the warrants issued in February 2010 was adjusted from 6,373,266 shares to 7,307,186 shares and the per share strike price of such warrants was proportionately decreased from $2.583 to $2.253, each as a result of the weighted-average anti-dilution provisions in the warrants. The Company has concluded that these warrants should continue to be classified as a component of equity.
Sale of Series A Convertible Preferred Stock and Issuance of Common Stock Warrants
In February 2010, the Company issued and sold an aggregate of 794,659 shares of Series A Convertible Preferred Stock (Series A Stock) and warrants to purchase up to 6,373,266 shares of common stock in a private placement for a total issuance price of $11.9 million and net proceeds of approximately $10.9 million. The Series A Stock was convertible into 4,521,616 shares of the Company’s common stock with no par value per share, and each warrant has an exercise price of $2.583 per share of common stock. In connection with this transaction, the Company issued a warrant to purchase up to 180,865 shares of common stock at an exercise price of $2.952 per share to the placement agent in February 2010. The warrants are immediately exercisable, have a five year term and provide for weighted-average anti-dilution protection in the event that the Company issues additional securities at a price less than the then-effective exercise price of the warrants.
The proceeds from the February 2010 transaction have been allocated to the Series A Stock and the warrants based on their relative fair values. The Company concluded that each share of Series A Stock had an estimated fair value of $9.54 at the time of issuance with a total fair value of approximately $7.6 million, and that each warrant issued had an estimated fair value of approximately $0.72 for each share exercisable under such warrant, or a total fair value of approximately $4.6 million. Based on the total proceeds of $11.9 million, the values recorded on the Company’s balance sheet were reduced to approximately $7.4 million for the Series A Stock and approximately $4.5 million for the warrants. The total estimated fair value of the warrant issued to the placement agent was estimated to be approximately $0.1 million, and was recorded as part of the financing costs associated with the transaction.
The Company has evaluated the warrants issued in the transaction and has concluded that equity classification is appropriate as all warrants are considered to be indexed to the Company’s equity and there are no settlement provisions that would result in classification as a debt instrument.
The Company also determined that the valuation of the components of the February 2010 transaction results in a beneficial conversion feature of $144,000 for the Series A Stock based on a comparison of the estimated fair value and allocated value. Based on the terms of the Series A Stock, the beneficial conversion feature has been recorded as an increase in value to the Series A Stock with an off-setting negative impact to accumulated deficit, and will increase the net loss attributable to common shareholders for the fiscal year ended June 30, 2010.
In April 2010, the shareholders approved the full conversion of the Series A Stock at a special shareholders’ meeting, and the 794,659 shares of Series A Stock thereafter automatically converted into 4,521,616 shares of common stock. As a result of this conversion, the Company’s consolidated balance sheet reflects a single class of stock ownership, and the net proceeds from the February 2010 transaction is reflected as common stock. As of June 30, 2010, there were 49,310 shares of common stock related to this conversion that were not issued, which subsequently were issued in fiscal 2011.
Sale of Common Stock and Issuance of Common Stock Warrant
In November 2009, the Company sold 2,070,000 shares of its common stock through a public offering of common stock at $2.10 per share with gross proceeds of approximately $4.3 million and net proceeds of approximately $3.7 million. In addition, the Company issued a warrant for the purchase of 103,500 shares of the Company’s common stock at $2.625 per share to the underwriter of the offering. The warrant may be exercised at any time beginning on October 25, 2010 and ending on October 30, 2014. The warrant features a net exercise provision which enables the holder to choose to exercise the warrant without paying cash by surrendering shares subject to the warrant. This right is available only if a registration statement covering the shares subject to the warrant is not available at the time of exercise. The Company also agreed to grant a single demand registration right to the holder of the warrant under certain circumstances. The fair value of the warrant was estimated at $1.70 per share, or $176,000, utilizing a Black-Scholes model, and was recorded in equity as a financing cost.
The Company has evaluated the warrants issued in this transaction and has concluded that equity classification is appropriate as all warrants are considered to be indexed to the Company’s equity and there are no settlement provisions that would result in classification as a debt instrument.
Reverse stock split
In December 2008, the Board of Directors and shareholders approved a reverse stock split of the Company’s outstanding shares of common stock. On December 8, 2009, the Company filed a certificate of amendment to its amended and restated certificate of incorporation, as amended, with the Secretary of State of the State of California effecting a one-for-three reverse stock split of the outstanding shares of common stock. All share, per share and stock option data information in the consolidated financial statements and the notes thereto have been retroactively adjusted for all periods to give effect to the reverse stock split.
NOTE 8-SHARE-BASED COMPENSATION
Equity Compensation Plans
The Company has four active stock option plans administered by the Compensation Committee of the Board of Directors. In June 2011, the Board of Directors modified the Company’s 2009 Equity Incentive Plan to authorize an additional 3.2 million shares available for issuance. As of June 30, 2011, the Company had reserved an aggregate of 8.2 million shares of common stock for issuance under its four active plans: 2000 Stock Option Plan, 2001 Supplemental Stock Option Plan (2001 Plan), 2003 Equity Incentive Plan (2003 Plan) and the 2009 Equity Incentive Plan (2009 Plan) (collectively, the Option Plans). The Option Plans provide for the granting of stock options. In addition, the 2003 Plan and the 2009 Plan provide for the granting of restricted stock, stock units, stock options and stock appreciation rights. The Option Plans were approved by the Company’s shareholders with the exception of the 2001 Plan. Currently, the Company may grant new awards only under the 2009 Plan. The Compensation Committee may also grant options outside of the Option Plans as an inducement to an employee commencing employment with the Company (Inducement Options). As of June 30, 2011, the Company had reserved an aggregate of 0.5 million shares of common stock for the issuance of Inducement Options.
Options granted generally vest over a three-year period. Options generally expire after a period not to exceed six years, except in the event of termination, whereupon vested shares must be exercised generally within three months under the 2009 Plan and 2003 Plan and within 30 days under the other Option Plans, or upon death or disability, in which cases an extended six- or twelve-month exercise period is specified. As of June 30, 2011, approximately 6.7 million shares were reserved for issuance upon exercise of outstanding awards and options and approximately 2.0 million shares were available for grant under the Option Plans.
The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model, which uses the weighted-average assumptions noted in the following table.
Prior to the fourth quarter of fiscal 2010, the expected volatility utilized in the valuation of equity awards was solely based on the historical volatility of the Company’s stock utilizing the daily closing prices. During the third quarter of fiscal 2010, the Company completed a Series A Convertible Preferred Stock financing, which included common stock warrants. The circumstances of this financing lead the Company to perform a valuation analysis and volatility study in order to properly ascribe the fair values of the proceeds of the financing to both the stock and the warrants. The Company then performed a similar volatility study for equity compensation and believes this approach is more sophisticated and a better indicator of expected volatility of its stock because it considers additional factors, such as the overall market conditions, the industry sector and the expected and realistic pricing of equity instruments in the marketplace and is generally reflective of both historical and implied volatility. Accordingly, the Company commenced using this new approach for estimating expected volatility for equity compensation beginning in the fourth quarter of fiscal 2010. The Company applies a forfeiture rate based upon historical pre-vesting option cancellations. The risk-free interest rate is determined based upon a constant maturity U.S. Treasury security with a contractual life approximating the expected term of the option. The expected term of options granted is estimated based on a number of factors, including but not limited to the vesting term of the award, historical employee exercise behavior (for both options that have run their course and outstanding options), the expected volatility of the Company’s stock and an employee’s average length of service.
Option activity is summarized below (shares and aggregate intrinsic value in thousands):
The following table summarizes information about stock options (in thousands, except per share amounts):
As of June 30, 2011, there was total unrecognized compensation expense related to unvested equity-based compensation arrangements under the Option Plans (including options, stock units and SAR awards) and the Inducement Options of $12.4 million. This expense, associated with non-vested stock and options granted prior to June 30, 2011, is expected to be recognized over a weighted-average period of 1.9 years.
Restricted Stock Units
The fair value of each restricted stock unit (“RSU”) is the market price of the Company’s stock on the date of grant. RSUs are generally payable in an equal number of shares of the Company’s common stock at the time of vesting of the units. RSUs typically vest over three years. There were no RSUs vested as of June 30, 2011.
The following table summarizes information about stock unit activity (in thousands, except per share amounts):
The grant-date fair value of the shares underlying the RSUs at the date of grant was $11.8 million in fiscal 2011. This amount is being recognized to expense over the corresponding vesting period. For fiscal 2011, the Company recognized $0.6 million in share-based compensation expense related to these awards. There were no RSUs outstanding in fiscal 2010.
Stock Appreciation Rights
In June 2011, the Company modified options which had been granted to three executives during fiscal 2010 to purchase 1.6 million shares of the Company’s common stock and reissued the options as SAR awards. No other terms of the awards changed. The purpose of the amendment and reissuance is to provide that, upon exercise, the SAR will be settled in cash or stock, at the discretion of the Company. Based on the SAR settlement provisions, and the Company’s intentions, this modification changed these awards from equity-based instruments to liability-based instruments. As such, the fair value of the SAR awards is recalculated at each subsequent reporting period until settlement. The Company uses a Black-Scholes valuation model to determine the fair value and has initially recorded a current liability of $2.2 million related to this modification. This initial liability represents a reclassification from amounts previously recorded as additional paid-in capital.
Ongoing compensation expense will be recorded based on the grant-date fair value and the proportionate amount of the requisite service period that has been rendered to date. Changes in the fair value of the vested SAR awards will be recorded as an adjustment to the liability until settlement of the SAR awards.
As of June 30, 2011, there were 0.9 million of SAR awards vested with an exercise price of $2.49, a remaining contractual term of 4.8 years and an aggregate intrinsic value of $0.2 million. No SAR awards were exercised during fiscal 2011.
2006 Employee Stock Purchase Plans
In February 2007, the Company adopted the 2006 Employee Stock Purchase Plan (2006 ESPP). In June 2011, the Board of Directors modified the Company’s 2006 ESPP to make an additional 600,000 shares available for issuance. As of June 30, 2011, 755,000 shares of common stock have been reserved under the 2006 ESPP for issuance and purchase by employees of the Company to assist them in acquiring a stock ownership interest in the Company and to encourage them to remain employees of the Company. The 2006 ESPP is qualified under Section 423 of the Code and permits eligible employees to purchase common stock at a discount through payroll deductions during specified six-month offering periods. No employee may purchase more than $25,000 worth of stock in any calendar year or 2,500 shares in any one offering period.
During fiscal 2011 and 2010, the Company issued approximately 1,400 and 1,000 shares, respectively, under the 2006 ESPP for combined proceeds of $2,600 and $1,000, respectively.
NOTE 9-401(k) PLAN
The Company maintains an employee savings and retirement plan (the 401(k) Plan) covering all of the Company’s employees. The 401(k) Plan permits but does not require matching contributions by the Company on behalf of participants. The Company does not make matching contributions.
NOTE 10-COMMITMENTS AND CONTINGENCIES
Leases
The Company leases its office, production and sales facilities under non-cancelable operating leases that expire in various years through fiscal year 2020. The leases provide for biennial or annual rent escalations intended to approximate increases in cost of living indices, and certain of the leases provide for rent abatement. The Company has a five-year option to renew its lease on its San Diego headquarters facility and a five-year option to renew its lease on its San Jose facility. In July 2010, the Company modified its San Diego headquarters lease and reduced the facility by one building, or 67,285 square feet, which proportionally reduced the monthly base rent and share of facility expenses. Future minimum lease payments under these arrangements are as follows (in thousands):
Rental expense is recognized on a straight-line basis over the respective lease terms and was $3.3 million and $4.3 million in fiscal 2011 and 2010, respectively.
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 June 30, 2011 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 December 2009, Crossroads Systems, Incorporated (“Crossroads”) filed a lawsuit against the Company and several other companies in the United States District Court for the Western District of Texas (the “Complaint”). The Complaint was served on the Company in December 2009, and alleged that its products infringe upon United States Patent Nos. 6,425,035 and 7,051,147. The Court had scheduled a hearing on issues of claim construction for June 3, 2010. Although the Company was prepared to vigorously defend against Crossroads’ lawsuit, in advance of the claim construction briefing, the parties reached a settlement of the lawsuit and the Court entered an Order of Dismissal of the lawsuit on May 25, 2010.
NOTE 11-SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following tables present selected quarterly financial information (in thousands, except per share data) for the periods indicated. This information has been derived from the Company’s unaudited quarterly consolidated condensed financial statements, which in the opinion of management include all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of such information. These operating results are not necessarily indicative of results for any future period.
(1) Net loss per share is computed independently for each quarter and the full year based upon respective weighted-average shares outstanding. Therefore, the sum of the quarterly earnings per share amounts may not equal the annual amounts reported.
(2) Basic loss per share is computed by dividing net loss applicable to common shareholders by the weighted-average number of common shares assumed to be outstanding during the periods of computation.
NOTE 12-SUBSEQUENT EVENTS
Credit Facility
In August, 2011, the Company entered into a Loan and Security Agreement (“Credit Facility”) that provides for an $8.0 million secured revolving loan. The proceeds of the Credit Facility may be used to fund the Company’s working capital and to fund its general business requirements. The Credit Facility is scheduled to mature August 8, 2013.
The obligations under the Credit Facility are secured by all assets of the Company. Borrowings under the Credit Facility will 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.
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 payable.