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OVERLAND STORAGE INC - 10-Q/A - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) 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. Factors that could cause or contribute to such differences include, but are not limited to: our ability to maintain and increase sales volumes of our products; our ability to continue to aggressively control costs; the continued availability of our non-OEM accounts receivable financing arrangements; our ability to achieve the intended cost savings and maintain quality with our new manufacturing partner; our ability to generate cash from operations; our ability to raise outside capital and to repay our debt as it comes due; our ability to introduce new competitive products and the degree of market acceptance of such new products; the timing and market acceptance of new products introduced by our competitors; our ability to maintain strong relationships with branded channel partners; our ability to maintain the listing of our common stock on The NASDAQ Capital Market (Capital Market); customers', suppliers' and creditors' perceptions of our continued viability; rescheduling or cancellation of customer orders; loss of a major customer; general competition and price measures in the market place; unexpected shortages of critical components; worldwide information technology spending levels; and general economic conditions. 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. Actual events or results may differ materially from such statements. In evaluating such statements we urge you to specifically consider various factors identified in this report, including the matters set forth below under the caption "Risk Factors" in Item 1A of Part II of this report, and set forth in our annual report on Form 10-K for the fiscal year ended June 30, 2010 filed with the Securities and Exchange Commission (SEC) on September 24, 2010 under the caption "Risk Factors" in Item 1A of Part I, any of which could cause actual results to differ materially from those indicated by such forward-looking statements. 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 small and medium enterprises (SMEs), corporate departments and small and medium businesses (SMBs) to anticipate and respond to change. Whether an organization's data is distributed around the corner or across continents, our solutions tie it all together for easy and cost-effective management of different tiers of information over time. We enable companies to expend fewer resources on information technology (IT) allowing them to focus on being more responsive to the needs of their customers. We develop and deliver a comprehensive solution set of award-winning products and services for 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. Overview This overview discusses matters on which we primarily focus 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 value-added resellers (VARs), with the remainder from our private label arrangements with original equipment manufacturers (OEMs). 12-------------------------------------------------------------------------------- Table of Contents Business Transition. In August 2005, we announced that our largest OEM customer, Hewlett Packard Company (HP), had selected an alternate supplier for its next-generation mid-range tape automation products. HP began purchasing the alternate supplier's new product line during the first quarter of calendar year 2006, which decreased our sales to HP. Although we believe that our sales to HP will continue to decline, in the fourth quarter of fiscal 2009 we extended our supply agreement with HP until July 2012 with automatic renewals for three successive one-year periods unless earlier terminated by either party. In the first nine months of fiscal 2011, revenue from HP decreased 28.6% compared with the first nine months of fiscal 2010. During the first nine months of fiscal 2011, we continued to experience decreased revenues as compared to the first nine months of fiscal 2010. We believe customers have delayed purchases or chosen not to purchase for a number of reasons, including, among others, the continued conservative infrastructure and IT spending and reluctance by some customers to purchase our products due to weakness in our financial condition. We reported net revenue of $17.1 million for the third quarter of fiscal 2011, compared with $18.6 million for the third quarter of fiscal 2010. We reported net revenue of $52.6 million for the first nine months of fiscal 2011, compared with $58.4 million for the first nine months of fiscal 2010. Revenue from HP represented approximately 24.6% of total net revenue in the third quarter of fiscal 2011 compared with 24.1% of total net revenue in the third quarter of fiscal 2010. Revenue from HP represented approximately 18.9% of total net revenue in the first nine months of fiscal 2011 compared with 23.9% of total net revenue in the first nine months of fiscal 2010. We incurred a net loss of $3.4 million, or $0.22 per share, for the third quarter of fiscal 2011 compared to a net loss of $2.5 million, or $0.42 per share, for the third quarter of 2010. We incurred a net loss of $10.8 million, or $0.83 per share, for the first nine months of fiscal 2011 compared to a net loss of $8.8 million, or $1.67 per share, for the first nine months of fiscal 2010. The increase in net losses for the quarter was the result of declines in net revenue. The increase in net losses year to date was the result of declines in net revenue, partially offset by our sale of a minority ownership interest in any amounts we receive from litigation awards or settlements arising from our patent infringement lawsuit against BDT AG and its affiliates (BDT), Dell Inc. (Dell) and International Business Machines Corporation (IBM) and our related complaint for patent infringement in the United States International Trade Commission against the same defendants. Liquidity and capital resources. At March 31, 2011, we had a cash balance of $16.7 million, compared to $8.9 million at June 30, 2010. In the first nine months of fiscal 2011, we incurred a net loss of $10.8 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 $13.9 million. Cash management and preservation continue to be a top priority. We expect to incur negative operating cash flows during the remainder of fiscal 2011 as we reshape our business model and seek to improve operational efficiencies. We have projected that cash on hand 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 March 31, 2011, we had working capital of $13.6 million, reflecting a $5.0 million increase in current assets and a $6.2 million decrease in current liabilities compared to June 30, 2010. The increase in current assets is primarily attributable to our private placement of common stock in March 2011. The decrease in current liabilities is primarily attributable to a $3.2 million decrease in accounts payable and accrued liabilities primarily related to operating activities, a $0.7 million reduction in debt related to the repayment of our note payable to Anacomp, Inc. (Anacomp) and a $2.3 million reduction in our current liabilities associated with our non-OEM accounts receivable financing arrangements. See "Liquidity and Capital Resources" below for a description of these arrangements. Industry trends. We estimate that the cost of data management is four times the cost of storage devices. Furthermore, many SMEs and SMBs are seeking to implement tiered storage for primary and secondary data utilizing a combination of low cost Serial Advanced Technology Attachment (SATA) drives and high performance Serial Attached SCSI (SAS) drives. IDC estimates that the total networked attached storage (NAS) market will grow at approximately 7.6% 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 at 10.8%. 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 38.2% and 46.5% of our revenue during the first nine months of fiscal 2011 and 2010, respectively. 13-------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies and Estimates We describe our significant accounting policies in Note 1, "Operations and Summary of Significant Accounting Policies," of the notes to consolidated financial statements included in our annual report on Form 10-K for the fiscal year ended June 30, 2010; and we discuss our critical accounting policies and estimates in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of that report. Unless otherwise described below, there have been no material changes in our critical accounting policies and estimates. Results of Operations The following tables set forth certain financial data as a percentage of net revenue: Three months ended March 31, Nine months ended March 31, 2011 2010 2011 2010 Net revenue 100.0% 100.0% 100.0% 100.0% Cost of revenue 66.2 74.9 70.5 73.1 Gross profit 33.8 25.1 29.5 26.9 Operating expenses: Sales and marketing 21.3 25.1 23.9 23.1 Research and development 11.6 8.0 10.4 7.5 General and administrative 17.1 15.2 18.2 13.9 50.0 48.3 52.5 44.5 Loss from operations (16.2) (23.2) (23.0) (17.6) Other income (expense), net (2.8) (0.4) 3.0 (0.4) Loss before income taxes (19.0) (23.6) (20.0) (18.0) Provision for income taxes 0.6 (10.2) 0.4 (3.0) Net loss (19.6)% (13.4)% (20.4)% (15.0)% A summary of the sales mix by product follows: Three months ended March 31, Nine months ended March 31, 2011 2010 2011 2010 Tape based products: NEO Series® 31.7% 44.8% 38.1% 42.3% ARCvault®family - 0.1 0.1 4.2 31.7 44.9 38.2 46.5 Disk based products: REO Series® 1.9 2.0 2.4 3.5 ULTAMUS® - 0.1 - 0.9 Snap Server® 13.7 10.8 15.6 9.8 15.6 12.9 18.0 14.2 Service 37.6 33.4 33.5 30.4 Spare parts and other 15.1 8.6 10.0 8.5 VR2® - 0.2 0.3 0.4 100.0% 100.0% 100.0% 100.0% 14 -------------------------------------------------------------------------------- Table of Contents The third quarter of fiscal 2011 compared to the third quarter of fiscal 2010 Net Revenue. Net revenue in the third quarter of fiscal 2011 decreased to $17.1 million from $18.6 million in the third quarter of fiscal 2010. The decrease of $1.5 million, or 8.0%, was primarily in our OEM channel related to decreased revenue from HP which represented approximately 24.6% of net revenue in the third quarter of fiscal 2011 compared to 24.1% of net revenue in the third quarter of fiscal 2010. The slight increase in percentage of net revenue was related to a backlog in the second quarter of fiscal 2011. Net revenue within our branded channel remained relatively constant. Product Revenue Net product revenue from OEM customers in the third quarter of fiscal 2011 decreased to $2.3 million from $3.3 million in the third quarter of fiscal 2010. The decrease of $1.0 million, or 30.3%, was primarily a result of decreased revenue from HP. Net product revenue from Overland branded products, excluding service revenue, in the third quarter of fiscal 2011 decreased to $8.4 million from $9.0 million in the third quarter of fiscal 2010. The decrease of $0.6 million, or 6.7%, was primarily a result of a decrease in revenue from our tape based products offset by an increase in disk based products. Service Revenue Net service revenue in the third quarter of fiscal 2011 increased to $6.5, or 4.8%, from $6.2 million in the third quarter of fiscal 2010. As a percentage of total revenue, service revenue increased 4.3% to 37.7% for the third quarter of fiscal 2011 compared to 33.4% in the third quarter of fiscal 2010. Royalty Fees Net royalty fees were minimal in the third quarter of fiscal 2011 and third quarter of fiscal 2010. Gross Profit. Gross profit in the third quarter of fiscal 2011 increased to $5.8 million from $4.7 million in the third quarter of fiscal 2010 due to increased sales of higher margin products and an improved product mix. Gross margin increased to 33.8% in the third quarter of fiscal 2011 from 25.1% in the third quarter of fiscal 2010 primarily related to the increase in branded product revenue as a percentage of total revenue. Product Revenue Gross profit on product revenue was $2.0 million during the third quarter of fiscal 2011 compared with $1.1 million for the third quarter of fiscal 2010. Gross margin on product revenue at 19.2% for the third quarter of fiscal 2011 increased from 8.6% for the third quarter of fiscal 2010 due to increased sales of higher margin products and an improved product mix. Service Revenue Gross profit on service revenue was relatively constant at $3.7 million during the third quarter of fiscal 2011 compared with $3.5 million for the third quarter of fiscal 2010. Gross margin on service revenue at 57.7% for the third quarter of fiscal 2011 was relatively constant compared with 57.0% for the third quarter of fiscal 2010. Share-Based Compensation. During the third quarters of fiscal 2011 and 2010, we recorded share-based compensation expense of approximately $0.4 million and $0.3 million, respectively. Share-based compensation expense for the fourth quarter of fiscal 2011 is expected to be approximately $0.5 million. The following table summarizes share-based compensation by income statement caption (in thousands): Three months ended March 31, 2011 2010 Change Cost of product sales $ 2 $ 35 $ (33 ) Sales and marketing 12 52 (40 ) Research and development 88 73 15 General and administrative 335 117 218 $ 437 $ 277 $ 160 15 -------------------------------------------------------------------------------- Table of Contents Sales and Marketing Expenses. Sales and marketing expenses in the third quarter of fiscal 2011 decreased to $3.6 million from $4.7 million during the third quarter of fiscal 2010. The decrease of approximately $1.1 million, or 23.4%, was primarily the result of (i) a reduction of $0.4 million in employee related expenses in connection with our reduction in workforce that resulted in a decrease in the average headcount by 14 employees from the third quarter of fiscal 2010 to the third quarter of fiscal 2011, (ii) a reduction of $0.3 million in public relations and advertising costs, including contractor fees, due to reductions in marketing programs and reducing our scope of outsourced marketing projects and (iii) a decrease of $0.2 million in severance costs associated with the fiscal 2010 restructurings. Research and Development Expenses. Research and development expenses in the third quarter of fiscal 2011 increased to $2.0 million from $1.5 million during the third quarter of fiscal 2010. The increase of approximately $0.5 million, or 33.3%, was primarily a result of (i) an increase of $0.3 million in employee and related expenses associated with an increase in average headcount by five employees associated with the restructuring of our research and development department, including the addition of a chief technology officer and (ii) an increase of $0.1 million in outside contractor fees. General and Administrative Expenses. General and administrative expenses in the third quarter of fiscal 2011 increased to $2.9 million from $2.8 million during the third quarter of fiscal 2010. The increase of approximately $0.1 million, or 3.6%, was primarily a result of (i) an increase of $0.4 million in executive bonuses and (ii) an increase of $0.2 million in share-based compensation expense primarily associated with a grant of options in the third quarter of fiscal 2010 to executive officers. These increases were offset by (i) a decrease of $0.1 million in employee related expenses in connection with our reduction in workforce that resulted in a decrease in the average headcount by six employees from the third quarter of fiscal 2010 to the third quarter of fiscal 2011 and (ii) a decrease of $0.3 million in legal fees associated with our prior litigation with Crossroads which was settled in May 2010. Interest Expense. Interest expense in the third quarter of fiscal 2011 decreased to $0.2 million from $0.4 million in the third quarter of fiscal 2010. The decrease of approximately $0.2 million, or 50.0%, was primarily a result of a decrease in interest expense related to our non-OEM accounts receivable financing agreements. Other Income (expense), net. Other income (expense), net, during the third quarter of fiscal 2011 reflected expense of $0.2 million compared to income of $0.3 million during the third quarter of fiscal 2010. The decrease of approximately $0.5 million was primarily due to a decrease of foreign currency gains due to foreign currency fluctuations. Provision for (Benefit from) Income Taxes. Provision for (benefit from) income taxes during the third quarter of fiscal 2011 reflected a provision for income taxes of $0.1 million compared to a benefit of $1.9 million during the third quarter of fiscal 2010. The provision in the third quarter of fiscal 2011 primarily related to our pre-tax loss in the third quarter of fiscal 2011. The net benefit in the third quarter of fiscal 2010 primarily related to our net operating loss carry back recognized pursuant to amended IRC code section 172(b)(1)(H). The first nine months of fiscal 2011 compared to the first nine months of fiscal 2010 Net Revenue. Net revenue in the first nine months of fiscal 2011 decreased to $52.6 million from $58.4 million in the first nine months of fiscal 2010. The decrease of $5.8 million, or 9.9%, was primarily in our OEM channel related to decreased revenue from HP which represented approximately 18.9% of net revenue in the first nine months of fiscal 2011 compared with 23.9% of net revenue in the first nine months of fiscal 2010. Net revenue in our branded channel remained relatively constant. Product Revenue Net product revenue from OEM customers in the first nine months of fiscal 2011 decreased to $6.1 million from $11.4 million in the first nine months of fiscal 2010. The decrease of $5.3 million, or 46.5%, was primarily a result of decreased revenue from HP. Net product revenue from Overland branded products, excluding service revenue, was constant at $27.8 in the first nine months of fiscal 2011 and the first nine months of fiscal 2010. Service Revenue Net service revenue was relatively constant at $17.6 million in the first nine months of fiscal 2011 compared with $17.8 million in the first nine months of fiscal 2010. As a percentage of total revenue, service revenue increased 3.1% to 33.5% for the first nine months of fiscal 2011 compared to 30.4% in the first nine months of fiscal 2010. Royalty Fees Net royalty fees in the first nine months of fiscal 2011 decreased to $0.3 million from $0.4 million in the first nine months of fiscal 2010. The decrease was primarily the result of a decrease of $0.1 million in royalties from our VR2® products. 16 -------------------------------------------------------------------------------- Table of Contents Gross Profit. Gross profit in the first nine months of fiscal 2011 was relatively constant at $15.5 million compared to $15.7 million in the first nine months of fiscal 2010. Gross margin at 29.5% for the first nine months of fiscal 2011 increased from 26.9% for the first nine months of fiscal 2010 due to increased branded product revenue as a percentage of total revenue. Product Revenue Gross profit on product revenue in the first nine months of fiscal 2011 was relatively constant at $5.9 million compared to $5.8 million for the first nine months of fiscal 2010. Gross margin on product revenue at 16.9% for the first nine months of fiscal 2011 increased from 14.5% for the first nine months of fiscal 2010 due to increased sales of higher margin products and an improved product mix. Service Revenue Gross profit on service revenue was relatively constant at $9.4 million in the first nine months of fiscal 2011 compared with $9.5 million in the first nine months of fiscal 2010. Gross margin on service revenue at 53.2% for the first nine months of fiscal 2011 was relatively constant compared with 53.3% for the first nine months of fiscal 2010. Share-Based Compensation. During the first nine months of fiscal 2011 and 2010, we recorded share-based compensation expense of approximately $2.5 million and $0.5 million, respectively. The increase of approximately $2.0 million in the first nine months of fiscal 2011 compared to the first nine months of fiscal 2010 is primarily due to a grant of options in the third quarter of fiscal 2010 to acquire, in the aggregate, 1.8 million shares of our common stock to executive officers. In addition, in October 2010, we granted 463,000 restricted stock units, in the aggregate, to certain executives. The following table summarizes share-based compensation by income statement caption (in thousands): Nine months ended March 31, 2011 2010 Change Cost of product sales $ 8 $ 88 $ (80 ) Sales and marketing 526 170 356 Research and development 312 101 211 General and administrative 1,638 166 1,472 $ 2,484 $ 525 $ 1,959 Sales and Marketing Expenses. Sales and marketing expenses in the first nine months of fiscal 2011 decreased to $12.6 million from $13.5 million during the first nine months of fiscal 2010. The decrease of approximately $0.9 million, or 6.7%, was primarily the result of (i) a reduction of $0.8 million in employee related expenses in connection with our reduction in workforce that resulted in a decrease in the average headcount by five employees from the first nine months of fiscal 2010 to the first nine months of fiscal 2011, (ii) a decrease of $0.2 million in severance costs associated with the fiscal 2010 restructurings and (iii) a reduction of $0.2 million in public relations and advertising costs, including contractor fees, due to reductions in marketing programs and bringing previously outsourced projects in house. These decreases were partially offset by an increase of $0.4 million share-based compensation expense primarily associated with a grant of options in the third quarter of fiscal 2010 to executive officers. Research and Development Expenses. Research and development expenses in the first nine months of fiscal 2011 increased to $5.5 million from $4.4 million during the first nine months of fiscal 2010. The increase of approximately $1.1 million, or 25.0%, was primarily a result of (i) an increase of approximately $0.9 million in employee related expenses associated with an increase in average headcount by six employees associated with the restructuring of our research and development department, including the addition of a chief technology officer, (ii) an increase of $0.2 million in outside contractor fees and (iii) an increase of $0.2 million in share-based compensation expense primarily associated with a grant of options in the third quarter of fiscal 2010 to an executive officer. These increases were partially offset by a decrease of $0.3 million in development expense associated with the timing of new product development. General and Administrative Expenses. General and administrative expenses in the first nine months of fiscal 2011 increased to $9.6 million from $8.1 million during the first nine months of fiscal 2010. The increase of approximately $1.5 million, or 18.5%, was primarily a result of (i) an increase of $1.5 million in share-based compensation expense primarily associated with a grant of options in the third quarter of fiscal 2010 to executive officers, (ii) an increase of $0.4 million in executive bonuses and (iii) an increase of $0.3 million in outside contractor expenses, principally for financial and accounting services. These increases were partially offset by (i) a decrease of $0.6 million in legal fees associated with our prior litigation with Crossroads which was settled in May 2010 and (ii) a decrease of $0.3 million in severance expense associated with a former executive officer. 17 -------------------------------------------------------------------------------- Table of Contents Interest Expense. Interest expense in the first nine months of fiscal 2011 decreased to $1.0 million from $1.2 million during the first nine months of fiscal 2010. The decrease of approximately $0.2 million, or 16.7%, was primarily a result of a decrease in interest expense related to our non-OEM accounts receivable financing agreements. The first nine months of fiscal 2010 also included interest expense associated with our note payable to Anacomp of $0.2 million. Other Income (expense), net. Other income (expense), net, in the first nine months of fiscal 2011 reflected income of $2.5 million compared to income of $0.9 million during the first nine months of fiscal 2010. The increase of approximately $1.6 million 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 in the United States International Trade Commission against the same defendants. This increase was partially offset by a decrease of approximately $0.9 million in realized currency exchange gains due to foreign currency fluctuations. In the first nine months of fiscal 2010, we liquidated our auction rate securities resulting in a recognized gain of $0.5 million. Provision for (Benefit from) Income Taxes. Provision for (benefit from) income taxes during the first nine months of fiscal 2011 reflected a provision for income taxes of $0.2 million compared to a benefit of $1.8 million during the first nine months of fiscal 2010. The provision in the first nine months of fiscal 2011 primarily related to our pre-tax loss in the first nine months of fiscal 2011. The net benefit in the first nine months of fiscal 2010 primarily related to our net operating loss carry back recognized pursuant to amended IRC code section 172(b)(1)(H). Liquidity and Capital Resources At March 31, 2011, we had a cash balance of $16.7 million, compared to $8.9 million at June 30, 2010. 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 $13.9 million. Cash management and preservation continues to be a top priority. We expect to incur negative operating cash flows during the remainder of fiscal 2011 as we reshape our business model and seek to improve operational efficiencies. As of March 31, 2011, we had working capital of $13.6 million, reflecting $5.0 million increase in current assets and a $6.2 million decrease in current liabilities compared to June 30, 2010. The increase in current assets is primarily attributable to our private placement of common stock in March 2011. The decrease in current liabilities is primarily attributable to a $3.2 million decrease in accounts payable and accrued liabilities primarily related to operating activities, a $0.7 million reduction in debt related to the repayment of our note payable to Anacomp and a $2.3 million reduction in our current liabilities associated with our non-OEM accounts receivable financing arrangements. In November 2008, we entered into the Marquette Commercial Finance (MCF) Financing Agreement which provides up to $9.0 million (gross) of financing against domestic non-OEM accounts receivable. In March 2009, we entered into the Faunus Group International (FGI) Financing Agreement which provides up to $5.0 million (gross) of financing against foreign non-OEM accounts receivable. In April 2011, we terminated the FGI Financing Agreement pursuant to its terms and paid a $100,000 termination fee to FGI. Under the MCF Financing Agreement, we are not obligated to offer any accounts (invoices) in any month, and MCF has the right to decline to purchase any offered accounts (invoices). To date, individual invoices declined by MCF were considered immaterial to our accounts receivable balance, financial position and cash flows. A significant increase in rebates claimed as a percentage of our gross collections could lead to our failure to satisfy the dilution covenant. We were in compliance with the dilution covenant in the MCF Financing Agreement at March 31, 2011. We continue to monitor our compliance with the dilution covenant, which is based on the aggregate amount of credit memoranda, discounts and other downward adjustments to the original invoiced price divided by gross collections. Based upon our current operating assumptions, we expect to remain in compliance with the permissible dilution covenant throughout the remainder of fiscal 2011. We have projected that cash on hand 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, 2010 includes an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern. 18 -------------------------------------------------------------------------------- Table of Contents During the first nine months of fiscal 2011, we used $8.1 million in cash for operating activities compared to $9.3 million during the first nine months of fiscal 2010. This use of cash was primarily a result of our net loss of $10.8 million for the first nine months of fiscal 2011, 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 $0.4 million during the first nine months of fiscal 2011 compared to $1.9 million cash generated from investing activities in the first nine months of fiscal 2010. During the first nine months of fiscal 2011, we acquired intangible assets consisting of existing technology (acquired technology) for $150,000. Capital expenditures during the first nine months of fiscal 2011 and 2010 totaled $0.2 million and $144,000, respectively. Such expenditures were associated with machinery and equipment to support new product introductions. During the first nine months of fiscal 2010, we generated cash of approximately $2.0 million due to the liquidation of our auction rate securities. We generated cash from our financing activities of $16.2 million during the first nine months of fiscal 2011 compared to $11.9 million during the first nine months of fiscal 2010. 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 $13.9 million. In November 2010, we sold 3.4 million shares of our common stock to certain institutional investors at $1.25 per share for gross proceeds of $4.2 million (net proceeds of $4.0 million). During the first nine months of fiscal 2011, we made payments totaling $0.7 million against the Anacomp note, and repayments of $2.3 million for amounts funded under our non-OEM accounts receivable financing agreements. Cash generated from financing activities for the first nine months of fiscal 2010 primarily relates to the sale of 794,659 shares of Series A Convertible Preferred 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 (net proceeds of approximately $10.9 million) and the sale of 2.1 million 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 (net proceeds of approximately $3.7 million) offset by scheduled payments under the notes payable to Anacomp and Adaptec, which totaled $2.2 million during the first nine months of fiscal 2010. 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 any increases in raw material prices caused by inflation. If at any time we cannot pass on such increases, our margins could suffer. Our exposure to the effects of inflation could be magnified by the concentration of our OEM business, where our margins tend to be lower. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements or significant guarantees to third parties that are not fully recorded in our consolidated condensed balance sheets or fully disclosed in the notes to our consolidated condensed financial statements. Recent Accounting Pronouncements See Note 11 to our consolidated condensed financial statements for information about recent accounting pronouncements. |