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OVERLAND STORAGE INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions that are difficult to predict. Words and expressions reflecting optimism, satisfaction or disappointment with current prospects, as well as words such as "believes," "hopes," "intends," "estimates," "expects," "projects," "plans," "anticipates" and variations thereof, or the use of future tense, identify forward-looking statements, but their absence does not mean that a statement is not forward-looking. Such forward-looking statements are not guarantees of performance and our actual results could differ materially from those contained in such statements. Factors that could cause or contribute to such differences include, but are not limited to: our anticipated closing of the merger with Sphere 3D; our ability to successfully integrate the businesses of Tandberg Data with our other businesses; our ability to maintain and increase sales volumes of our products; our ability to continue to aggressively control costs and operating expenses; our ability to achieve the intended cost savings and maintain quality with our manufacturing partner; our ability to generate cash from operations; the ability of our suppliers to provide an adequate supply of components for our products at prices consistent with historical prices; our ability to raise outside capital and to repay our debt as it comes due; our ability to introduce new competitive products and the degree of market acceptance of such new products; the timing and market acceptance of new products introduced by our competitors; our ability to maintain strong relationships with branded channel partners; our ability to maintain the listing of our common stock on the NASDAQ Capital Market; customers', suppliers', and creditors' perceptions of our continued viability; rescheduling or cancellation of customer orders; loss of a major customer; our ability to enforce our intellectual property rights and protect our intellectual property (including the outcome of our ongoing patent litigation); general competition and price measures in the market place; unexpected shortages of critical components; worldwide information technology spending levels; and general economic conditions. In evaluating such statements we urge you to specifically consider various factors identified in this report, including the matters set forth under the heading "Risk Factors" in 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. Actual events or results may differ materially from such statements. Share and per share amounts herein have been adjusted to give effect to the April 9, 2014 one-for-five reverse stock split. We are a trusted global provider of unified data management and data protection solutions across the data lifecycle. We provide an integrated range of technologies and services for primary, nearline, offline, and archival data storage. Our solutions consolidate and protect data for easy and cost-effective management of different tiers of information whether the distributed data is local or global based. In May 2014, we announced that we entered into a definitive agreement for a proposed merger with Sphere 3D, which is intended to bring together next generation technologies for virtualization and cloud coupled with end-to-end scalable storage offerings, allowing the combined company to address the growing virtualization and cloud markets upon the consummation of the merger. We develop and deliver a comprehensive solution set of award-winning products and services for storing data throughout the organization and during the entire data lifecycle. Our SnapScale® clustered network attached storage ("NAS") products allow customers to scale-out in capacity and performance as their storage needs grow. Our SnapServer® products are unified NAS servers that integrate into businesses requiring simple, expandable block and file storage. Our SnapSAN® products are storage area network ("SAN") arrays designed to ensure primary and secondary data is accessible and protected regardless of its location. Our SnapScale®, SnapServer®, and SnapSAN® solutions are available with backup, replication, and mirroring software in highly scalable configurations. These solutions provide simplified disk-based data protection and maximum flexibility to protect mission critical data for both continuous local backup and remote disaster recovery. Our NEO Series®, StorageLoader®, and StorageLibrary® tape library solutions are designed to meet the need for cost-effective, reliable data storage for long-term archiving and data storage compliance requirements, offering a wide range of capacity, performance and feature sets. In January 2014, we completed our acquisition of Tandberg Data Holdings S.à r.l. ("Tandberg Data") which added a range of RDX® products including RDX QuikStor®, RDX QuikStation® and RDX® media, as well as additional tape automation solutions. Our RDX QuikStor® and QuikStation® removable media-based storage systems offer reliable and convenient storage for backup, archive, data interchange and disaster recovery. 23-------------------------------------------------------------------------------- Table of Contents 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 small and medium enterprises ("SMEs"), small and medium businesses ("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 "Part I, Item 1. Business" 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. The majority of our sales are generated from sales of our branded products through a worldwide channel, which includes systems integrators and VARs. We reported net revenue of $65.7 million for fiscal 2014, compared with $48.0 million for fiscal 2013. We incurred a net loss of $22.9 million, or $1.99 per share, for fiscal 2014 compared with a net loss of $19.6 million, or $3.41 per share, for fiscal 2013. Acquisition. In January 2014, we completed our acquisition of Tandberg Data, a privately held global leader of data storage and data protection solutions in exchange for shares of our common stock, and Tandberg Data became a wholly-owned subsidiary of the Company. Our financial position and operating performance include the financial position of Tandberg Data and operating performance from and after January 21, 2014. Liquidity and capital resources. At June 30, 2014, we had a cash balance of $4.3 million, compared to $8.8 million at June 30, 2013. In fiscal 2014, we incurred a net loss of $22.9 million. At June 30, 2014, we had a balance of $19.9 million recorded as long-term debt of which $14.5 million was owed to a related party. At June 30, 2014, our credit facility had a remaining external borrowing capacity of up to $2.6 million. Cash management and preservation continue to be a top priority. We expect to incur negative operating cash flows during the continued period of integration for our acquisition completed in January 2014 as we work to combine the entities and to improve operational efficiencies. Management has projected that cash on hand, our short-term investment (the common shares of Sphere 3D we own), available borrowings under our credit facility, and other sources of funding will be sufficient to allow us to continue operations for the next 12 months. Significant changes from our current forecasts, including, but not limited to: (i) shortfalls from projected sales levels, (ii) unexpected increases in product costs, (iii) increases in operating costs, (iv) changes to the historical timing of collecting accounts receivable, and/or (v) our inability to liquidate our short-term investment 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 (including from Sphere 3D), 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, and/or prevent us from consummating the proposed merger with Sphere 3D. We may seek debt, equity or equity-based financing (such as convertible debt) when market conditions and the merger agreement with Sphere 3D permit. As of June 30, 2014, we had working capital of $11.8 million, reflecting increases in current assets and current liabilities of $16.4 million and $11.4 million, respectively, during fiscal 2014. The increase in current assets and current liabilities as a whole, is related to our acquisition completed in January 2014. The increase in current assets is primarily attributable to (i) a $7.5 million increase in accounts receivable, a (ii) a $5.2 million increase in inventory, and a $7.8 million increase in our short-term investment in Sphere 3D, offset by a $4.6 million decrease in cash. The increase in current liabilities is primarily attributable to (i) a $7.7 million increase in accounts payable and accrued liabilities, (ii) a $1.9 million increase in other current liabilities, and (iii) a $1.4 24-------------------------------------------------------------------------------- Table of Contents million increase in accrued payroll and employee compensation related to an increase in average year-to-date headcount from our acquisition in January 2014. Recent Developments • In May 2014, we announced that we entered into a definitive agreement for a proposed merger with Sphere 3D. Pursuant to the terms of the merger agreement, upon the consummation of the merger, we would become a wholly owned subsidiary of Sphere 3D. The merger is expected to close in the second quarter of fiscal 2015. • In June 2014, we won "Tape-Based Product of the Year" at the 2014 Storage Awards for our NEO® 8000e tape library. • In July 2014, we settled all claims in our patent infringement litigation filed against BDT Media Automation GmbH ("BDT"). In connection with the settlement, we entered into a patent cross-license agreement with BDT. • In August 2014, we announced our collaboration with BitTorrent, Inc. to embed BitTorrent Sync™ within our SnapServer® NAS product line. This solution delivers an integrated, secure private cloud mobility solution, and synchronizes files between geographically-dispersed mobile devices, tablets, desktop clients, and networked storage systems with no transfer limits or subscription fees. • In August 2014, we launched the V3 hyper-converged virtual desktop appliances to address the rapidly-growing virtualization and cloud markets. Developed in partnership with Sphere 3D, the V3 appliances are the first in a series of planned turn-key solutions that will expand our product portfolio. The "purpose-built" V3 appliance delivers an easy-to-deploy virtual desktop solution with simplified management tools and lower total cost of ownership. • In August 2014, we announced the availability of our GuardianOS® 7.6 release software in a new desktop form factor NAS platform. With a small desktop footprint, the SnapServer XSD 40™ is the newest member of our scalable SnapServer® Series of NAS servers, and with SnapServer Manager™, it makes it easy for customers with small or remote offices to easily manage and protect their data from a central console. 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, net revenue and expenses, and related disclosure of contingent liabilities. We review our estimates on an ongoing basis. 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. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably possible could materially impact the financial statements. The footnotes to our consolidated financial statements also include disclosure of significant accounting policies. We believe the critical accounting policies below to be critical to the judgments, estimates and assumptions used in the preparation of the consolidated financial statements. Revenue Recognition We recognize revenue from sales of products when persuasive evidence of an arrangement exists, the price is fixed or determinable, collectibility 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. 25-------------------------------------------------------------------------------- Table of Contents Generally, title and risk of loss transfer to the customer when the product leaves our dock, except for our Tandberg Data subsidiary, where title and risk of loss generally transfer to the customer when the product arrives at the customer's location. 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. 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 write-down 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. Goodwill and Purchased Intangible Assets Goodwill is recorded when the consideration paid for an acquisition exceeds the fair value of net tangible and intangible assets acquired. Goodwill is measured and tested for impairment on an annual basis or more frequently if we believe indicators of impairment exist. Triggering events for impairment reviews may be indicators such as adverse industry or economic trends, restructuring actions, lower projections of profitability, or a sustained decline in our market capitalization. Purchased intangible assets are amortized on a straight-line basis over their economic lives of three to ten years for developed technology, and 15 years for customer relationships as the Company believes this method most closely reflects the pattern in which the economic benefits of the assets will be consumed. When the carrying value is not considered recoverable, an impairment loss for the amount by which the carrying value of an intangible asset exceeds its fair value is recognized, with an offsetting reduction in the carrying value of the related intangible asset. If our future results are significantly different than forecasted, we may be required to further evaluate its intangible assets for recoverability and such analysis could result in an impairment charge in a future period. Warranty Obligations 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. Warrants We have warrants to purchase common stock that are issued and outstanding and have been classified as equity. The terms of these warrants, in particular their anti-dilution provisions, are evaluated on an on-going basis to determine whether equity classification remains appropriate. If these warrants were classified as a liability obligation, then the warrants would be adjusted to fair value at each reporting period with the fair market value adjustments being recorded to earnings. 26-------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth certain financial data as a percentage of net revenue: Fiscal Year 2014 2013 Net revenue 100.0 % 100.0 % Cost of revenue 69.1 65.0 Gross profit 30.9 35.0 Operating expenses: Sales and marketing 28.0 36.6 Research and development 9.4 13.6 General and administrative 29.9 24.1 67.3 74.3 Loss from operations (36.4 ) (39.3 ) Other income (expense), net (2.3 ) (1.2 ) Loss before income taxes (38.7 ) (40.5 ) Provision for income taxes (3.9 ) 0.3 Net loss (34.8 )% (40.8 )% A summary of the sales mix by product follows: Fiscal Year 2014 2013 Disk systems 38.3 % 20.0 % Tape automation systems 21.6 35.0 Tape drives and media 13.7 5.1 Service 26.4 39.9 100.0 % 100.0 % Fiscal 2014 compared with Fiscal 2013 Net Revenue. Net revenue increased to $65.7 million during fiscal 2014 from $48.0 million during fiscal 2013, an increase of $17.7 million, or 36.9%. The increase in net revenue, is related to our acquisition completed in January 2014, which contributed $25.5 million in net revenue in fiscal 2014. The increase from our acquisition was partially offset by a $3.5 million decrease in revenue from our branded products, primarily as a result of decreased sales volumes of our products sold in the Americas and EMEA regions, and a $3.5 million decrease in service revenue. OEM revenue represented approximately 15.0% of net revenue in fiscal 2014 compared to 12.2% of net revenue fiscal 2013. Product Revenue Net product revenue increased to $48.4 million during fiscal 2014 from $28.8 million during fiscal 2013. The increase of approximately $19.6 million, or 68.1%, resulted from our acquisition that was completed in January 2014, which contributed $23.8 million of product revenue in fiscal 2014. The increase from our acquisition was offset by a decrease in revenue from our branded products due to a decrease in sales of our tape automation systems of $4.2 million. 27-------------------------------------------------------------------------------- Table of Contents Service Revenue Net service revenue decreased to $17.3 million during fiscal 2014 from $19.2 million during fiscal 2013. The decrease of approximately $1.9 million, or 9.9%, was primarily due to decreased service revenue from extended service contracts primarily related to lower tape automation system sales in EMEA and the Americas regions, offset by $1.7 million of service revenue generated by our acquisition that was completed in January 2014. Gross Profit. Overall gross profit increased to $20.3 million during fiscal 2014 compared to $16.8 million during fiscal 2013. Gross margin decreased to 30.9% during fiscal 2014 from 35.0% during fiscal 2013. The decrease in overall gross margin was primarily due to a 13.6% decrease in our service revenue as a percentage of net revenue, whereby service revenue typically has a higher gross margin than product revenue. The change to the net revenue mix was primarily related to our acquisition completed in January 2014. Product Revenue Gross profit on product revenue during fiscal 2014 was $10.2 million compared to $3.9 million during fiscal 2013. The increase of $6.3 million, or 162%, was primarily due increase sales volumes related to our acquisition completed in January 2014. Gross margin on our products was 21.1% for fiscal 2014 compared to 13.5% for fiscal 2013 due to higher margins for the sale of products we acquired through our acquisition that was completed in January 2014. Service Revenue Gross profit on service revenue during fiscal 2014 was $10.1 million compared to $12.9 million during fiscal 2013. The decrease of $2.8 million, or 21.7%, was primarily due to a decrease in extended service contracts related to a decrease in product sales. Gross margin on service revenue was 58.4% for fiscal 2014 compared to 67.3% for fiscal 2013 due to allocation of fixed costs over a smaller revenue base. Sales and Marketing Expense. Sales and marketing expense in fiscal 2014 increased to $18.4 million from $17.6 million during fiscal 2013. The increase of $0.8 million, or 4.5%, was primarily a result of an increase of $2.2 million in employee and related expenses associated with an increase in our average headcount after our acquisition completed in January 2014; offset by a decrease of $0.7 million in share-based compensation expense, and a decrease of $0.5 million in public relations and advertising expense. Research and Development Expense. Research and development expense in fiscal 2014 decreased to $6.2 million from $6.5 million during fiscal 2013. The decrease of $0.3 million, or 4.6%, was primarily a result of a decrease in outside contractors as well as a decrease in employee and related expenses associated with a decrease in our average headcount. General and Administrative Expense. General and administrative expense in fiscal 2014 increased to $19.7 million from $11.6 million during fiscal 2013. The increase of $8.1 million, or 69.8%, was primarily a result of a $3.4 million increase in legal and advisory expenses primarily related to the completion and integration of our acquisition in January 2014 and our proposed merger with Sphere 3D announced in May 2014, a $2.8 million increase in employee related expenses primarily associated with an increase in headcount, and a $1.8 million increase in outside contractor expenses, each primarily related to the completion and integration of our acquisition in January 2014. Interest Expense. We incurred interest expense of $1.2 million and $0.6 million during fiscal 2014 and 2013, respectively. The increase was primarily related to interest expense for the convertible notes we sold in fiscal 2014. Other Income (Expense), Net. During fiscal 2014, we incurred $0.3 million of other income (expense), net, compared with $13,000 of expense during fiscal 2013. In fiscal 2014, other income (expense), net primarily related to realized foreign currency losses. Provision for Income Taxes. During fiscal 2014, we recognized income tax benefit of $2.6 million compared to a tax expense of $0.2 million in fiscal 2013. In fiscal 2014, the tax benefit primarily related to unrealized gains on our related party short-term investment, which will adjust as the unrealized gains change or when the unrealized gains are realized. In fiscal 2013, the tax expense primarily related to taxes for our foreign subsidiaries. 28-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources At June 30, 2014, we had a cash balance of $4.3 million, compared to $8.8 million at June 30, 2013. In fiscal 2014, we incurred a net loss of $22.9 million. At June 30, 2014, we had a balance of $19.9 million recorded as long-term debt of which $14.5 million was owed to a related party. At June 30, 2014, our credit facility had a remaining external borrowing capacity of up to $2.6 million. Cash management and preservation continue to be a top priority. We expect to incur negative operating cash flows during the continued period of integration for our acquisition completed in January 2014 as we work to combine the entities and to improve operational efficiencies. As of June 30, 2014, we had working capital of $11.8 million, reflecting decreases in current assets and current liabilities of $16.4 million and $11.4 million, respectively, during fiscal 2014. The increase in current assets and current liabilities as a whole, is related to our acquisition completed in January 2014. The increase in current assets is primarily attributable to (i) a $7.5 million increase in accounts receivable, a (ii) a $5.2 million increase in inventory, and a $7.8 million increase in our short-term investment in Sphere 3D, offset by a $4.6 million decrease in cash. The increase in current liabilities is primarily attributable to (i) a $7.7 million increase in accounts payable and accrued liabilities, (ii) a $1.9 million increase in other current liabilities, and (iii) a $1.4 million increase in accrued payroll and employee compensation related to an increase in average year-to-date headcount from our acquisition in January 2014. Management has projected that cash on hand, our short-term investment (the common shares of Sphere 3D we own), available borrowings under our credit facility, and other sources of funding will be sufficient to allow us to continue operations for the next 12 months. Significant changes from our current forecasts, including, but not limited to: (i) shortfalls from projected sales levels, (ii) unexpected increases in product costs, (iii) increases in operating costs, (iv) changes to the historical timing of collecting accounts receivable, and/or (v) our inability to liquidate our short-term investment 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 (including from Sphere 3D), 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, and/or prevent us from consummating the proposed merger with Sphere 3D. We may seek debt, equity or equity-based financing (such as convertible debt) when market conditions and the merger agreement with Sphere 3D permit. 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, 2014 includes an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern. During fiscal 2014, we used cash in operating activities of $19.0 million, compared to $14.0 million in fiscal 2013. The use of cash during fiscal 2014 was primarily a result of our net loss of $22.9 million offset by $4.4 million in non-cash items, which were primarily share-based compensation, deferred tax benefit, depreciation and amortization. In addition, we had decreases in inventory and deferred revenue. We generated cash in investing activities of $0.9 million during fiscal 2014, compared to cash used in investing activities of $1.0 million in fiscal 2013. In fiscal 2014, we assumed $1.7 million of cash and $0.4 million of restricted cash (no longer restricted at the end of fiscal 2014) from our acquisition completed in January 2014, offset by $0.3 million of intangible assets purchased related to a technology license agreement. During both fiscal 2014 and 2013, capital expenditures totaled $1.0 million. In fiscal 2014, such expenditures were primarily associated with the implementation of a new enterprise resource planning system. In fiscal 2013, such expenditures were associated with machinery and equipment to support quality assurance, as well as computer equipment and software associated with the replacement of our enterprise resource planning system. We generated cash from our financing activities of $13.5 million during fiscal 2014, compared to $13.3 million during fiscal 2013. During fiscal 2014, we received $7.0 million from the sale of our convertible notes, $5.0 million from a note payable with a related party, and $1.9 million from net proceeds from our credit facility; offset by $0.5 million paid for taxes for net settlement of restricted stock units. During fiscal 2013, we received $13.25 million (net proceeds of approximately $13.0 million) from the sale of our convertible notes, $1.0 million from the issuance of common stock; offset by $0.8 million paid for taxes for net settlement of restricted stock units. 29-------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Arrangements During the ordinary course of business, we provide standby letters of credit to third parties as required for certain transactions initiated by us. As of June 30, 2014, we had standby letters of credit of $0.7 million that were not recorded on our consolidated balance sheets. Contractual Obligations The following schedule summarizes our contractual obligations to make future payments at June 30, 2014 (in thousands): Less than After 5 Contractual Obligations Total 1 year 1-3 years 4-5 years years Long-term debt - related party, including interest(1) $ 18,139 $ 1,025 $ 4,502 $ 12,612 $ - Credit facility 5,407 - 5,407 - - Operating lease obligations (2) 7,948 2,690 3,637 1,601 20 Purchase obligations(3) 2,461 2,461 - - - Total contractual obligations $ 33,955 $ 6,176 $ 13,546 $ 14,213 $ 20 Other commercial commitments: Letters of credit $ 662 $ 662 $ - $ - $ - ________________(1) Long-term debt includes our related party notes. Interest payments have been calculated using the amortization profile of the debt outstanding at June 30, 2014, taking into account the fixed rate paid at our fiscal year end. (2) Represents contractual lease obligations under non-cancelable operating leases. (3) Represents purchase orders for inventory and non-inventory items entered into prior to June 30, 2014, with purchase dates extending beyond July 1, 2014. Some of these purchase obligations may be canceled. 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. 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 foreign subsidiaries 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 resulted in a loss of $353,000 and $19,000 for fiscal 2014 and fiscal 2013, respectively. 30-------------------------------------------------------------------------------- Table of Contents |