Description
Overland Storage, Inc. 10% Owner GROUP INC CLINTON bought 2,879,718 shares on 9-11-2012 at $ 1.77
BUSINESS OVERVIEW
Overview
We are a trusted global provider of unified data management and data protection solutions designed to enable small and medium enterprises (“SMEs”), distributed enterprises, and small and medium businesses (“SMBs”) to anticipate and respond to data storage requirements. Whether an organization's data is locally or globally based, our solutions consolidate and protect data for easy and cost-effective management of different tiers of information. We enable companies to expend fewer resources on information technology (“IT”) allowing them to focus on being more responsive to the needs of their customers.
We develop and deliver a comprehensive solution set of award-winning products and services for storing data throughout the organization and during the entire data lifecycle. Our SnapServer ® product is a complete line of network attached storage (“NAS”) products, and our SnapSAN ™ products are storage area network (“SAN”) solutions designed to ensure primary and secondary data is accessible and protected regardless of its location. Our SnapServer ® and SnapSAN ™ solutions are available with backup, replication and mirroring software in highly scalable configurations. These solutions provide simplified disk-based data protection and maximum flexibility to protect mission critical data for both continuous local backup and remote disaster recovery. Our NEO SERIES ® and REO SERIES ® libraries are tape and virtual tape solutions designed to meet the need for cost-effective, reliable data storage for long-term archiving and compliance requirements.
Our approach emphasizes long-term investment protection for our customers and reduces the complexities and ongoing costs associated with storage management. Moreover, most of our products are designed with a scalable architecture which enables companies to purchase additional storage as needed, on a just-in-time basis, and make it available instantly without downtime.
End users of our products include SMEs, SMBs, distributed enterprise companies such as divisions and operating units of large multi-national corporations, governmental organizations, and educational institutions. Our products are used in a broad range of industries including financial services, video surveillance, healthcare, retail, manufacturing, telecommunications, broadcasting, research and development and many others.
We sell our solutions worldwide in the Americas, Europe, the Middle East and Africa (“EMEA”) and the Asia Pacific (“APAC”) region. We generate sales of our branded products through a worldwide channel, which consists of commercial distributors, direct market resellers (“DMRs”) and value-added resellers (“VARs”).
We were incorporated in California in 1980 as Overland Data, Inc., and changed our name to Overland Storage, Inc. in 2002. Our headquarters is located at 9112 Spectrum Center Boulevard, San Diego, California 92123, and our telephone number is (858) 571-5555 .
Our Direction and Strategy
In today's business environment, we believe that improving productivity and effectively managing digital assets, while controlling operating expenses, has become one of the top priorities for organizations worldwide. At the same time, we believe that the cost and complexity of managing vital information has risen exponentially. As a result of these opposing forces, we believe that many companies find themselves lacking the essential resources and expertise required to adequately manage information across their businesses and they continue to spend a significant portion of their time and money tying isolated islands of data together. Without an effective alternative to mitigate the cost and complexity of traditional approaches, their data simply cannot be effectively shared and sufficiently protected. We provide solutions designed to deliver enterprise features with the simplicity that allows organizations to reduce the cost of managing and protecting their information. Our comprehensive data storage and protection solutions are designed to enable IT managers to easily and cost effectively share and preserve critical and non-critical data across their organizations and to provide continuous access, replication for disaster recovery, and reduced backup windows for improved business continuity.
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 Serial Advanced Technology Attachment (“SATA”) drives, high performance Serial Attached SCSI (“SAS”) drives and Solid State Drives (“SSDs”). International Data Corporation (“IDC”) estimates that the total 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 our SnapServer ® 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 31.4% and 37.7% of our revenue during fiscal 2012 and 2011, respectively.
Our Products and Services
Our data management and data protection solutions provide SMEs, SMBs, distributed enterprises and branch offices with disk-based systems for primary or nearline storage, disk backup and recovery, and software for data management and protection. For long-term storage requirements, we offer automated tape solutions for tape backup and archive.
Data Management Software
Our GuardianOS ™ storage-optimized platform OS is designed for SnapServer ® NAS devices to deliver simplified data management and consolidation throughout distributed IT environments. The GuardianOS ™ platform provides a flexible solution for storage infrastructures, combining cross-platform file sharing with block-level data access on a single device. In addition to a unified storage architecture, the GuardianOS ™ platform offers scalability through features such as DynamicRAID ™ , centralized storage management and a comprehensive suite of data protection tools. The flexibility and scalability of GuardianOS ™ reduces the total cost of ownership of storage infrastructures.
Our Snap Enterprise Data Replicator ® (“Snap EDR”) provides multi-directional, WAN-optimized replication for SnapServer ® systems. With Snap EDR, administrators can automatically replicate data between multiple SnapServer systems for data distribution, data consolidation, and disaster recovery.
Research and Development
We incurred research and development costs of $8.1 million and $7.7 million in fiscal 2012 and 2011, representing 13.7% and 10.9% of net revenue, respectively. In fiscal 2012, we continued to augment our product lines by expanding our hardware platforms and feature enhancements to our software. Noteworthy product releases for fiscal 2012 included the SnapServer ® DX Series with DynamicRAID ™ . Our plans for fiscal 2013 include hardware and software enhancements across all of our product lines. Particular areas of focus are the introduction of the next generation SnapSAN solutions, Scale-out NAS products, cloud capabilities and enterprise storage software.
Manufacturing and Suppliers
We perform product assembly, integration and testing at our manufacturing facility in San Diego, California. We purchase servers, tape drives, chassis, printed circuit boards, integrated circuits, and all other major components from outside suppliers. We carefully select suppliers based on their ability to provide quality parts and components which meet technical specifications and volume requirements. We actively monitor these suppliers but we are subject to substantial risks associated with the performance of our suppliers. For certain components, we qualify only a single source, which magnifies the risk of shortages and decreases our ability to negotiate with that supplier. See “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” under the heading “Risk Factors” in Part I, Section 1A of this report. We had $0.1 million of firm backlog orders at June 30, 2012 and 2011.
We have occupied our current headquarters and manufacturing facility since March 2002. 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 San Diego headquarters is subject to a 12-year lease with one five-year extension option. Currently, we have the capacity to support unit production levels several times greater than the current rate of production. In order to accommodate normal business fluctuations and control staffing levels carefully to meet customer requirements at any time, we augment our direct labor force by employing temporary staff from time to time.
Competition
The worldwide storage market is highly competitive. Competitors vary in size from small start-ups to large multi-national corporations which may have substantially greater financial, research and development and marketing resources. In the tape automation market, we believe our primary competitors are Dell Inc. (“Dell”), Hewlett-Packard Company, Spectra Logic and Quantum Corporation. Key competitive factors include product features, reliability, durability, scalability and price. Barriers to entry in tape automation are relatively high.
Our primary disk-based platform competitors are EMC Corporation (both branded EMC and Iomega division), NetGear, Inc., NetApp, Inc., HP, IBM, and Dell. Key competitive factors in these markets include performance, functionality, scalability, availability, interoperability, connectivity, time to market enhancements and total value of ownership. Barriers to entry for disk-based backup products are low.
The markets for all of our products are characterized by significant price competition and we anticipate that our products will continue to face price pressure.
Proprietary Rights
General — We presently hold 33 United States patents and we have eight United States patents pending. In general, these patents have a 20-year term from the first effective filing date for each patent. The patents that are material to our business will begin to expire in November 2015. We also hold a number of foreign patents and patent applications for certain of our products and technologies. These rights, however, may not prevent competitors from developing products substantially equivalent or superior to our products. In addition, our present and future patents may be challenged, invalidated or circumvented, reducing or eliminating our proprietary protection. We continue to be diligent about maintaining our patent portfolio and monitoring potential infringement of our patents.
VR 2® Technology — We have entered into various intellectual property licensing agreements relating to our VR 2® technology. These agreements require the payment of royalty fees based on sales by licensees of products containing our VR 2® technology.
Employees
As of June 30, 2012, we had 184 full-time employees and 3 part-time employees, including 79 in sales and marketing, 33 in research and development, 50 in manufacturing and operations and 25 in finance, information systems, human resources and other management. There are no collective bargaining contracts covering any of the employees and we believe that our relationship with our employees is good.
Financial Information about Segments and Geographic Areas
We operate our business in one reportable segment. For information about our revenues from external customers, measures of profits, losses and total assets, and our revenues from external customers and long-lived assets broken down by geographic area, see Note 1 (Operations and Summary of Significant Accounting Policies-“Segment Data” and “Information about Geographic Areas”) to our consolidated financial statements.
Recent Developments
In July 2012, we released the SnapSAN ™ 3000 for midrange businesses, and the SnapSAN ™ 5000 for the enterprise, which replaced the SnapSAN ™ S2000. Both systems are highlighted by features like thin provisioning, volume cloning, synchronous and asynchronous remote replication, snapshots and disk spin down for reduced power consumption. The SnapSAN ™ 5000 offers additional performance, SSD integration for caching and policy-based tiering, and performance analysis, tuning and compliance tools.
In August 2012, we announced that Randy Gast joined us as Senior Vice President of Strategic Alliances and Client Services.
Additional Information
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available on our website at http://www.overlandstorage.com , free of charge, as soon as reasonably practicable after we electronically file such reports with, or furnish those reports to, the Securities and Exchange Commission. The contents of our website are not a part of this report.
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 forecasts, including, but not limited to: (i) shortfalls from projected sales levels, (ii) unexpected increases in product costs, (iii) increases in operating costs and/or (iv) changes 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.
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 seven fiscal years and we anticipate continued losses during fiscal 2013. As of June 30, 2012, we had an accumulated deficit of $112.7 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, 2012 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.
In 2010, we implemented cost reduction efforts, including reductions in our worldwide 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.
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 effect 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 SnapServer ® 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.
CEO BACKGROUND
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 prior experience as a director and Chief Executive Officer of Summa Four, along with his experience from his career in related industries and as a board member of other public technology companies, provides our 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. (“Intuit”), 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 Hewlett Packard Company (“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 International Business Machines Corporation (“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 of directors 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 our 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 Senior 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. Since June 2011, 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 September 2011, Mr. De Perio has been the President and Vice Chairman of ROI Acquisition Corp. (Nasdaq: ROIQ). In April 2011, Mr. De Perio was elected to our Board of Directors pursuant to the terms of the Purchase Agreement. Mr. De Perio’s experience as an investor in public technology companies enables him to provide our Board of Directors with insights as to the perspectives of our institutional shareholder base.
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. (“Adaptec”). From August 2002 to July 2004, he served as President and Chief Executive Officer 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 our President and Chief Executive Officer provides our Board of Directors with unique insight and direct access to strategic and operational information about us. 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 us.
Scott McClendon has served as the Executive Chairman of our Board of Directors since May 2011 and, from March 2001 to May 2011, served as Chairman of our Board of Directors. 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 Chairman of our Board of Directors, 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 his current experience as the Executive Chairman of our Board of Directors and director of Procera provide him with a unique set of managerial, operational and strategic skills, which provides our Board of Directors insights into our challenges, opportunities and operations.
Shmuel Shottan served as Chief Technology Officer of BlueArc Corporation (“BlueArc”), a supplier of enterprise Network Attached Storage (“NAS”) from September 2001 to September 2011 and Senior Vice President of Engineering of BlueArc from September 2001 to April 2006. In September 2011, BlueArc was acquired by Hitachi Data Systems Corporation, a supplier of mid-range and high-end storage systems, where Mr. Shottan holds the position of Vice President of Product Operations and Technology. 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 our 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 our Board of Directors on new product initiatives.
MANAGEMENT DISCUSSION FROM LATEST 10K
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, and earning royalties on our licensed technology. The majority of our sales are generated from sales of our branded products through a worldwide channel, which includes systems integrators and VARs.
Business Transition. During the fourth quarter of fiscal 2011, we fulfilled all our obligations for supply of tape libraries to our sole OEM customer; however, we will continue to provide spare parts and services under the agreement. In fiscal 2012, revenue from our sole OEM customer decreased by 23.2% compared to fiscal 2011. OEM product revenue, including spare parts, accounted for 3.9% and 10.3% of sales in fiscal 2012 and 2011, respectively. OEM total revenue accounted for 17.0% and 18.8% of net revenues in fiscal 2012 and 2011, respectively.
We reported net revenue of $59.6 million for fiscal 2012, compared with $70.2 million for fiscal 2011. The decline in net revenue resulted in a net loss of $16.2 million , or $0.66 per share, for fiscal 2012 compared with a net loss of $14.5 million , or $0.94 per share, for fiscal 2011.
Intellectual property rights . In August and October 2010, we filed patent infringement lawsuits in the United States District Court for the Southern District of California and United States International Trade Commission (“ITC”), respectively, against various parties. Both lawsuits claim infringement of two of our United States patents, Nos. 6,328,766 and 6,353,581.
In November 2011, we entered into a multi-year settlement and cross-licensing agreement with IBM pursuant to which we released all claims we had against Dell and IBM in the United States District Court for the Southern District of California and at the ITC. However, our infringement case against BDT AG and its affiliates continues.
In July 2012, the ITC released the public version of the Initial Determination, which finds that the six asserted claims of U.S. Patent No. 6,328,766 are valid. The Initial Determination finds no infringement of United States Patent No. 6,353,581. We petitioned the full Commission of the ITC for a review of some of the Initial Determination findings. The Commission has decided to review in part the Initial Determination on its merits and the Commission is expected to issue its decision in a final determination by October 22, 2012. See “Item 3. Legal Proceedings” for additional information on the patent litigation lawsuits.
In June 2012, we filed five additional patent infringement lawsuits in the United States District Court for the Southern District of California against seven companies. See “Item 3. Legal Proceedings” for additional information on these patent litigation lawsuits.
In August 2012, Quantum Corporation filed counterclaims against us in the United States District Court for the Southern District of California action, alleging trademark infringement and unfair competition claims, and infringement of United States Patent Nos. 5,491,812, 6,542,787, 6,498,771 and 5,925,119 by our products. Quantum is seeking monetary damages from us and injunctive relief.
Liquidity and capital resources. At June 30, 2012, we had a cash balance of $10.5 million , compared to $10.2 million at June 30, 2011. In fiscal 2012, we incurred a net loss of $16.2 million . During the third quarter of fiscal 2012, we sold an aggregate of 3,640,000 shares of our common stock for gross proceeds of approximately $7.3 million and net proceeds of approximately $6.6 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 year 2012 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 forecasts, including but not limited to: (i) shortfalls from projected sales levels, (ii) unexpected increases in product costs, (iii) increases in operating costs and/or (iv) changes in the historical timing of collecting accounts receivable could have a material adverse impact on our liquidity. This could force us to make further reductions in spending, extend payment terms with suppliers, liquidate assets where possible and/or suspend or curtail planned programs. Any of these actions could materially harm our business, results of operations and future prospects.
As of June 30, 2012, we had working capital of $7.4 million , reflecting decreases in current assets and current liabilities of $2.1 million and $0.8 million , respectively, during fiscal 2012. The decrease in current assets is primarily attributable to a $1.8 million decrease in accounts receivable due to lower sales, and a $1.9 million decrease in other current assets primarily due to a decrease in prepaid service contracts. These decreases were offset by a $1.2 million increase in inventory due to significant purchases at fiscal year end for the first quarter of fiscal 2013 product sales, and $0.3 million increase in cash. The decrease in current liabilities is primarily attributable to a $0.9 million decrease in the fair value of an equity award, offset by a slight increase in accounts payable and accrued liabilities related to operating activities.
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, high performance SAS (Serial Attached SCSI) and Solid State Drives (“SSDs”) drives. IDC estimates that the total NAS market will grow at approximately 9.1% through 2015, and the growth rate for NAS storage systems in price bands up to $15,000, where our SnapServer ® solutions lie, is estimated to be 17.3%. 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 31.4% and 37.7% of our revenue during fiscal 2012 and 2011, respectively.
Recent Developments
In July 2012, we released the SnapSAN ™ 3000 for midrange businesses, and the SnapSAN ™ 5000 for the enterprise, which replaced the SnapSAN ™ S2000. Both systems are highlighted by features like thin provisioning, volume cloning, synchronous and asynchronous remote replication, snapshots and disk spin down for reduced power consumption. The SnapSAN ™ 5000 offers additional performance, SSD integration for caching and policy-based tiering, and performance analysis, tuning and compliance tools.
In August 2012, we announced that Randy Gast joined us as Senior Vice President of Strategic Alliances and Client Services.
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 consolidated 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, 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.
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.
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 (“VR 2® ”) technology with third parties. The licensees pay us a royalty fee for sales of their products that incorporate our VR 2® 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 VR 2® technology.
Allowance for Doubtful Accounts
We estimate our allowance for doubtful accounts based on an assessment of the collectibility 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, 2012 would have affected our net loss by $0.5 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.
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.
Fiscal 2012 Compared with Fiscal 2011
Net Revenue. Net revenue decreased to $59.6 million during fiscal 2012 from $70.2 million during fiscal 2011, a decrease of $10.6 million, or 15.1%. The decline was due to lower revenue from our Overland branded products primarily as a result of decreased sales volumes in our taped-based and disk-based products sold in the Americas and EMEA. In addition, decreased revenues from our sole OEM customer represented approximately 29.0% of the overall decrease in revenues, as a result of the fulfillment of all our obligations for the supply of tape libraries in the fourth quarter of fiscal 2011.
Product Revenue
Net product revenue decreased to $35.2 million during fiscal 2012 from $45.7 million during fiscal 2011. The decrease of approximately $10.5 million, or 23.0%, was primarily associated with (i) a decrease of $4.2 million in OEM revenue related to the fulfillment of our obligations under the product supply portion of an agreement with our sole OEM customer, (ii) $3.5 million decrease in sales of our NEO ® products, (iii) $1.2 million decrease in sales of our SnapServer ® products, (iv) $1.1 million decrease in sales of spare parts, and (v) $0.4 million decrease in sales of our REO ® products. The decrease in sales of our SnapServer ® products was primarily attributable to two factors: (i) we increased the selling price of our SnapServer ® products as a result of the increased cost of disk drives due to the severe flooding in Thailand in October 2011, which negatively impacted short-term demand for these products; and (ii) the production ramp-up time for our newly launched disk-based products was longer than originally anticipated, which has caused customers to delay orders.
Service Revenue
Net service revenue was relatively constant at $24.3 million during fiscal 2012 compared to $24.2 million during fiscal 2011.
Royalty Fees
Net royalty fees decreased to $0.2 million during fiscal 2012 from $0.3 million during fiscal 2011. The decrease of $0.1 million, or 33.3%, was primarily associated with lower VR 2® technology royalties. VR 2® technology royalties during fiscal 2012 totaled $0.1 million compared with $0.2 million during fiscal 2011.
Gross Profit. Overall gross profit decreased to $19.2 million during fiscal 2012 compared to $21.2 million during fiscal 2011. Gross margin increased to 32.1% during fiscal 2012 from 30.2% during fiscal 2011 primarily related to the increase in higher margin service revenue as a percentage of total revenue.
Product Revenue
Gross profit on product revenue during fiscal 2012 was $4.9 million compared to $7.5 million during fiscal 2011. The decrease of $2.6 million, or 34.7%, was primarily due to the 23.0% decrease in net product revenue. Gross margin on product revenue at 13.9% for fiscal 2012 decreased from 16.5% for fiscal 2011. This decrease was primarily due to increased prices for disk drives for our disk-based products as a result of the flooding in Thailand in October 2011, as well as additional production costs incurred when we launched our new disk based products.
Service Revenue
Gross profit on service revenue during fiscal 2012 was $14.1 million compared to $13.3 million during fiscal 2011. The increase of $0.8 million, or 6.0%, was primarily due to our performing an increasing portion of service repair internally beginning the third quarter of fiscal 2011, rather than utilizing third-party vendors. Gross margin on service revenue at 58.2% for fiscal 2012 increased from 55.0% for fiscal 2011.
Sales and Marketing Expense. Sales and marketing expense in fiscal 2012 decreased to $16.2 million from $16.4 million during fiscal 2011. The decrease of $0.2 million, or 1.2%, was primarily a result of a decrease of $0.7 million in employee and related expenses associated with a decrease in the average headcount, offset by an increase of $0.3 million in public relations and advertising expense, including contractor fees, due to reductions in marketing programs and bringing previously outsourced projects in house, and an increase of $0.2 million in share-based compensation expense primarily associated with options granted to an executive officer.
Research and Development Expense. Research and development expense in fiscal 2012 increased to $8.1 million from $7.7 million during fiscal 2011. The increase of $0.4 million, or 5.2%, was primarily a result of an increase of $0.3 million in development expense associated with new product development, and an increase of $0.1 million in share-based compensation expense primarily associated with options granted to an executive officer.
General and Administrative Expense. General and administrative expense in fiscal 2012 decreased to $11.8 million from $12.7 million during fiscal 2011. The decrease of $0.9 million, or 7.1%, was primarily a result of (i) a decrease of $1.5 million in in employee related expenses associated with a decreases in average headcount and facility costs related to the downsizing of our San Diego facility, (ii) a decrease of $0.8 million in outside contractor and audit expenses, principally for financial and accounting services, and (iii) a decrease of $0.3 million in fees as a result of the termination of our two non-OEM financing agreements. These decreases were offset by an increase of $1.6 million in share-based compensation expense primarily associated with options granted to executive officers, and an increase of $0.2 million in legal fees.
Interest Income. We generated interest income of $0.4 million during fiscal 2012 related to the recovery of accounts receivable in our foreign subsidiaries previously written off in fiscal 2003. We had no interest income in fiscal 2011.
Interest Expense. We incurred interest expense of $0.1 million and $1.1 million during fiscal 2012 and 2011, respectively. The decrease was primarily a result of the termination of our two non-OEM financing agreements. Interest expense in fiscal 2012 was related to borrowings on our credit facility.
Other Income (expense), net. During fiscal 2012, we incurred other income (expense), net, of $0.7 million of income compared with $2.5 million of income during fiscal 2011. The change of $1.8 million, or 72.0%, was primarily due to the receipt of $0.5 million in fiscal 2012 related to the recovery of accounts receivable in our foreign subsidiaries previously written off in 2003, compared to the receipt of $3.0 million in fiscal 2011 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 lawsuits. In addition, we realized $0.2 million in foreign currency gains in fiscal 2012, compared to $0.5 million in realized foreign currency losses in fiscal 2011.
Provision for Income Taxes. During fiscal 2012, we recognized income tax expense of $0.1 million compared to $0.3 million in fiscal 2011. The decrease of $0.2 million is primarily due to a reduction in tax rate for our foreign operations.
Liquidity and Capital Resources
At June 30, 2012, we had a cash balance of $10.5 million , compared to $10.2 million at June 30, 2011. In fiscal 2012, we incurred a net loss of $16.2 million . During the third quarter of fiscal 2012, we sold an aggregate of 3,640,000 shares of our common stock for gross proceeds of approximately $7.3 million and net proceeds of approximately $6.6 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 2012 as we continue to reshape our business model and further improve operational efficiencies.
As of June 30, 2012, we had working capital of $7.4 million , reflecting decreases in current assets and current liabilities of $2.1 million and $0.8 million , respectively, during fiscal 2012. The decrease in current assets is primarily attributable to a $1.8 million decrease in accounts receivable due to lower sales, and a $1.9 million decrease in other current assets primarily due to a decrease in prepaid service contracts. These decreases were offset by a $1.2 million increase in inventory due to significant purchases at fiscal year end for first quarter of fiscal 2013 product sales, and $0.3 million increase in cash. The decrease in current liabilities is primarily attributable to a $0.9 million decrease in the fair value of an equity award, offset by a slight increase in accounts payable and accrued liabilities related to operating activities.
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 forecasts, including but not limited to: (i) shortfalls from projected sales levels, (ii) unexpected increases in product costs, (iii) increases in operating costs and/or (iv) changes in the historical timing of collecting accounts receivable could have a material adverse impact on our liquidity. This could force us to make further reductions in spending, extend payment terms with suppliers, liquidate assets where possible and/or suspend or curtail planned programs. Any of these actions could materially harm our business, results of operations and future prospects.
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, 2012 includes an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern.
During fiscal 2012, we used cash in operating activities of $8.7 million , compared to $10.9 million in fiscal 2011. The use of cash during fiscal 2012 was primarily a result of our net loss of $16.2 million offset by $6.6 million in non-cash items, which were share-based compensation, depreciation and amortization. In addition, we had decreases in accounts receivable due to lower sales, offset by increases in inventory.
We used cash in investing activities of $0.9 million during fiscal 2012, compared to $0.5 million in fiscal 2011. During fiscal 2012 and 2011, capital expenditures totaled $0.9 million and $0.3 million, respectively. Such expenditures were associated with machinery and equipment to support new product introductions. During fiscal 2011, we acquired intangible assets consisting of existing technology (acquired technology) for $150,000.
We generated cash from our financing activities of $9.9 million during fiscal 2012, compared to $12.7 million during fiscal 2011. During fiscal 2012, we sold an aggregate of 3,640,000 shares of our common stock for gross proceeds of approximately $7.3 million (net proceeds of approximately $6.6 million), we drew $3.5 million on our credit facility, and received $0.7 million from the exercise of warrants and stock options, offset by $0.8 million paid for taxes for net settlement of restricted stock units. During fiscal 2011, cash generated from financing activities primarily relates to the sale of 3,376,000 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), and the sale 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 (net proceeds of approximately $13.8 million). During fiscal 2011, cash generated from financing activities was offset by payments totaling $0.7 million against a note payable, and repayments of $4.4 million for amounts funded under our non-OEM accounts receivable financing agreements.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
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, and earning royalties on our licensed technology. The majority of our sales are generated through our branded channel, which includes systems integrators and VARs.
Business transition. During the fourth quarter of fiscal 2011, we fulfilled all of our obligations for supply of tape libraries to our sole OEM customer; however, we will continue to provide spare parts and services under the agreement. In the first nine months of fiscal 2012, revenue from our sole OEM customer decreased 27% compared to the first nine months of fiscal 2011.
We reported net revenue of $15.2 million for the third quarter of fiscal 2012, compared to $17.1 million for the third quarter of fiscal 2011. We reported net revenue of $44.3 million for the first nine months of fiscal 2012, compared to $52.6 million for the first nine months of fiscal 2011. We incurred a net loss of $3.8 million , or $0.16 per share, for the third quarter of fiscal 2012 compared to a net loss of $3.4 million , or $0.22 per share, for the third quarter of fiscal 2011. We incurred a net loss of $13.5 million , or $0.57 per share, for the first nine months of fiscal 2012 compared to a net loss of $10.8 million , or $0.83 per share, for the first nine months of fiscal 2011.
Intellectual property rights . In November 2011, we entered into a multi-year settlement and cross-licensing agreement with IBM pursuant to which we released all claims we had against IBM and Dell in connection with the patent infringement lawsuits we filed in the United States District Court for the Southern District of California and with the United States International Trade Commission ("ITC"), against BDT AG and certain of its affiliates, Dell and IBM. However, our infringement case against BDT AG and its affiliates continues and on January 20, 2012, we announced that an order of the chief administrative law judge of the ITC stated that the initial determination date will be no later than May 24, 2012.
Liquidity and capital resources. At March 31, 2012 , we had a cash balance of $13.4 million , compared to $10.2 million at June 30, 2011. In the first nine months of fiscal 2012, we incurred a net loss of $13.5 million . During the third quarter of fiscal 2012, we sold an aggregate of 3,640,000 shares of our common stock at $2.00 per share for gross proceeds of approximately $7.3 million and net proceeds of approximately $6.6 million. Cash management and preservation continues to be a top priority. We expect to incur negative operating cash flows during the remainder of fiscal 2012 as we continue to reshape our business model and seek to 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) shortages of necessary components of our products, (iv) increases in operating costs, and/or (v) 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, 2012 , we had working capital of $9.1 million , reflecting an increase in current assets and current liabilities of $1.2 million and $0.7 million , respectively, compared to June 30, 2011. The increase in current assets is primarily attributable to our issuance of common stock in March 2012, offset by the use of cash in operating activities and reduced sales. The increase in current liabilities is primarily attributable to an increase in accrued liabilities primarily related to operating activities and accrued contingent fees related to our patent infringement lawsuit, offset by decreases in accounts payable and accrued payroll and employee compensation.
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 9.1% through 2015, 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 17.3%. 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 31.9% and 38.2% of our revenue during the first nine months of fiscal 2012 and 2011, respectively.
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, 2011; 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.
Gross Profit. Gross profit in the third quarter of fiscal 2012 decreased to $4.7 million compared to $5.8 million in the third quarter of fiscal 2011. Gross margin decreased to 31.1% in the third quarter of fiscal 2012 compared to 33.8% in the third quarter of fiscal 2011, primarily due to increased prices for disk drives for our disk-based products as a result of the flooding in Thailand in October 2011, as well as additional costs incurred while we ramped up our new disk based products.
Product Revenue
Gross profit on product revenue was $1.1 million for the third quarter of fiscal 2012 compared to $2.0 million for the third quarter of fiscal 2011. The decrease of $0.9 million was primarily due to the 16.1% decrease in total net product revenue and fixed costs spread over a smaller revenue base. Gross margin on product revenue was 12.8% for the third quarter of fiscal 2012, a decrease from 19.2% for the third quarter of fiscal 2011. This decrease was primarily due to increased prices for disk drives for our disk-based products as a result of the flooding in Thailand in October 2011, as well as additional costs incurred while we ramped up our new disk based products.
Service Revenue
Gross profit on service revenue was relatively constant at $3.5 million during the third quarter of fiscal 2012 compared to $3.7 million in the third quarter of fiscal 2011. Gross margin on service revenue of 57.1% for the third quarter of fiscal 2012 was relatively constant compared to 57.7% for the third quarter of fiscal 2011.
Share-Based Compensation. During the third quarter of fiscal 2012 and 2011, we recorded share-based compensation expense of approximately $1.1 million and $0.4 million , respectively. The increase of approximately $0.7 million in the third quarter of fiscal 2012 compared to the third quarter of 2011 is primarily due to the vesting of restricted stock awards granted to certain executives at the end of fiscal 2011. Share-based compensation expense for the fourth quarter of fiscal 2012 is expected to be approximately $1.2 million.
General and Administrative Expenses . General and administrative expenses were constant at $2.9 million during the third quarter of fiscal 2012 and fiscal 2011; however, there were decreases of $0.3 million in outside contractor and audit expenses, principally for financial and accounting services, and $0.2 million in employee-related expenses associated with decreases in average headcount and facility costs related to downsizing of our San Diego facility. These decreases were offset by an increase of $0.5 million in share-based compensation expense primarily associated with restricted stock awards granted to executive officers in June 2011.
Interest Expense . Interest expense decreased to $43,000 during the third quarter of fiscal 2012 compared to $0.2 million for the third quarter of fiscal 2011. The decrease was primarily a result of the termination of our two non-OEM accounts receivable financing agreements. Interest expense in the third quarter of fiscal 2012 is related to borrowings on our credit facility.
The First Nine Months of Fiscal 2012 Compared to the First Nine Months of Fiscal 2011
Net Revenue. Net revenue decreased to $44.3 million during the first nine months of fiscal 2012 compared to $52.6 million during the first nine months of fiscal 2011, a decrease of $8.3 million , or 15.8%. The decline was primarily due to lower revenue from our sole OEM customer, which represented approximately 16.4% of net revenue in the first nine months of fiscal 2012 compared to 18.9% of net revenue in the first nine months of fiscal 2011. In our branded channel, the decrease in net revenue was attributable to decreased volumes in our disk-based and tape-based products sold in the Americas region, and decreased volumes in our disk-based products sold in the EMEA region.
Product Revenue
Net product revenue decreased to $25.8 million during the first nine months of fiscal 2012 compared to $34.7 million during the first nine months of fiscal 2011. The decrease of $8.9 million , or 25.6%, was primarily associated with a decrease of $4.7 million in OEM revenue related to the fulfillment of our obligations under the product supply portion of an agreement with our sole OEM customer, $2.0 million decrease in sales of our NEO ® products, $1.3 million decrease in sales of our Snap Server ® products, $0.5 million decrease in sales of our REO ® products, and $0.4 million decrease in sales of our spare parts. The decrease in sales of our Snap Server ® products was primarily attributable to two factors: (i) we increased the selling price of our Snap Server ® products as a result of the increased cost of disk drives due to the severe flooding in Thailand, which negatively impacted short-term demand for these products; and (ii) the production ramp-up time for our newly launched Snap Server DX Series TM has taken longer than originally anticipated, which has caused customers to delay orders.
Service Revenue
Net service revenue increased to $18.4 million in the first nine months of fiscal 2012 compared to $17.6 million during the first nine months of fiscal 2011. The increase of $0.8 million, or 4.5%, was primarily due to an increase in our out-of-warranty service contracts. As a percentage of total revenue, service revenue increased 7.9% to 41.4% for the first nine months of fiscal 2012 compared to 33.5% for the first nine months of fiscal 2011.
Royalty Fees
Net royalty fees were minimal in the first nine months of fiscal 2012 and first nine months of fiscal 2011.
Gross Profit. Gross profit in the first nine months of fiscal 2012 decreased to $14.3 million compared to $15.5 million in the first nine months of fiscal 2011. Gross margin increased to 32.3% in the first nine months of fiscal 2012 compared to 29.5% in the first nine months of fiscal 2011, primarily related to the increase in higher margin service revenue as a percentage of total revenue.
Product Revenue
Gross profit on product revenue was $3.5 million for the first nine months of fiscal 2012 compared to $5.9 million for the first nine months of fiscal 2011. The decrease of $2.4 million was primarily due to the 25.6% decrease in total net product revenue and fixed costs spread over a smaller revenue base. Gross margin on product revenue was 13.5% for the first nine months of fiscal 2012 compared to 16.9% for the first nine months of fiscal 2011. This decrease was primarily due to increased prices for disk drives for our disk-based products as a result of the flooding in Thailand in October 2011, as well as additional costs incurred while we ramped up our new disk based products.
Service Revenue
Gross profit on service revenue was $10.7 million during the first nine months of fiscal 2012 compared to $9.4 million in the first nine months of fiscal 2011. The increase of $1.3 million was primarily due to our performing an increasing portion of service repair internally beginning in the third quarter of fiscal 2011, rather than utilizing third-party vendors. Gross margin on service revenue of 58.3% for the first nine months of fiscal 2012 increased from 53.2% for the first nine months of fiscal 2011.
Share-Based Compensation. During the first nine months of fiscal 2012 and 2011, we recorded share-based compensation expense of approximately $3.8 million and $2.5 million , respectively. The increase of approximately $1.3 million in the first nine months of fiscal 2012 compared to the first nine months of 2011 is primarily due to the vesting of restricted stock awards granted to certain executives at the end of fiscal 2011.
CONF CALL
Vern LoForti - President and CEO
Thank you, Tanya. Good afternoon everyone and welcome to our fiscal 2009 first quarter conference call. Kurt Kalbfleisch, our CFO is with me this afternoon, after my comments I will turn the call over to Kurt who will provide more detailed remarks on our financial performance and then we will respond to any questions that you might have. Before we begin, we want to note that our formal earnings release was put out over the wire about a half hour ago at 4:30 pm Eastern Time this afternoon and can be found on our Web site at overlandstorage.com. The webcast of this call can also be found on the IR section of our Web site and will be archived there for one year.
During the course of our discussion today including the question-and-answer session of this call, we will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We may discuss our future plans, we will discuss our future plans and prospects for revenue, product introductions, market conditions, competitive conditions, gross profit margins, spending levels, working capital needs and cash balances. We caution you that forward-looking statements relating to these and other subjects we may discuss involve risks, uncertainties and assumptions that are difficult to predict. They are not guarantees of performance and the company’s actual results could differ materially from those contained in such statements. There are many factors that could cause or contribute to such differences, we refer you to the risk factors and cautionary language contained in today’s formal press release announcing our results as well as our filings with the SEC including risk factors, management discussion and analysis and other sections of the company’s periodic reports currently on file with the SEC. We remind you that our forward-looking statements are based on our current expectations and speak only as of the date of this release. The company undertakes no obligation to undertake any forward-looking statements to reflect new information, events or circumstances after the date of this release and conference call.
With that behind us, I would like to discuss the results. As you have seen from our press release, we reported revenue for the quarter of $32.3 million and a net loss of $0.54 per share. This represented just a 1.8% decrease in revenue compared to the $32.9 million reported in the prior year first quarter and 11.6% increase compared to $28.9 million in revenue in the immediately preceding June quarter. We are pleased to be able to report the 11.6% sequential revenue growth in Q1 which is often a slow quarter for us given the holiday season in Europe.
There are a number of dynamics which affected revenue for this quarter that I would like to discuss with you, the first of which is the layering in of the Snap acquisition. You will recall that we completed the acquisition right at the end of June and we immediately launched into the integration process which took us till the end of September to integrate the organization and all of the business systems of Snap which needed to be disconnected from Adaptec. We knew that this first quarter would be a rocky one but we were pleased with the level of Snap revenue we were able to generate.
The second item that bears upon the Q1 results is our OEM revenue. As expected, on a year-over-year basis OEM sales declined, they were down about 25% compared to Q1 of FY08. However we were pleased that we actually saw an uptick, a small one, about 2% in OEM revenue on a sequential basis compared to the June quarter. We are conscious of the fact that the fiscal year end of our largest OEM is October.
Another item to discuss is the global economy; the worldwide financial crisis is certainly affecting many businesses. We did see softness in our central European region where we saw a larger share of delayed deals. We still have a very significant pipeline but a number of deals were pushed out into the subsequent quarter. However, we were able to get many deals done around other parts of the world and we feel that we may be insulated to a certain extent because of the lower price range of our products relative to alternate high-end solutions. This is especially true with our new Snap products. In fact we would hope to benefit if this is the case from end users who because of economic constraints search for more affordable solutions.
Lastly, after the acquisition of Snap and the release of our Q4 results, we indicated to our employees and to you the investing public that we needed to accomplish a restructuring. As can be expected, there was great apprehension within our workforce concerning the future and I believe this negatively affected sales in the month of August. Once we announced the details of the restructuring on August 22 however, the effect of the change in leadership of the sales and marketing teams was dramatic. The worldwide team pulled together and produced a significant acceleration in daily bookings that helped us make the numbers that we reported in these results. We are working now to continue that momentum into the December quarter.
Let me turn to gross margins. In addition to a growing top line, a growing gross margin is also key to our return to profitability. With that in mind, we were extremely pleased to report gross margin for the first quarter of 27%. Our gross margin has not been this high in almost four years, as a matter of fact, it was last at that level in the December 2004 quarter. So, this really represented a significant pop from the 21.1% margin reported in the June quarter, immediately preceding this quarter, and it was really driven by improved channel mix branded versus OEM, product mix and lower manufacturing and warranty costs. We are hopeful that we can continue this improvement in future quarters.
Let’s me turn to a comment about OpEx, Kurt will talk about this more, we knew that the acquisition of Snap if you recall our announcement about that acquisition that it would add approximately $3 million per quarter in OpEx. It was for that reason that we needed to restructure our business model. As we have already discussed we cut about $10 million in planned FY09 spending as part of that August 27 restructuring. However, given the fact that that restructuring was affected two-thirds of the way through the quarter and because we recorded about $400,000 restructuring specific cost, OpEx in Q1 were extremely high. We do however expect that future quarters will benefit from this restructuring and that OpEx will fall by about 15% in Q2 compared to the Q1 reported levels.
Let me comment on cash. We ended the quarter with $5.4 million in cash on hand and we have publicly reported that we are seeking $10 million in new financing to fund future operations and growth in working capital as we grow our revenue line. We have retained a professional advisor to assist us in this effort and have Ben [ph] engaged with a large number of potential funding sources. The global liquidity crisis obviously has made this a difficult task but we are pleased that there are non-bank institutions that are privately well funded and are still doing deals, and as indicated in our release, we have recently received letters of intent which we are now considering and working through the process of documentation, analyzation and we hope to be able to report further on this front to you in the near future.
As I indicated in the closing quote of the earnings release, I am significantly encouraged by the passion and productivity of our sales and marketing team. We have really effectively broken down all the organizational laws such that all resources in the company that can be brought to bear to close sales are instantly available for the sales organization and are all working together on a real-time basis. Furthermore, two weeks ago we held a European customer conference where I had a chance to personally interact with our partners in that territory. I was surprised and pleased by the level of interest in our new Snap family of products, and in their desire, the desire of those partners, to participate with us in our push into the video surveillance market. We truly believe that Snap is the perfect storage solution with a transition that is sweeping the globe as we move away from analog video tape solutions to high-res MPEG quality IP cameras and network video recorders. We intend to leverage these Snap products and the fit to this market to capture a share of that market.
With that said, let me now turn the call over to Kurt to discuss some more detail behind the quarterly results and then we will open up the call for your questions. Kurt?
Kurt Kalbfleisch - CFO and VP of Finance
Thank you, Vern. First I would like to expand on some details of this quarter’s revenue performance. As reported, total revenues for the quarter were $32.3 million down just 1.8% from $32.9 million in the same quarter last year but up 11.6% from $28.9 million in the preceding quarter. The (inaudible) to HP were projected to be down this quarter but came in flat to last quarter. During Q1, HP sales comprised 26.7% of total company revenue compared to 35.3% last year and 29.8% in the sequential quarter. Revenue within the branded channel was $23.1 million, up 12.3% from $20.5 million compared to the first quarter of last year and up 16.5% from $19.8 million compared to last quarter. Service revenue continued to grow posting an 18.3% increase over the same quarter in the prior year and up 2.6% from the prior quarter. The addition of the Snap products to our disk based offerings provided new disk based revenue in the amount of $3.5 million during the quarter resulting in an increase to our disk based product revenue when compared to the first quarter of last year of 98% and sequentially of 78%. Revenue for our REO family of products and ultimates were down 8.9% compared to the first quarter of last year and 18.1% sequentially. VR 2 royalties for the quarter amounted to $172,000 this number represents pure royalties with no chip sales.
The gross margin percentage for the quarter increased to 27% up from 21.1% on a sequential basis and from 19.7% from the prior year quarter. The increase in margin of 5.9% on a sequential basis reflects the continuing shift towards a higher concentration of branded revenues versus OEM revenues and improved product mix as well as reduced inventory charges and warranty costs.
Now on spending level, total operating expenses for the quarter were $15.6 million, up 40.5% from $11.1 million in the prior year quarter and up 14.2% sequentially from $13.7 million. The other marketing expense was up 41%, R&D was up 64% and G&A was up 20% sequentially. The quarter-over-quarter delta [ph] is reflective of planned spending increases in sales and marketing as well as the integration of the Snap Server business. Q1 also reflected one-time costs associated with their August restructuring following the acquisition in the Snap Server business. Given our net operating loss [ph] position and full reserve established against our deferred tax assets, our income tax line consists primarily taxes on our foreign subsidiary.
As for cash flow and the balance sheet, as of fiscal year end, the company had $9.7 million in cash and as of the end of Q1 we had $5.4 million. Accounts receivable increased during the quarter by 25% while days sales outstanding improved by 16%. Inventory levels remained relatively flat on a sequential basis.
Vern, back to you.
Vern LoForti - President and CEO
Thank you, Kurt. Tanya, we will open the call up for questions at this point.
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