**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, DC 20549**

 

##### **FORM 10-K**

 

**(Mark One)**
| **ý** | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**     | ** ** | ** ** |
|------------|------------|---------------------------------------------------------------------------------------------------------|------------|------------|
|       |       |                                                                                                    |       |       |
|       |       | **For the fiscal year ended: JULY 3, 2005**                                                        |       |       |
|       |       |                                                                                                    |       |       |
| ** ** | ** ** | **OR**                                                                                                  | ** ** | ** ** |
|       |       |                                                                                                    |       |       |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 or  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** | ** ** | ** ** |

 

**For the transition period from            to           **

 

**Commission File Number:  000-22071**

 

**OVERLAND STORAGE, INC.**

(Exact name of registrant as specified in its charter)

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

 

**4820 Overland Avenue, San Diego, California  92123**

(Address of principal executive offices, including zip code)

 

**(858) 571-5555**

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

**None**

 

Securities registered pursuant to Section 12(g) of the Act:

**Common Stock, no par value**

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes    ý      No  o

 

Indicate by check mark if disclosure ofdelinquent filers pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part IIIof this Form 10-K or any amendment to this Form 10-K. o

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12B-2 of the Act).  Yes    ý     No o

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 126-2of the Exchange Act). Yes    o     No ý

 

Theaggregate market value of the voting stock held by non-affiliates of theregistrant as of September 7, 2005 was $58,548,764 based on the closingprice reported on such date by The NASDAQ Stock Market. Shares of Common Stockheld by officers and directors and by persons who hold 5% or more of theoutstanding Common Stock have been excluded from the calculation of this amountbecause such persons may be deemed to be affiliates. This determination ofaffiliate status is not necessarily conclusive.

 

Asof September 7**,**2005, thenumber of outstanding shares of the registrant’s Common Stock was 14,199,097.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

### **Portions of the Proxy Statement tobe filed in connection with registrant’s Annual Meeting of Shareholders to beheld on November 15, 2005 (the “Proxy Statement”) are incorporatedherein by reference into Part III of this Report.**  

 

 

----

 

### **PART I**

### ** **

*ThisReport contains certain statements of a forward-looking nature relating tofuture events or the future performance of our company. Words such as “expects,”“anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similarexpressions or variations of such words are intended to identifyforward-looking statements, but are not the only means of identifyingforward-looking statements. Prospective investors are cautioned that suchstatements are only predictions and that actual events or results may differmaterially. In evaluating such statements, prospective investors shouldspecifically consider various factors identified in this Report, including thematters set forth below under the caption “Risk Factors,” which could causeactual results to differ materially from those indicated by suchforward-looking statements.*

 

#### **General**

#### ** **

Overland was originally founded and incorporated asOverland Data, Inc. in California in 1980. In June 2002, we changed our name to Overland Storage, Inc.  Our principal executive offices are locatedat 4820 Overland Avenue, San Diego, California 92123, telephone 858-571-5555.

 

For 25 years we have delivered data protection solutionsdesigned for backup and recovery to ensure business continuity.  Historically, we have focused on delivering aportfolio of tape automation solutions including loader and library systemsdesigned for small business and midrange computing environments.  Beginning with the June 2003 acquisitionof Okapi Software, Inc. (Okapi or Okapi software), aprivately-owned company based in San Diego, California, we expanded our product offerings to include a family of intelligentdisk-based backup and recovery appliances to complement our tapesolutions.  In August 2005, weacquired Zetta Systems, Inc. (Zetta or Zetta Systems), a privately-ownedcompany based in the Seattle, Washington area, and plan to utilize the Zettasoftware as the basis for a new line of protected primary disk-based storageappliances.

 

One of the main market differentiators of our productshas been that we design them around a modular, scalable architecture.  This enables customers to purchase storage asthey need it, rather than having to purchase larger monolithic devices withexcess capacity.  Customers can purchasean initial module to meet their near-term needs, and later increase speed andcapacity by adding modules that can be interconnected to function as a singlesystem.  This provides a lower priceentry point, investment protection, and an increased level of fault tolerance,as each module is self-sufficient and will continue to function even if anotherwere to fail.

 

We also differentiate ourselves with our “go-to-market”approach.  We are the only supplier inour market space that has a completely indirect sales model.  We do not have a direct sales force.  The majority of our sales have historicallybeen generated through private label arrangements with original equipmentmanufacturers (OEMs).  The remainder ofour sales are made through commercial distributors, direct market retailers(DMRs or catalogers) and value-added resellers (VARs).

 

End-users of our products include small and midsizebusinesses, as well as divisions and operating units of large multi-nationalcorporations, governmental organizations, universities and other non-profitinstitutions.  Our products are used in abroad range of industry sectors including financial services, healthcare,retail, manufacturing, telecommunications, broadcasting, research and developmentand many others.  Our products are soldworld-wide in the Americas, EMEA (Europe, Middle East, Africa) and AsiaPacific.  Approximately 58.8% of ourrevenues are generated internationally, primarily in Europe.

 

Our Internet address is www.overlandstorage.com.  We make available free of charge on ourInternet website our annual report on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K, and amendments to those reports filedpursuant to Section 13(a) or 15(d) of the Securities ExchangeAct as soon as reasonably practicable after we electronically file suchmaterial with, or furnish it to, the Securities and Exchange Commission.  The contents of our website are not a part ofthis Report.

 

#### **Our Direction andStrategy**

#### ** **

Our strategy is to become a market leader and innovativesupplier of a complete portfolio of tiered data storage solutions by providingintelligent appliances and software modules designed to work together to ensurethat information is “automatically safe, readily available and always there.”  We intend to deliver products to address allthree tiers of data storage:  primary “protected”disk, secondary disk-based backup and tertiary automated tape libraries forarchival.  Our focus will continue to beon mid-range solutions that can be easily sold worldwide through our indirectnetwork of resellers.  We intend toleverage our leadership position in mid-range tape automation into a similarposition in primary and secondary intelligent disk-based appliances.

 

2

----

 

Historically, magnetic tape has been used for all formsof data backup and recovery.  This isbecause tape was, and still is, the only reliable, “removable”, high capacitystorage media that can be taken off-site to ensure that data is safeguarded incase of disaster.  For a number of yearsnow, Overland has held a market-leading position in mid-range tape automation,and sales of tape automation appliances have represented more than 90% of ourrevenue for each of the last three fiscal years.  In order to protect our position, in thefourth quarter of fiscal 2005 we commenced development of a new tape automationplatform that we expect will spawn several new price competitive products.  These products will be delivered to market inthe second half of fiscal 2006.  Althoughwe expect that tape solutions will continue to be the anchor of the dataprotection strategy at most companies, tape backup is time consuming and oftenunreliable and inefficient.  The processof recovering data from tape is also time consuming and inefficient.  Ultimately, we expect that tape will likelybe relegated to an archival role for infrequently accessed data.

 

Over the last couple of years, theadvent of low-cost serial ATA disk and iSCSI networking technology, togetherwith greatly increased regulatory compliance requirements and the continuedgrowth of digital data, have driven businesses to use secondary storagedisk-based backup appliances.  One of thegreatest benefits of disk-based backup is the speed of restoration.  Studies show that approximately 90% ofrecovered data is two weeks old or younger, or last accessed within thatperiod.  As a result, many IT managersare electing to use disk-based appliances as an intermediate staging area, withthe backup data eventually moving to tape. We have enjoyed initial success in this relatively new market space, andwe believe there is significant promise for future growth.

 

In addition to daily or periodicbackup, companies are also looking for ways to protect their data continuously. Software protection is being applied toprimary storage devices through a combination of features including file andblock-based replication, near instantaneous snapshotting, virtualization andthin provisioning.  We intend to use thesoftware technology developed by Zetta Systems, which we acquired in August2005, as the basis for a line of protected primary storage appliances to beintroduced in the second fiscal quarter of our fiscal  2006. This product line will be marketed and sold through our existing brandedsales channel.  It will be targeted tothe mid-market with a goal of delivering enterprise-class availability,built-in data protection and exceptional performance at an affordable price.  The primary storage market is currently manytimes larger than the secondary and tertiary storage markets, and we anticipatethat the primary storage market will be the source of much of our long termrevenue growth.

 

Success in the primary and secondarydisk-based appliance markets will require us to introduce a steady stream ofnew products that are feature-rich and competitively priced.  Therefore, we must significantly enhance oursoftware development team and commit additional sales and marketing resourcesto promote and sell the products.

 

**Products**

 

Our current products and other offerings include:

 

•                  *Tape Automation* - Automated tape libraries are devicescapable of managing multiple data cartridges and incorporate two or more tapedrives to provide unattended backup of large quantities of data.  Our libraries incorporate tape drivessupplied by other manufacturers based on the leading mid-range tapetechnologies, including LTO (Linear Tape Open) and DLTtape.  We currently offer the following tapeautomation products:

 

•                  *Scalable NEO SERIES**®*** – We offer 3 versions of our NEO productfamily:

 

• NEO 2000 can accommodate up to 2 tape drivesand 30 cartridges and can scale up to 8 modules high with 16 tape drives and240 cartridges.

 

• NEO 4000 can accommodate up to 4 tape drivesand 60 cartridges and can scale up to 4 modules high to comprise a system of 16tape drives and 240 cartridges. Customers can configure NEO systems with a combination of NEO 2000 and4000 modules.

 

• NEO 8000 consists of a base modelwith 100-cartridge capacity which can be scaled up to 500 cartridges through afield-enabled software key. Additionally, two NEO 8000s can be interconnected to provide up to 1,000cartridge capacity.

 

3

----

 

•                  *PowerLoaders***®***and Loaders* –Made for smaller environments that do not require scalability, we offer bothpower loaders with one or two tape drives, and loaders with only a single tapedrive.

 

•                  *Disk-based Products*– In August 2003, we began shipping our REO SERIESTM ofdisk-based products based on the technology we received in the Okapi Softwareacquisition.  The REO product familycurrently consists of three products:

 

•                  REO 1000 with 4 disk drives and anative capacity of 1.6 terabytes;

 

•                  REO 4000 with 8 disk drives and anative capacity of 3.2 terabytes; and

 

•                  REO 9000 with 12 or 24 disk drivesand a native capacity of up to 9.6 terabytes.

 

Thestrength of these intelligent appliances lies in the embedded Protection OSTMsoftware which enables them to be configured as virtual tape libraries, dynamicvirtual tape drives and/or disk LUN volumes. The optional REO Multi-Site PACTM software is also availableto protect remote data by facilitating the transfer of data in virtual tapeformat from a remote REO to a central REO for management and tape storage.

 

•                  *Related Products andServices*– We have a variety of products and services supporting ourtape libraries, PowerLoaders and loaders. We currently offer the following additional products and services:

 

•                  Desktop and internal upgrade tapedrives.

 

•                  Spares and post warrantyreturn-to-factory and on-site service.

 

•                  Media, including tape cartridges forSDLT and LTO formats.

 

•                  *VR2***®****(Variable RateRandomizer) – VR2**is ourpatented dataencoding technology. This technology, which is embedded in an Applications SpecificIntegrated Circuit (ASIC) chip, is capable of significantly increasing thenative capacity and data transfer rate performance of linear tape technologieswithout requiring any changes in tape path design, recording heads and/ormedia.  This performance is accomplishedby achieving encoding efficiency of greater than 99%.  We have licensed VR2 to TandbergData ASA for use in its Scalable Linear Recording (SLR) tape drives, to ImationCorporation as the owner of the Travan technology format, to Quantum, formerlyCertance, for use in its Travan tape drive offerings, and to Storage TechnologyCorporation (StorageTek) for use in its T9940 and T9840 drives and future tapedrive products.

 

**Customers**

 

Our operating structure is optimized for our mid-rangestrategy in that our products do not require us to have a “direct” (toend-users) sales or service force.  Wesell all our products on an indirect basis, primarily through three channels ortypes of customers: (i) OEMs; (ii) distributors; and (iii) VARs.  Regardless of the channel through which theyare sold, all of our products are designed and manufactured to meet OEM-levelrequirements and reliability standards.

 

•                  ***OEM Channel***- Our significant OEM supply agreements have been with Hewlett Packard Company(HP) and International Business Machine Corporation (IBM), both of whichincorporate our NEO products into their system offerings.  Fujitsu and NEC also purchase NEO productsand sell them under their respective labels. However, we are required to sell to them through their appointedreseller, and consequently we classify them as VAR customers rather than OEMcustomers.

 

In August 2005,we announced that HP had selected an alternate supplier for its next-generationmid-range tape automation product.  Weexpect HP to begin purchasing the first product of this new line from thealternate supplier during calendar year 2006. Although HP will continue to purchase the tape automation productscurrently supplied by Overland for some time, the new product will eventuallyreplace the majority of those purchases. We cannot predict how quickly thistransition will occur, but believe the impact to our revenue in fiscal 2006will be minimal. The impact in fiscal 2007 is expected to be significant.  In light of this anticipated loss in futurerevenue, we intend to focus heavily on the delivery of new products through ourhigher-margin branded channel.

 

Althoughwe continually strive to win new OEM business, the OEM sales cycle is oftenlengthy and uncertain.  It typically consistsof a general technology evaluation, qualification of product specifications,verification of product performance against these specifications, integrationtesting of the product within the customers’ systems, product announcement andvolume shipment.

 

4

----

 

As iscustomary in the industry, our OEM contracts have a three year term, providefor periodic price reviews and the customers are not required to purchaseminimum quantities.  Our existingcontracts with HP (dated August 2003) and IBM (dated November 2002)also provide that title to inventory shipped from our warehouse into variousinventory hub locations remains with us until the products are shipped to theircustomers.  HP, including the formerCompaq that HP acquired in May 2002, has been our largest customer,accounting for approximately 54.3%, 58.8% and 58.4% of sales in fiscal 2005,2004 and 2003, respectively.  No othercustomer accounted for more than 10% of sales in any year during the three-yearperiod.

 

•                  ***Distribution Channel***- Our primary distribution customers include Bell Microproducts, Inc.,Ingram Micro, Inc. and Tech Data Corporation in the United States andapproximately eight technical distributors in Europe.  Typically, these distributors sell ourproducts to smaller VARs and catalogers who in turn sell to end-users.  The distribution agreements includeprovisions for rights of return, stock rotation and price protection, commonterms in the commercial distribution area. Because of these terms, revenue from shipments to these customers is notrecognized until the related products are in turn sold by the distributor.  We support these distributors through adedicated field sales force and provide further support through field salespersonnel who work with the smaller VARs and catalogers to generate end-usersales and create the pull through its distribution customers.

 

•                  ***VAR Channel***- Our VAR channel includes systems integrators and larger VARs who qualify topurchase direct from Overland.  Some ofthese customers specialize in the insurance, banking, financial, geophysical ormedical industries, and offer a variety of value-added services relating to ourproducts.  Our products frequently arepackaged by these customers as part of a complete data processing system orcombined with other storage devices, such as redundant array of independentdisks (RAID) systems, to deliver a complete storage subsystem.  These customers also recommend our productsas replacement solutions when backup systems are upgraded, and bundle ourproducts with storage management software specific to the end-user’ssystem.  We support this channel throughour field sales representatives.

 

Our products are soldboth domestically and internationally and we have sales personnel located invarious cities throughout the world.  Wedivide our sales into three geographical regions: (1) the Americas,consisting of North and South America; (2) Europe, Middle East and Africa(EMEA); and (3) Asia Pacific (APAC). Primary support for customers in the Americas is provided from our SanDiego headquarters office.  EMEA issupported by our wholly-owned subsidiaries located in Wokingham, England;Paris, France; and Munich, Germany.  Thesubsidiary in England provides sales, technical support and repair services,while the subsidiaries in France and Germany provide sales and technicalsupport.  Our APAC customers aresupported by our sales office in Singapore and Korea.  We assign to our international distributorsthe right to sell our products in a country or group of countries.  In addition, many domestic customers ship aportion of our products to their overseas customers.  Our foreign sales for fiscal years 2005, 2004and 2003 were approximately $138.5 million, $116.5 million and $85.1 million,respectively, representing 58.8%, 48.9% and 43.4%, respectively, of our totalnet revenues. Foreign sales in the United Kingdom and Singapore, primarily inour OEM channel, were approximately $65.8 million and $21.8 million,respectively in fiscal 2005, $67.2 million and $9.4 million, respectively, infiscal 2004 and $52.2 million and $2.7 million, respectively in fiscal 2003.

 

Our marketing efforts includesupport for both our OEM and branded customers. Our branded channel partners are provided with a full range of marketingmaterials, including product specification literature, software connectivityinformation and application notes.  Oursales management and engineering personnel provide support to the channelpartners and, in certain instances, visit potential customer sites to explainand demonstrate the technical advantages of our products.  We maintain press relations both domesticallyand in Europe, and participate in national and regional trade shows in varyingdegrees both domestically and internationally.

 

Sales to customers outside of the U.S. represent asignificant portion of our sales. International sales are subject to various risks and uncertainties.  See “Our international operations areimportant to our business and involve unique risks” in Risk Factors below.  Sales generated by our European channelgenerally show seasonal slowing during our first fiscal quarter (July throughSeptember), reflecting the summer holiday period in Europe.

 

**CustomerService and Support**

 

Ourtechnical support personnel are trained on our products and assist customerswith “plug-and-play” compatibility between multiple hardware platforms,operating systems and backup, data interchange and storage managementsoftware.  Our application engineers areavailable to solve more complex customer problems and visit customer sites whennecessary.  Customers that need serviceand support can contact us through our toll-free telephone lines, facsimile andInternet e-mail.  Application notes anduser manuals can be obtained directly from our website.

 

5

----

 

We generally provide a three-year advance replacementreturn-to-factory warranty on our NEO SERIES, PowerLoader and LoaderXpressproducts and a one year advance replacement return-to-factory warranty on ourREO SERIES.  We also provide on-siteservice for the first warranty year of the NEO SERIES products for which wecontract with third-party service providers. For most products, we offer a program called XchangeNOW as part of ourreturn-to-factory warranty that enables customers to receive an advancereplacement unit shipped within two business days after placing a servicerequest.  Our customer ships thedefective unit back to us using the shipping materials from the replacementunit.  Separately priced on-sitewarranties are offered for sale to customers of other product lines.  We contract with outside vendors to provideservice relating to all on-site warranties.

 

**Researchand Development**

 

We incurred research and development (R&D) costs of$10.7 million,  $7.3 million and $7.4million in fiscal years 2005, 2004 and 2003, respectively, representing 4.5%,3.0% and 3.8% of net revenues, respectively. We currently employ 69 peoplein our R&D department, including electrical, mechanical and firmwareengineers who support our tape automation business and software engineers whosupport our REO disk-based appliance products. In fiscal 2006 our development efforts will focus on four projects: (1) anew tape automation platform that we anticipate will spawn several new productstargeting the price conscious small and medium business market; (2) a newprotected primary storage appliance based on the software we received in the August 2005acquisition of Zetta Systems; (3) the addition of scalability to ourcurrent line of REO disk based backup and recovery appliances; and (4) softwarefor interoperability of all of our tiered storage products.  We expect these projects will increaseR&D expenditures as a percent of net revenues to greater than 7.0% infiscal 2006.  Development of the tapeautomation platform has passed the prototype phase and we expect initialcustomer shipments to begin in the third quarter of fiscal 2006.  Development of both the new protected primarystorage appliance and REO scalability will soon be in beta testing with firstcustomer shipments expected in the second quarter of fiscal 2006.  Development of software interoperability ofall our tiered storage products is still in the early research stage.  We currently have no customer-sponsoredR&D activities.

 

In general, our level of R&D spending is dependentupon our product development cycles. During the later stages of the cycles, including the building of alphaand beta units and design verification testing, significant amounts ofdevelopment materials are consumed.  OEMcustomers also generally require evaluation units to qualify a new design.  We anticipate that our move into primarystorage will require a higher level of R&D spending in order for us to becompetitive and successful in this new market. Despite our R&D efforts, we may not be able to identify, develop,manufacture, market or support new or enhanced products successfully or on atimely basis and any new products may not gain market acceptance.

 

#### **Manufacturing andSuppliers**

#### ** **

Historically, we have maintained a fully integratedfactory in San Diego, California. However, in September 2004, in order to reduce our cost structure,increase our flexibility and improve our focus on product development, weannounced plans to outsource all of our manufacturing to Sanmina-SCICorporation (Sanmina).  The transition ofmanufacturing of all of our products to Sanmina was completed in August 2005.  Currently, all of our products are producedby Sanmina at their Rapid City, South Dakota plant.

 

We purchase completed products from Sanmina.  They are generally responsible for procuringall raw materials and producing the products to meet our specifications.  However, we currently purchase tape drives andcertain printed circuit boards (PCBs) which are incorporated into our tapeautomation products and consign the drives and PCBs to Sanmina.  Tape drives are the most expensive materialcomponent of these products and consignment enables us to avoid an additionalmarkup from Sanmina.  For certain tapedrives, we qualify only a single source, which can magnify the risk ofshortages and decrease our ability to negotiate with our suppliers on the basisof price.  From time to time in the past, we have notobtained as many drives as we have needed from various vendors due to driveshortages or quality issues.

 

In general, Overland-branded products are notmanufactured until an order is received. The typical lead-time for manufacturing products is three to five daysand backlog is generally not a significant factor to our business.  Our two largest OEM customers, HP and IBM,have both required that we maintain inventory on hand, known as buffer stock,at any given time sufficient to supply their forecasted requirements for thenext three weeks.  They provide weeklyforecast information that allows us to manage both raw material and finishedgoods inventories.  The buffer stock isshipped into various distribution hubs around the world and we retain ownershipof that inventory until it is pulled by HP and IBM to fulfill customer orders,at which time we record the sale.

 

6

----

 

**Competition**

 

The worldwide storage market is intensely competitiveand barriers to entry are relatively low. However, no significant new entry hasoccurred in several years.  Ourcompetitors vary in size from small start-ups to large multi-nationalcorporations who have substantially greater financial, R&D and marketingresources.  In the tape automation market,our primary competition includes Advanced Digital Information Corporation andQuantum Corporation with limited competition from Storage TechnologyCorporation (recently acquired by Sun Microsystems, Inc.) in larger scalelibraries.  Key competitive factorsinclude product features, reliability, durability, scalability and price.

 

Our disk-based products currently compete with productsmade by Quantum Corporation, Advanced Digital Information Corporation, StorageTechnology Corporation, EMC Corporation, Network Appliance, Inc. andnumerous small startups.  We believeadditional competitors are likely to enter the market.   Key competitive factors in these marketsinclude performance, functionality, scalability, availability,interoperability, connectivity, time to market enhancements and total value ofownership.

 

The markets for all of our products are characterized bysignificant price competition, and we anticipate that our products will faceincreasing price pressure.

 

**ProprietaryRights**

 

#### **General –**In the tape automation space, we believe thatpatent, copyright, trademark and trade secret protection are less significantthan factors such as the knowledge, ability and experience of our personnel,new product introductions and product enhancements.  In the secondary disk-based appliance andprimary protected storage spaces, we believe intellectual property protectionwill be an important competitive advantage, and we intend to secure asignificant number of patents, copyrights and trademarks as quickly as possibleto obtain a leadership position in these areas.

#### ** **

#### **We presently hold 17**United States patents and have 6United States patents pending. In general, these patents have a 20-yearterm from the first effective filing date for each patent. We also hold anumber of foreign patents and patent applications for certain of our productsand technologies.  These rights, however, may not prevent competitors fromdeveloping substantially equivalent or superior products to ours.  In addition, our present and future patentsmay be challenged, invalidated or circumvented, reducing or eliminating ourproprietary protection.

#### ** **

**VR2Technology** – We have entered into various intellectualproperty licensing agreements relating to our VR2 technology.  These agreements require the payment ofroyalty fees based on sales by licensees of products containing VR2.  In certain instances, we sell to the licenseeASIC chips embodying VR2 priced to include the cost of the chip plusan embedded royalty fee.

 

**Employees**

 

As of June 30,2005, we had 335 employees, including 133 in sales and marketing, 61 inresearch and development, 89 in manufacturing and operations and 52 in finance,information systems, human resources and other management.  There are no collective bargaining contractscovering any of the employees and we believe that our relationship with ouremployees is good.

 

7

----

 

**RISK FACTORS**

 

*An investment in our company involvesa high degree of risk.  In addition tothe other information included in this Report, you should carefully considerthe following risk factors in evaluating an investment in our company.  You should consider these matters inconjunction with the other information included or incorporated by reference inthis Report.*

 

**Our business has been highlydependent on our level of sales to one major customer, and such customer willnot be purchasing our next generation product***.*

 

Hewlett-PackardCompany (HP), including the former Compaq which HP acquired in May 2002,has been our largest customer, accounting for approximately 54.3% of netrevenues in fiscal 2005, 58.8% of net revenues in fiscal 2004 and 58.4% of netrevenues in fiscal 2003.  No othercustomer accounted for more than 10% of net revenues in fiscal 2005.  Neither HP nor any other customer isobligated to purchase a specific amount of our products or provide bindingforecasts of purchases for any period.

 

In August 2005, we announced that HP had selectedan alternate supplier for its next-generation mid-range tape automationproduct.  We expect HP to beginpurchasing the first product of this new line from the alternate supplierduring calendar year 2006.  We expect HPto continue to purchase the tape automation products currently supplied by usfor some time, but the new product will eventually replace the majority ofthose purchases. We cannot predict how quickly this transition will occur, butwe believe the impact to our revenue during fiscal 2007 will be significant andthere may be some impact to revenue in fiscal 2006.

 

**InAugust 2005, we acquired Zetta Systems, Inc. and the failure tosuccessfully integrate this acquisition, or others in the future, could harmour business, financial condition and operating results.**

 

Wehave in the past and expect in the future to make acquisitions of complementarybusinesses, products or technologies as we implement our businessstrategy.  For example, in June 2003we acquired Okapi Software, Inc. and in August 2005 we acquired ZettaSystems.  We are working now to integrateZetta and to introduce products based on the Zetta software.  If we fail to integrate Zetta successfully,it could harm our business, financial condition and operating results.

 

Mergersand acquisitions involve numerous risks, including liabilities that we mayassume from the acquired company, difficulties in the assimilation of theoperations and personnel of the acquired business, the diversion of management’sattention from other business concerns, risks of entering markets in which wehave no direct prior experience, and the potential loss of key employees of theacquired business.

 

Futuremergers and acquisitions by us also may result in dilutive issuances of ourequity securities and the incurrence of additional debt and amortizationexpenses related to intangible assets. Any of these factors could adversely affect our business, liquidity,results of operation and financial position.

 

**Wehave outsourced all of our manufacturing to Sanmina-SCI Corporation.  If we are unable to obtain our products fromSanmina-SCI in a cost effective and timely manner that meets our customers’expectations, such failure could materially and adversely impact our business,financial condition and results of operations.**

 

In July 2005,we completed the outsourcing of all our manufacturing to Sanmina-SCICorporation.  We face a number of risksas a result of our decision to outsource manufacturing to Sanmina.  Sanmina will be the sole source supplier forall of our products.  Because of thisdependence on one supplier, we are at greater risk of experiencing shortages orother delays in customer deliveries which could result in customerdissatisfaction and lost sales.  We willalso be dependent on Sanmina for product quality, over which we will havelimited control.  Our agreement withSanmina also commits us to purchase products and materials based upon aforecast of customer demand that we provide. In the event of a reduction or shift in product mix in the forecast, wewould be obligated to purchase finished goods in excess of customer demand, orbe required to reimburse Sanmina for unique parts or excess or obsoleteinventory.  As a result, we couldexperience reduced gross margins based on these purchase commitments.

 

**Our newdisk-based products involve many significant risks.**

 

In August 2003,we began shipping our REO SERIES of secondary disk-based backup and recoveryproducts based on technology acquired from Okapi Software, Inc.  We also expect to introduce a disk-basedprotected primary storage product in October 2005 based on the technologyacquired from Zetta Systems, Inc.

 

8

----

 

Thesuccess of these disk-based products is uncertain and subject to significantrisks, any of which could have a material adverse effect on our business,liquidity, results of operation and financial position.  We must commit significant resources to thesenew products before determining whether they will succeed.  If these new products are not adopted bycustomers or do not achieve anticipated sales levels, any related intangibleassets we have recorded may be impaired. Such impairment would result in a charge against earnings in the periodfor which impairment is determined to exist, and reduce our assets and shareholders’equity.

 

Priorto our acquisition of Okapi Software, we had not been involved in thedevelopment, marketing and sale of disk-based products, and prior to ouracquisition of Zetta Systems, we had not been involved in the protected primarystorage market.  The protected primarystorage area is still new to many of our personnel.  We will need to continuously update andperiodically upgrade these products to stay competitive.  Any delay in the commercial release of new orenhanced disk-based products could result in a significant loss of potentialrevenues and may adversely impact the market price of our common stock.

 

If ourdisk-based products do not achieve market acceptance or success, then theassociation of our brand name with these products may adversely affect ourreputation and our sales of other products, as well as dilute the value of ourbrand name.

 

**The market priceof our common stock may be volatile***.*

 

Themarket price of our common stock has experienced significant fluctuations sinceit commenced trading in February 1997. The market price of our common stock may continue to fluctuatesignificantly in the future.  Manyfactors could cause the market price of our common stock to fluctuate,including:

 

•                  announcements concerning us, our competitors, our customers or ourindustry;

 

•                  changes in earnings estimates by analysts;

 

•                  purchasing decisions of HP and other significant customers;

 

•                  quarterly variations in operating results;

 

•                  the introduction of new technologies or products;

 

•                  changes in product pricing policies by us or our competitors; and

 

•                  changes in general economic conditions.

 

Inaddition, stock markets have experienced extreme price and volume volatility inrecent years.  This volatility has had asubstantial effect on the market prices of securities of many smaller publiccompanies for reasons frequently unrelated or disproportionate to the operatingperformance of the specific companies. These market fluctuations may adversely affect the market price of ourcommon stock.

 

**Our financial results mayfluctuate substantially for many reasons, and past results should not be reliedon as indications of future performance.**

 

Allof the markets that we serve are volatile and subject to market shifts, whichwe may not be able to discern in advance. A slowdown in the demand forworkstations, mid-range computer systems, networks and servers could have asignificant adverse effect on the demand for our products in any givenperiod.  We have experienced delays inreceipt of purchase orders and, on occasion, anticipated purchase orders havebeen rescheduled or have not materialized due to changes in customerrequirements.  Our customers may cancelor delay purchase orders for a variety of reasons, including the reschedulingof new product introductions, changes in their inventory practices orforecasted demand, general economic conditions affecting our customers’markets, changes in our pricing or the pricing of our competitors, new productannouncements by us or others, quality or reliability problems related to ourproducts or selection of competitive products as alternate sources ofsupply.  In particular, our ability toforecast sales to distributors, integrators and value-added resellers isespecially limited as these customers typically provide to us relatively shortorder lead times or are permitted to change orders on short notice.  Given that a large portion of our sales aregenerated by our European channel, our first fiscal quarter (July throughSeptember) is commonly impacted by seasonally slow European orders, reflectingthe summer holiday period in Europe.

 

9

----

 

Inaddition, our financial results have fluctuated and will continue to fluctuatequarterly and annually based on many other factors such as:

 

•                  changes in customer mix (e.g., OEM vs. branded);

 

•                  changes in product mix;

 

•                  fluctuations in average selling prices;

 

•                  currency exchange fluctuations;

 

•                  increases in costs and expenses associated with the introduction of newproducts; and

 

•                  increases in the cost of or limitations on availability of materials.

 

Basedon all of the foregoing, we believe that our revenues and operating resultswill continue to fluctuate, and period-to-period comparisons are notnecessarily meaningful and should not be relied on as indications of futureperformance.  Furthermore, in some futurequarters, our revenues and operating results could be below the expectations ofpublic market analysts or investors, which could result in a material adverseeffect on the price of our common stock. In addition, portions of our expenses are fixed and difficult to reduceif revenues do not meet our expectations. These fixed expenses magnify the material adverse effect of any revenueshortfall.

 

**We face intense competition andprice pressure, and many of our competitors have substantially greaterresources than we do.**

 

Theworldwide storage market is intensely competitive as a number of manufacturersof tape automation solutions and storage management software products competefor a limited number of customers.  Inaddition, barriers to entry are relatively low in these markets.  We currently participate in the mid-range ofthe tape backup market.  In this segment,some of our competitors have substantially greater financial and otherresources, larger research and development staffs, and more experience andcapabilities in manufacturing, marketing and distributing products.  Our hardware products currently compete withproducts made by Advanced Digital Information Corporation, Quantum Corporationand Storage Technology Corporation (recently acquired by SunMicrosystems).  Our disk-based products currently compete withproducts made by International Business Machines Corporation, HP, ComputerAssociates International, Inc., EMC Corporation, Veritas SoftwareCorporation, Quantum Corporation, Network Appliance, Inc. and numeroussmall startups.  The markets for our productsare characterized by significant price competition, and we anticipate that ourproducts will face increasing price pressure. This pressure could result in significant price erosion, reduced profitmargins and loss of market share, any of which could have a material adverseeffect on our business, liquidity, results of operation and financial position.

 

**Our business is highly dependenton the continued availability and market acceptance of the tape technologiesincorporated in our products.**

 

Wehave historically derived a majority of our revenue from products thatincorporate tape drives purchased from other manufacturers and based on uniqueformats and tape technologies.  Certainof these tape drives are available only from a single manufacturer.  For the foreseeable future, we expect tocontinue to derive a substantial amount of our revenue from productsincorporating these tape drives.

 

Aportion of our products incorporate DLTtape drives manufactured by QuantumCorporation.  Quantum also is one of ourcompetitors because Quantum markets its own tape automation products.  We do not have a long-term contract withQuantum, which could cease supplying tape drives directly to us.

 

Inaddition, from time to time in the past, we have not obtained as many drives aswe have needed from various vendors due to drive shortages or qualityissues.  Any prolonged inability toobtain adequate deliveries could require us to pay more for components, partsand other supplies, seek alternative sources of supply, delay shipment ofproducts and damage relationships with current and prospective customers.  This type of delay or damage could have amaterial adverse effect on our business, liquidity, results of operation andfinancial position.  In fiscal 1997, weexperienced problems with the supply of a newly-introduced tape drive and theseproblems materially adversely affected our sales and earnings for that year.  And, in the fourth quarter of fiscal 2005, weexperienced drive availability issues which had a lesser effect on sales andearnings for the quarter.

 

10

----

 

We cannot assure you thatthese or similar problems will not reoccur, or that we will not experiencesimilar or more serious disruptions in supply in the future with current or newversions of tape drives.

 

Ourfuture operating results depend on the continued availability and marketacceptance of the current tape technologies that we use.  If tape drives incorporating othertechnologies gain comparable or superior market acceptance than those currentlyincorporated in our products, we might have to modify the design of our tapeautomation products to incorporate these tape drives.  Our inability to do so or to obtainsufficient quantities of these tape drives could have a material adverse effecton our business, liquidity, results of operation and financial position.

 

Our tape-based storage solutionscompete indirectly with other storage technologies, such as hard disk drives,and may face competition in the future from other emerging technologies.  The prices of hard disk drives continue todecrease while capacity and performance have increased.  We expect that our tape-based products willface increased competition from these alternative technologies.  If our strategy to compete in disk-basedmarkets does not succeed, our business, financial condition and operatingresults will be materially and adversely affected.

 

**Our success depends on ourability to anticipate rapid technological changes and develop new and enhancedproducts.**

 

Asan advanced technology company, we are subject to numerous risks anduncertainties, generally characterized by rapid technological change andintense competition.  In thisenvironment, our future success will depend on our ability to anticipatechanges in technology, to develop new and enhanced products on a timely andcost-effective basis and to introduce, manufacture and achieve marketacceptance of these new and enhanced products. Development schedules for high technology products are inherentlysubject to uncertainty.  We may not meetour product development schedules, including those for products based on ourdisk-based technology, and development costs could exceed budgetedamounts.  In addition, there can be noassurance that the licensees of our VR2 technology will meet theirproduct development schedules.  Ourbusiness, liquidity, results of operation and financial position may bematerially and adversely affected if the products or product enhancements thatwe develop are delayed or not delivered due to developmental problems, qualityissues or component shortage problems, or if our products or productenhancements do not achieve market acceptance or are unreliable.  The introduction, whether by us or ourcompetitors, of new products embodying new technologies, such as new sequentialor random access mass storage devices, and the emergence of new industrystandards could render existing products obsolete or not marketable, which mayhave a material adverse effect on our business, liquidity, results of operationand financial position.

 

**Our international operations areimportant to our business and involve unique risks.**

 

Historically,sales to customers outside of the U.S. have represented a significant portionof our sales and we expect them to continue representing a significant portionof sales.  Sales to customers outside theU.S. are subject to various risks, including:

 

•                  the imposition of governmental controls mandating compliance withvarious foreign and U.S. export laws;

 

•                  currency exchange fluctuations;

 

•                  political and economic instability;

 

•                  trade restrictions;

 

•                  changes in tariffs and taxes;

 

•                  longer payment cycles (typically associated with international sales);and

 

•                  difficulties in staffing and managing international operations.

 

Furthermore,we cannot assure that we will be able to comply with changes in foreignstandards in the future, even though we endeavor to meet standards establishedby foreign regulatory bodies.  Ourinability to design products that comply with foreign standards could have amaterial adverse effect on our business, liquidity, results of operation andfinancial position.

 

***We aresubject to exchange rate risk in connection with our international operations.***

*** ***

We do not currently engage in foreign currency hedgingactivities and therefore we are exposed to some level of currency risk. Asforeign currency exchange rates vary, the fluctuations in revenues and expensesmay materially impact the financial statements upon consolidation.

 

11

----

 

A weaker U.S. dollarwould result in an increase to revenues and expenses upon consolidation, and astronger U.S. dollar would result in a decrease to revenues and expenses uponconsolidation.  Currently, nearly all ofour international sales are denominated in U.S. dollars.

 

Furthermore, the results of operations of our foreignsubsidiaries are exposed to foreign exchange rate fluctuations as the financialresults of the subsidiaries are translated from the local currency to U.S.dollars upon consolidation.  Because ofthe significance of the operations of our subsidiaries to our consolidatedoperations, as exchange rates vary, net sales and other operating results, whentranslated, may differ materially from our prior performance and ourexpectations. In addition, because of the significance of our overseasoperations, we could also be significantly affected by weak economic conditionsin foreign markets that could reduce demand for our products and furthernegatively impact the results of our operations in a material and adversemanner.

 

**Our ability tocompete effectively depends in part on our ability to protect effectively ourintellectual property rights.**

 

Werely on a combination of patent, copyright, trademark, trade secret and otherintellectual property laws to protect our intellectual property rights.  These rights, however, may not preventcompetitors from developing products that are substantially equivalent orsuperior to our products. To the extent we have or obtain patents, suchpatents may not afford meaningful protection for our technology and products.Others may challenge our patents and, as a result, our patents could benarrowed, invalidated or declared unenforceable. In addition, current or futurepatent applications may not result in the issuance of patents in the UnitedStates or foreign countries.  The laws of certain foreigncountries may not protect our intellectual property to the same extent as U.S.laws.  Furthermore, competitors mayindependently develop similar products, duplicate our products or, if patentsare issued to us, design around these patents.

 

Inorder to protect or enforce our patent rights, we may initiate interferenceproceedings, oppositions, or patent litigation against third parties, such asinfringement suits. These lawsuits could be expensive, take significant timeand divert management’s attention from other business concerns. The patentposition of information technology firms generally is highly uncertain,involves complex legal and factual questions, and has recently been the subjectof much litigation. No consistent policy has emerged from the U.S. Patent and TrademarkOffice or the courts regarding the breadth of claims allowed or the degree ofprotection afforded under information technology patents.

 

**Our success will depend partly on ourability to operate without infringing on or misappropriating the proprietaryrights of others.**

 

Ourbusiness is such that we may at any time be sued for infringing the patentrights or misappropriating the proprietary rights of others. For example, duringfiscal 2004 we settled a case alleging patent infringement.  Intellectual property litigation is costlyand, even if we prevail, the cost of such litigation could adversely affect ourbusiness, financial condition and results of operations. In addition,litigation is time consuming and could divert management attention and resourcesaway from our business. If we do not prevail in any litigation, we could berequired to stop the infringing activity and/or pay substantial damages. Undersome circumstances in the United States, these damages could be triple theactual damages the patent holder incurs. If we have supplied infringingproducts to third parties for marketing or licensed third parties tomanufacture, use or market infringing products, we may be obligated toindemnify these third parties for any damages they may be required to pay tothe patent holder and for any losses the third parties may sustain themselvesas the result of lost sales or damages paid to the patent holder.

 

If athird party holding rights under a patent successfully asserts an infringementclaim with respect to any of our products, we may be prevented frommanufacturing or marketing our infringing product in the country or countriescovered by the patent we infringe, unless we can obtain a license from thepatent holder. Any required license may not be available to us on acceptableterms, or at all. Some licenses may be non-exclusive, and therefore, ourcompetitors may have access to the same technology licensed to us. If we failto obtain a required license or are unable to design around a patent, we may beunable to market some of our products, which could have a material adverseeffect on our business, financial condition and results of operations.

 

**Our warranty reserves may notadequately cover our warranty obligations.**

 

Wehave established reserves for the estimated liability associated with ourproduct warranties.  However, we couldexperience unforeseen circumstances where these or future reserves may notadequately cover our warranty obligations. For example, the failure or inadequate performance of product componentsthat we purchase could increase our warranty obligations beyond these reserves.

 

12

----

 

**Our successdepends on our ability to attract, retain and motivate our executives and otherkey personnel.**

 

Ourfuture success depends in large part on our ability to attract, retain andmotivate our executives and other key personnel, many of whom have beeninstrumental in developing new technologies and setting strategic plans.  Our growth also depends in large part on ourcontinuing ability to hire, motivate and retain highly qualified management,technical, sales and marketing team members. Competition for qualifiedpersonnel is intense and there can be no assurance that we will retain existingpersonnel or attract additional qualified personnel in the future.

 

**Changes in stock option accounting rules mayadversely impact our reported operating results prepared in accordance withgenerally accepted accounting principles, our stock price and our competitivenessin the employee marketplace.**

 

Technologycompanies in general and our company in particular have a history of dependingupon and using broad based employee stock option programs to hire, incentivizeand retain employees in a competitive marketplace. For fiscal years 2005, 2004and 2003, we did not recognize compensation expense for stock options issued toemployees or directors, except in limited cases involving modifications ofstock options, and we instead disclosed in the notes to our financial statementsinformation about what such charges would be if they were expensed.  Beginning with the first quarter of fiscal2006, we have adopted SFAS No. 123(R), which will require us to recordequity-based compensation expense for stock options and employee stock purchaseplan rights granted to employees based on the fair value of the equityinstrument at the time of grant. The change in accounting rules will leadto a decrease in reported earnings or an increase in reported net loss, as thecase may be. This may negatively impact our future stock price. In addition,this change in accounting rules could impact our ability to utilize broadbased employee stock plans to reward employees and could result in acompetitive disadvantage to us in the employee marketplace.  See Note 1, “Operations and Summary ofSignificant Accounting Policies - Stock Based Compensation, of Notes toConsolidated Financial Statements” for more information concerning our adoptionof this accounting standard.

 

**ITEM 2. *Properties***

 

We own no real property and we currently lease allfacilities used in our business. Our headquarters are located in San Diego,California in a two-building light industrial complex comprising approximately160,000 square feet. The lease expires in February 2014 and can be renewedfor one additional five-year period. This San Diego facility houses all of ourresearch and development, and administrative functions,  as well as a major portion of sales, salesadministration, marketing and customer support.

 

We lease a 17,000 square foot facility located inWokingham, England, which houses sales, technical support and repair services.The lease expires in January 2018. We also maintain small sales officeslocated close to Paris, France, Munich, Germany, Singapore and Korea.

 

We are obligated under a lease on a 15,000 square footfacility in Longmont, Colorado which was used by an operation we shut down in2001. The facility is currently vacant and the lease expires in November 2005.

 

**ITEM 3. *Legal Proceedings***

 

We arefrom time to time involved in various lawsuits and legal proceedings that arisein the ordinary course of business.  Weare currently not aware of any such legal proceedings or claims that we believewill have, individually or in the aggregate, a material adverse affect on ourbusiness, financial condition or operating results.  However, litigation is subject to inherentuncertainties, and an adverse result in these or other matters may arise fromtime to time that may harm our business.

 

**ITEM 4. *Submission of Matters to a Vote of Security Holders***

 

None

 

13

----

 

**PART II**

 

**ITEM 5. *Market for Registrant’s Common Equity and Related Shareholder Matters***

 

Ourcommon stock trades on The NASDAQ National Market under the symbol “OVRL”. Asof September 7, 2005, there were approximately 133 shareholders of record.We have not paid any cash dividends on our common stock and do not anticipatepaying any cash dividends in the foreseeable future. The high and low bidquotations of our common stock from June 29, 2003 through July 3, 2005were as follows:

 

| ** **        | ** ** | **Bid Quotations** | ** ** |
|-------------------|------------|--------------------|------------|
| ** **        | ** ** | **High**           | ** ** | **Low** | ** ** |
| Fiscal Year 2005: |       |               |       |   |   |
| Fourth quarter    |       | $                  | 14.86      |   | $ | 9.34 |   |
| Third quarter     |       | 17.19              |       | 13.92 |   |
| Second quarter    |       | 17.34              |       | 13.51 |   |
| First quarter     |       | 14.99              |       | 9.86 |   |
| Fiscal Year 2004: |       |               |       |   |   |
| Fourth quarter    |       | $                  | 17.61      |   | $ | 13.00 |   |
| Third quarter     |       | 23.57              |       | 16.04 |   |
| Second quarter    |       | 20.94              |       | 16.05 |   |
| First quarter     |       | 22.00              |       | 13.76 |   |

 

Theabove quotations reflect inter-dealer prices, without retail markup, markdownor commission and may not necessarily represent actual transactions.

 

**ShareRepurchase Authorization**

 

On August 11,2004, our board of directors authorized the purchase of up to $10.0 million ofour common stock on the open market or through negotiated transactions. Thisrepurchase authority allows us to selectively repurchase our common stock fromtime to time in the open market or in privately negotiated transactionsdepending on market price and other factors. The share repurchase authorization has no stated expirationdate. During the fourth quarter of fiscal 2005, 32,500 shares were repurchased underthe repurchase authorization as follows:

 

### **ISSUER PURCHASES OF EQUITY SECURITIES**

**UNDER SHARE REPURCHASE AUTHORIZATION**

 
| **Period**                             | ** ** | **(a) Total Number  of Shares  Purchased** | ** ** | **(b)  Average  Price Paid  per Share** | ** ** | **(c) Total Number  of Shares  Purchased as Part  of Publicly  Announced Plans  or Programs** | ** ** | **(d) Maximum  Number (or  Approximate Dollar  Value) of Shares that  May Yet Be  Purchased Under the  Plans or Programs** | ** ** |
|----------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|
| April 4 through May 1, 2005  |       | 0                                               |       | N/A                                     |       | N/A                                                                                                |       | $                                                                                                                                    | 10,000,000 |   |
| May 2 through May 29, 2005   |       | 0                                               |       | N/A                                     |       | N/A                                                                                                |       | $                                                                                                                                    | 10,000,000 |   |
| May 30, through July 3, 2005 |       | 32,500                                          |       | $                                       | 9.46       |                                                                                               | 32,500     |                                                                                                                                 | $          | 9,692,404 |   |
| Total                                  |       | 32,500                                          |       | $                                       | 9.46       |                                                                                               | 32,500     |                                                                                                                                 | $          | 9,692,404 |   |

 

14

----

 

**ITEM 6. *Selected Financial Data***

 

Thefollowing selected financial data has been derived from our auditedconsolidated financial statements and the related notes. This informationshould be read in conjunction with Item 7 of this Report - “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,” andwith our consolidated financial statements and the related notes set forth atthe pages indicated in Item 15(a)(1) of this Report.

 
| ** **                                        | ** ** | **Fiscal Year**                               | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                        | ** ** | **2005**                                      | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                        | ** ** | **(in thousands, except per share  amounts)** | ** ** |
| **Income Statement Data:**                        |       |                                          |       |   |   |   |   |   |   |   |   |
| Net revenue                                       |       | $                                             | 235,687    |   | $ | 238,139 |   | $ | 195,881 |   | $ | 163,380 |   | $ | 155,696 |   |
| Gross profit                                      |       | 60,917                                        |       | 64,654 |   | 54,018 |   | 42,445 |   | 39,034 |   |
| Income from operations                            |       | 3,524                                         |       | 15,598 |   | 10,310 |   | 6,516 |   | 3,699 |   |
| Income before income taxes                        |       | 5,068                                         |       | 16,199 |   | 10,193 |   | 6,839 |   | 4,017 |   |
| Net income                                        |       | 4,578                                         |       | 10,625 |   | 6,682 |   | 4,493 |   | 2,494 |   |
| Net income per share(1):                          |       |                                          |       |   |   |   |   |   |   |   |   |
| Basic                                             |       | $                                             | 0.33       |   | $ | 0.79 |   | $ | 0.59 |   | $ | 0.42 |   | $ | 0.24 |   |
| Diluted                                           |       | $                                             | 0.32       |   | $ | 0.74 |   | $ | 0.54 |   | $ | 0.40 |   | $ | 0.23 |   |
|                                              |       |                                          |       |   |   |   |   |   |   |   |   |
| **Balance Sheet Data:**                           |       |                                          |       |   |   |   |   |   |   |   |   |
| Cash, cash equivalents and short-term investments |       | $                                             | 76,887     |   | $ | 69,657 |   | $ | 55,020 |   | $ | 26,884 |   | $ | 10,844 |   |
| Working capital                                   |       | 110,363                                       |       | 103,244 |   | 84,326 |   | 54,463 |   | 46,999 |   |
| Total assets                                      |       | 164,554                                       |       | 144,851 |   | 130,922 |   | 81,003 |   | 70,171 |   |
| Long-term debt, inclusive of current portion      |       | —                                        |       | — |   | 3,957 |   | 4,655 |   | — |   |
| Shareholders’ equity                         |       | 121,494                                       |       | 113,514 |   | 93,264 |   | 59,266 |   | 51,679 |   |

 

----

(1)          SeeNote 1 of Notes to Consolidated Financial Statements for an explanation ofshares used in computing net income per share.

 

**ITEM 7. *Management’s Discussion and Analysis of Financial Condition and Resultsof Operations.***

 

*Thediscussion in this section contains certain statements of aforward-looking nature relating to future events or our future performance. Wordssuch as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates”and similar expressions or variations of such words are intended to identifyforward-looking statements, but are not the only means of identifyingforward-looking statements. Such statements are only predictions and actualevents or results may differ materially. In evaluating such statements, youshould specifically consider various factors identified in this Report,including the matters set forth under the caption “Risk Factors,” which couldcause actual results to differ materially from those indicated by suchforward-looking statements.*

 

**Overview**

 

Infiscal 2005, revenue decreased by 1.0%, net income by 56.9% and diluted earningsper share by 56.8%. Our performance reflects a 9.5% decrease in revenue fromour OEM customers partially offset by a 17.3% growth in revenue from ourbranded channel customers. Our largest customer accounted for approximately 54.3%of total net revenue in fiscal 2005 compared to 58.8% in fiscal 2004. Our grossprofit margin decreased from 27.1% in fiscal 2004 to 25.8% in fiscal 2005. Thedecline in gross profit included $2.1 million of transition costs related tothe outsourcing of our manufacturing process. While we experienced a decline inrevenue and gross profit, operating expenses grew by 17.0%. The spending increasewas in (i) sales and marketing expenses, reflecting an increase inheadcount primarily to support the growth in our branded channel, (ii) researchand development which included continued investment in REOTM developmentand (iii) general and administrative expenses as a result of increasedcosts associated with compliance with Section 404 of the Sarbanes-OxleyAct of 2002.

 

We ended the year with approximately $76.9 million incash, cash equivalents and short-term investments compared to $69.7 million infiscal 2004. At the end of fiscal years 2005 and 2004 we had no debtoutstanding on our credit facility. During fiscal 2005 we generated cash fromoperations of $8.2 million and generated $2.6 million from the exercise ofstock options and purchases under our Employee Stock Purchase Plan (ESPP);offset by capital expenditures of approximately $3.4 million.

 

15

----

 

Our strategy is to become a market leader and innovativesupplier of a complete portfolio of tiered data storage solutions by providingintelligent appliances and software modules designed to work together to ensurethat information is “automatically safe, readily available and always there.”  We intend to deliver products to address allthree tiers of data storage:  primary “protected”disk, secondary disk-based backup and tertiary automated tape libraries forarchival.  Our focus will continue to beon mid-range solutions that can be easily sold worldwide through our indirectnetwork of resellers.  We intend toleverage our leadership position in mid-range tape automation into a similarposition in primary and secondary intelligent disk-based appliances.

 

In September 2004, in order to enhance ourstrategic competitiveness and increase our flexibility, we announced a plan tooutsource all of our manufacturing, currently located in California, to a U.S.third party manufacturer. In November 2004, the contract with theoutsource manufacturer was finalized and all employees were notified oftermination dates and benefits. We completed the transfer all of ourmanufacturing operations in August 2005. We expect to incur between $2.5million and $3.0 million of pretax charges for outsourcing severance costs andother obligations. We recorded $2.1 million of these charges in fiscal 2005 asa cost of revenue, and expect up to an additional $900,000 in charges in the firstquarter of fiscal 2006. The charges in fiscal 2005 include an expense of $1.5million representing one-time termination benefits and $523,000 of othertransition costs which were recorded as incurred.

 

In August 2005,Hewlett-Packard Company (HP) informed us of its decision not to purchase itsnext-generation, mid-range tape automation production line from Overland. HPwill continue to purchase the tape automation products currently supplied by usfor some time; however, the new product will eventually replace the majority ofthose purchases. We cannot predict how quickly this transition will occur, but webelieve the impact to our revenue during fiscal 2006 will be minimal. Theimpact to our revenues in fiscal 2007 is expected to be significant. In lightof this anticipated loss in future revenue, we intend to focus heavily on thedelivery of new higher-margin products to our branded channel during fiscal2006. Our current three-year contract with HP expires in July 2006. Thecontract does not commit HP to buy specific quantities of product at any time.

 

**Critical Accounting Policies and Estimates**

 

Our discussion and analysis of our financial conditionand results of operations are based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States of America. The preparation of consolidatedfinancial statements requires that we make estimates and judgments that affectthe reported amounts of assets, liabilities, revenue and expenses, and relateddisclosure of contingent liabilities. On an on-going basis, we evaluate ourestimates, including those related to revenue recognition, bad debts,inventories, income taxes, warranty obligations and contingencies. We base ourestimates on historical experience and on various other assumptions that webelieve to be reasonable under the circumstances, the results of which form thebasis for making judgments about the carrying values of assets and liabilitiesthat are not readily apparent from other sources. Actual results may differfrom these estimates under different assumptions or conditions.

 

We believe the following accounting policies affect ourmore significant judgments and estimates used in the preparation of ourconsolidated financial statements.

 

***Revenue Recognition***

 

Revenueon direct product sales (excluding sales to distributors and certain OEMcustomers) is recognized upon shipment of products to such customers. Thesecustomers 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.Title and risk of loss transfer to the customer when the product leaves ourdock. Product sales to distribution customers are subject to certain rights ofreturn, stock rotation privileges and price protection. Because we are unableto estimate our exposure for returned product or price adjustments, revenuefrom shipments to these customers is not recognized until the related productsare in turn sold to the ultimate customer by the distributor. As part of ourexisting agreements with certain OEM customers, we ship products to variousdistribution hubs around the world and retain ownership of that inventory untilit is pulled by these OEM customers to fulfill their customer orders, at whichtime, generally the same business day, the Overland sale is recorded.

 

16

----

 

We have entered into various licensing agreements relatingto our Variable Rate Randomizer (VR2)technology. These agreements typically call for royalty fees based on sales bylicensees of products containing VR2. Royaltieson sales by licensees of products containing VR2 are recorded when earned, generally in theperiod during which the licensee ships the products containing VR2 technology. In certain instances, thecustomer has elected to purchase, from us, the Applications Specific IntegratedCircuit (ASIC) chips embodying VR2, which arepriced to include the cost of the chip plus an embedded royalty fee. In theseinstances, revenue on ASIC chip sales are recorded as product revenue whenearned, which is upon the shipment of the underlying ASIC chip incorporatingthe VR2 technology to the customer.

 

***Allowance for Doubtful Accounts***

 

Weestimate our allowance for doubtful accounts based on an assessment of thecollectibility of specific accounts and the overall condition of the accountsreceivable portfolio. When evaluating the adequacy of the allowance for doubtfulaccounts, we analyze specific trade and other receivables, historical baddebts, customer credits, customer concentrations, customer credit-worthiness,current economic trends and changes in customers’ payment terms and/orpatterns. If the financial condition of our customers were to deteriorate,resulting in an impairment of their ability to make additional payments, thenwe may need to make additional allowances. Likewise, if we determine that wecould realize more of our receivables in the future than previously estimated,we would adjust the allowance to increase income in the period we made thisdetermination. We review the allowance for doubtful accounts on a quarterlybasis and record adjustments as deemed necessary.

 

***Inventory Valuation***

 

We record inventories at the lower of cost or marketvalue. We assess the value of our inventories periodically based upon numerousfactors including expected product or material demand, current marketconditions, technological obsolescence, current cost and net realizable value.If necessary, we adjust our inventory for obsolete or unmarketable inventoryequal to the difference between the cost of the inventory and the estimatedmarket value. Likewise, we record an adverse purchase commitment liability whenanticipated market sales prices are lower than committed costs. If actualmarket conditions are less favorable than what we projected, we may need torecord additional inventory adjustments and adverse purchase commitments.

 

***Income Taxes***

 

We estimate our tax liabilitybased on current tax laws in the statutory jurisdictions in which we operate.These estimates include judgments about deferred tax assets and liabilitiesresulting from temporary differences between assets and liabilities recognizedfor financial reporting purposes and such amounts recognized for tax purposes,as well as about the realization of deferred tax assets. If we cannot realizecertain deferred tax assets or if the tax laws change unfavorably, we couldexperience potential significant losses in excess of provisions established.Likewise, if we can realize additional deferred tax assets or if tax lawschange favorably, we could experience potential significant gains.

 

17

----

 

***Warranty Obligations***

 

We generally provide a three-year advance replacementreturn-to-factory warranty on our NEO SERIES, PowerLoader and LoaderXpressproducts and a one year advance replacement return-to-factory warranty on ourREO SERIES. We also provide on-site service for the first warranty year of theNEO SERIES products for which we contract with third-party service providers. Formost products, we offer a program called XchangeNOW as part of ourreturn-to-factory warranty which enables customers to receive an advance replacementunit shipped within two business days after placing a service request. Thecustomer ships the defective unit back to us using the shipping materials fromthe replacement unit. We record a provision for estimated future warranty costsat the time of shipment for both the return-to-factory and on-site warranties.Separately priced on-site warranties are offered for sale to customers of otherproduct lines. We contract with outside vendors to provide service relating toall on-site warranties. Warranty revenue and amounts paid in advance to outsideservice organizations are recognized in the financial statements in revenue andcost of revenue, respectively, over the warranty period.

 

***Impairment of Long-Lived Assets***

 

We also consider potential impairment of both tangibleand intangible long-lived assets when circumstances indicate that the carryingamount of an asset may not be recoverable. In such circumstances, we may incurmaterial charges relating to the impairment of such asset. We would measure anyrequired impairment loss as the amount by which the asset’s carrying valueexceeds its fair value and we would record it as a reduction in the carryingvalue of the related assets and charge it to results of operations.

 

**Results of Operations**

** **

Thefollowing tables set forth certain financial data as a percentage of net revenue:

 
| ** **                  | ** ** | **Fiscal Year** | ** ** |
|-----------------------------|------------|-----------------|------------|
| ** **                  | ** ** | **2005**        | ** ** | **2004** | ** ** | **2003** | ** ** |
|                        |       |            |       |   |   |   |   |
| Net revenue                 |       | 100.0           | %          | 100.0 | % | 100.0 | % |
| Cost of revenue             |       | 74.2            |       | 72.9 |   | 72.4 |   |
| Gross profit                |       | 25.8            |       | 27.1 |   | 27.6 |   |
| Operating expenses:         |       |            |       |   |   |   |   |
| Sales and marketing         |       | 14.6            |       | 13.0 |   | 13.6 |   |
| Research and development    |       | 4.5             |       | 3.0 |   | 3.8 |   |
| General and administrative  |       | 5.2             |       | 4.6 |   | 4.9 |   |
|                        |       | 24.3            |       | 20.6 |   | 22.3 |   |
| Income from operations      |       | 1.5             |       | 6.5 |   | 5.3 |   |
| Other income (expense), net |       | 0.7             |       | 0.3 |   | (0.1 | ) |
| Income before income taxes  |       | 2.2             |       | 6.8 |   | 5.2 |   |
| Provision for income taxes  |       | 0.3             |       | 2.3 |   | 1.8 |   |
| Net income                  |       | 1.9             |       | 4.5 |   | 3.4 |   |

 

**FiscalYear 2005 Compared to Fiscal Year 2004**

 

***Net Revenue.*** Net revenue decreased from $238.1million in fiscal 2004 to $235.7 million in fiscal 2005. The decrease of $2.4million or 1.0% is primarily due to a 9.5% decrease in revenue from OEMcustomers, as a group. This decrease is primarily a result in declining salesto HP attributed to the decrease of NEO2000 products and spare parts. Net revenuefrom HP represented approximately 54.3% of net revenue in fiscal 2005 comparedto approximately 58.8% in fiscal 2004.

 

Net revenuefrom Overland branded products increased from $79.4 million in fiscal 2004 to$93.2 million in fiscal 2005. The increase of $13.8 million or 17.3% wasprimarily the result of an increase in sales of REO disk-based products and a $4.0million increase in revenue from Europe, Middle East and Africa (EMEA) relatedto shipments under a large contract with a European governmental agency. Fiscal2004 product sales represent less than an entire year of REO sales as we beganshipping the first REO product in August 2003. In addition, in October 2004,we introduced a new REO product which resulted in sales of approximately $7.1 millionfor fiscal 2005.

 

18

----

 

Inaddition, VR2 revenue in fiscal 2005 decreased from $3.8million in fiscal 2004 to $2.2 million in fiscal 2005. This decrease of $1.6million or 42% was the result of declining chip sales. In fiscal 2005,royalties represented $1.9 million of VR2 revenue compared to $1.7 million in fiscal2004. During fiscal 2005 chip sales decreased to $240,000 from $2.0 million infiscal 2004.

 

We project that revenue will grow in fiscal 2006 byapproximately 6% over fiscal 2005. This projection includes 40% growth in ourbranded business, driven largely by sales of new products including our newprotected primary storage offering and new scalable REO products we plan tointroduce in the second quarter of fiscal 2006, and our new tape automationproducts beginning in the third quarter of fiscal 2006. We estimate that thisgrowth in branded revenue will be partially offset by a 16% decline in sales toOEM customers, primarily HP.

 

A summary of the sales mix by product for the periodspresented in the statement of operations follows:

 
| ** **                 | ** ** | **Fiscal Year** | ** ** |
|----------------------------|------------|-----------------|------------|
| ** **                 | ** ** | **2005**        | ** ** | **2004** | ** ** | **2003** | ** ** |
| LibraryXpress products:    |       |            |       |   |   |   |   |
| NEO Series                 |       | 68.0            | %          | 68.8 | % | 66.1 | % |
| Loaders                    |       | 8.9             |       | 10.3 |   | 15.3 |   |
|                       |       | 76.9            |       | 79.1 |   | 81.4 |   |
| Spare parts, drives, other |       | 17.9            |       | 18.6 |   | 16.8 |   |
| Disk based                 |       | 4.2             |       | 0.7 |   | 0.0 |   |
| VR2                        |       | 1.0             |       | 1.6 |   | 1.8 |   |
|                       |       | 100.0           | %          | 100.0 | % | 100.0 | % |

 

***Gross Profit.*** Gross profit decreased from $64.7million in fiscal 2004 to $60.9 million in fiscal 2005. The decrease of approximately$3.8 million or 5.8% is primarily due to an overall decrease in our net revenueof $2.4 million, as described above, and an increase of $2.1 million in cost ofrevenue associated with the outsourcing of our manufacturing activities. In addition,during fiscal 2005 warranty costs increased by $2.6 million as a result of moreproducts under warranty compared to the prior year. These cost increases werepartially offset by favorable product mix within our branded channel and alarger concentration of higher margin sales of branded products versus lowermargin OEM products.

 

Excludingthe impact of outsourcing charges in fiscal 2005 and amortization in fiscal2006 of acquisition costs associated with the Zetta acquisition, we expect ourgross margin percentage in fiscal 2006 to be relatively unchanged from fiscal2005. Although sales of branded products are expected to represent a higherpercentage of total revenue in fiscal 2006 compared to fiscal 2005, we expectthat the gross margin percentage on our new products will initially be lowerthan our existing products, which is consistent with our past experience. Infiscal 2007 we will focus on cost reductions, which we expect will result in grossmargin improvements.

 

***Sales and Marketing Expenses.*** Sales and marketingexpenses increased to $34.4 million in fiscal 2005 from $30.8 million in fiscal2004. The increase of approximately $3.6 million or 11.5% is primarily associatedwith an expansion of our branded sales force. We expect that sales and marketingexpenses in fiscal 2006 will grow 15% to 20% over fiscal 2005 representingincremental spending to introduce and promote our new products introduced duringthe year, and to increase our sales and technical support services.

 

***Research and Development Expenses.*** Research anddevelopment expenses increased to $10.7 million in fiscal 2005 from $7.3million in fiscal 2004. The increase of approximately $3.4 million or 47.2% isprimarily due to an increase of approximately $1.4 million associated with anincrease in headcount for further development of REO and other new products,and a related increase in development costs of approximately $1.2 million. Weanticipate heavy R&D spending in fiscal 2006 for completion of thedevelopment of our new tape library platform, the new scalable REO products, andthe new protected primary storage offerings. We also expect heavy research anddevelopment spending related to the integration of the development team fromthe August 2005 acquisition of Zetta Systems. R&D spending for fiscal2006 is expected to grow by approximately 65% over fiscal 2005.

 

19

----

 

***General and Administrative Expenses***. General andadministrative expenses increased to $12.3 million in fiscal 2005 from $10.9million in fiscal 2004. The increase of approximately $1.4 million or 12.6% isprimarily due to a $1.3 million increase in consulting and auditing feesassociated with compliance with Section 404 of the Sarbanes-Oxley Act of2002, and an increase of approximately $555,000 associated with an increase in generaloperating activities during fiscal 2005. These increases were offset by a$639,000 decrease in legal fees in fiscal 2005, which primarily resulted fromthe settlement of the Raytheon patent infringement lawsuit in April 2004.We anticipate that general and administrative expenses in fiscal 2006 will berelatively flat compared to the spending in fiscal 2005.

 

***Interest Income, net***. Interest income increasedto $1.5 million in fiscal 2005 from $533,000 in fiscal 2004. The increase ofapproximately $1.0 million or 181.4% is due to higher average cash balancescombined with higher average yields when compared to fiscal 2004.

 

***Provision for Income Taxes.*** Provision for incometaxes decreased from $5.6 million in fiscal 2004 to $490,000 in fiscal 2005.The decrease of approximately $5.1 million or 91.2% is primarily the result of the decrease in fiscal 2005 earnings compared to fiscal 2004 and changesin prior year estimates due to the favorable settlement of IRS audits and statuteexpirations. Due to the expected taxable loss in fiscal 2006, weexpect to receive a benefit at the statutory rate. In addition, we expect abenefit comparable to fiscal 2005 related to the research and development taxcredit, and a reduced Extraterritorial Income Benefit (ETI), compared to fiscal2005, as a result of the phase out of the ETI exclusion.

 

**FiscalYear 2004 Compared to Fiscal Year 2003**

 

***Net Revenue*.**Netrevenue of $238.1 million in fiscal year 2004 was $42.2 million or21.6% above net revenue of $195.9 million in fiscal 2003. This revenuegrowth was driven by increased unit sales and generally reflected the continuedstrong performance of our NEO SERIES line of tape library products. Saleswithin our library product lines (NEO, LibraryXpress®, LibraryPro®, Loaders andPowerLoaders) grew 18.9% to $189.8 million, compared to$159.6 million in fiscal 2003. Fiscal 2004 sales to OEM customers were up22.5 % compared to fiscal 2003. The increase in revenue from our OEM customerswas driven largely by depressed quarters in the first part of fiscal 2003 dueto the uncertainty surrounding the HP/Compaq merger. While post mergerquarterly revenue steadily grew to a peak in the second quarter of fiscal 2004,revenue from HP declined slightly from this peak in the second half of the year.Sales to HP accounted for 58.8% of total net revenue in fiscal 2004, comparedto 58.4% in fiscal 2003.

 

Net revenue from Overland branded products during fiscal2004 grew 20.5% over fiscal 2003 from $65.9 million to $79.4 million. Thisincrease reflected our increased focus on the Overland branded channel over thepast two years. Sales of Overland branded library products increased 16.7% overfiscal 2003, driven primarily by NEO SERIES library revenue with the largestincrease coming from our domestic customers. Also contributing to the increasein branded channel results was revenue of $1.7 million generated from ourdisk-based REO products. Partially offsetting these increases was a 3.0%decrease in revenue from loader products.

 

Net revenue from spare parts of$27.7 million in fiscal 2004 were $7.1 million or 34.4% above net revenueof $20.6 million in fiscal 2003. This increase was driven primarily by ourOEM customers.

 

VR2 revenue during fiscal 2003 amounted to$3.8 million and was comprised of chip sales of $2.0 million, engineeringservice fees of $50,000 and royalties of $1.7 million. VR2 revenueduring fiscal 2003 amounted to $3.5 million and was comprised of chip sales of$785,000, engineering service fees of $775,000 and royalties of $1.9 million.

 

***Gross Profit***. Gross profit amounted to $64.7million in fiscal 2004, an increase of $10.7 million or 19.7% from $54.0million in fiscal 2003, resulting from a combination of higher sales volumes somewhatoffset by slightly lower gross margins. The gross margin percentage decreased slightlyto 27.1% in fiscal 2004, down from 27.6% in fiscal 2003. The decrease in grossmargin percentage was due primarily to $1.8 million of amortization related tothe Okapi technology asset. We also experienced higher warranty costs during fiscal2004 as our domestic warranty policy, which includes one year of on-sitewarranty with the purchase of many of our products, was extended to ourEuropean customers. Although product mix and channel mix had little effect onthe gross margin percentage when compared to the prior year, the increasedcosts discussed above were partially offset as material cost reductionsoutpaced average selling price degradation during fiscal 2004 and our pool ofrelatively fixed overhead costs was spread across a larger revenue base.

 

***Sales and Marketing Expenses***. Sales and marketingexpenses amounted to $30.9 million, representing 13.0% of net revenue in fiscal2004, compared to $26.7 million or 13.6% of net revenue in fiscal 2003. Theincreased expenditures resulted primarily from salary and related expensesassociated with the expansion of our Overland branded sales force, increasedspending associated with lead generation activities and increased marketdevelopment funding related to our OEM customers. Also contributing to theincrease were incremental expenses associated with promoting awareness aroundour disk-based products launched in early fiscal 2004.

 

20

----

 

***Research and Development Expenses.***R&Dexpenses amounted to $7.3 million or 3.0% of net revenue in fiscal 2004,compared to $7.4 million or 3.8% of net revenue in fiscal 2003. This decrease in absolute dollars was dueto the elimination of expenses for our wound down Longmont operations combinedwith the restructure of our advanced research group during the fourth quarterof fiscal 2003. Also, the fiscal 2003 period included an adjustment to theaccrued restructuring charges for the Longmont facility that did not repeat in fiscal2004. Offsetting these decreases were increased salaries and related costsassociated with our disk-based development team and increased developmentexpenses associated with our NEO8000 and future tape based products.

 

***General and Administrative Expenses***. General andadministrative expenses amounted to $10.9 million or 4.6% of net revenue in fiscal2004, compared to $9.6 million or 4.9% of net revenue in fiscal 2003. Thisincrease was due primarily to incremental legal fees associated with theRaytheon lawsuit, which was settled in the fourth quarter of fiscal 2004. Alsocontributing to the increase were consulting fees associated with compliancewith Section 404 of the Sarbanes-Oxley Act of 2002, and corporate strategydevelopment.

 

***Interest Income***. In fiscal 2004, we generatedinterest income of $601,000, compared to interest income of $427,000 in fiscal2003. The increase was due to higher average cash balances.

 

***Interest Expense***. In fiscal 2004, we incurredinterest expense of $68,000, compared to interest expense of $212,000 in fiscal2003. This decrease of interest expense was due to the repayment of alloutstanding balances on our long-term debt arrangement in the second quarter offiscal 2004.

 

***Other Expense/Income***. In fiscal 2004, wegenerated net other income of $68,000, compared to net other expense of$332,000 in fiscal 2003. These amounts primarily related to foreign currencytransaction fluctuations related to our United Kingdom operations.

 

***Provision for Income Taxes***. Our fiscal 2004provision for state federal and foreign income taxes amounted to$5.6 million. This equated to an effective tax rate of 34.4% in fiscal2004, flat when compared to fiscal 2003.

 

**Liquidityand Capital Resources**

 

At the end of fiscal 2005, we had $76.9 million ofcash, cash equivalents and short-term investments compared to $69.7 million at theend of fiscal 2004. In addition, we had $10.0 million available on our unusedbank line of credit. We believe these resources will be sufficient to fund ouroperations and to provide for our growth the next twelve months and into theforeseeable future. We have no other unused sources of liquidity at this time.

 

Our primary source of liquidity has historically beencash generated from operations. During fiscals 2005, 2004 and 2003, wegenerated $8.2 million, $14.6 million and $9.0 million, respectively, fromoperations. In addition to cash generated from operations in fiscal 2003, weraised an aggregate of $20.6 million in net proceeds through the sale of ourcommon stock. The decrease of $6.4 million in cash provided by operatingactivities compared to fiscal 2004 was primarily the result of a decrease innet income and an increase in accounts receivable of $4.0 million. The growthin operating cash flow in fiscal 2004 compared to fiscal 2003 resulted fromsignificantly improved profitability, a decrease in inventories resulting frombetter supply chain and buffer inventory management, as well as a larger taxbenefit from an increased volume of stock option exercises. Offsetting this wasthe use of operating cash to fund an increase in income taxes receivable andprepaid third-party warranty contracts and a decrease in accounts payable. Theincrease of income taxes receivable was primarily a result of the tax benefitreceived from the exercise of stock options. The increase in prepaidthird-party warranty contracts is a result of an increased focus on the sale ofwarranty upgrades and renewals. In fiscal 2003, operating cash flows wereprovided by increases in accounts payable and income taxes payable, net income,depreciation and amortization and tax benefits from the exercise of stockoptions. In fiscal 2003, operating cash was used to fund an increase inaccounts receivable and inventories. These increases in accounts receivable,inventory and accounts payable were related to increases in sales, primarily toHP.

 

Cashused in investing activities was $18.0 million in fiscal 2005, $59.2 millionfor fiscal 2004 and $3.7 million for fiscal 2003. During fiscal 2005, wepurchased short-term investments of approximately $114.2 million and receivedproceeds of approximately $99.6 million for the maturity and sale of similarinvestments. During fiscal 2004 we purchased $132.7 million of marketable debtsecurities and received proceeds of $75.6 million from the maturity ofmarketable debt securities.

 

21

----

 

Capital expendituresduring fiscal years 2005, 2004 and 2003 were approximately $3.4 million, $2.1million and $1.4 million, respectively, and were comprised primarily of purchasesof computers and related equipment. During fiscal 2003, we invested cash of $2.4million, in addition to issuing 134,551 shares of Overland common stock, toacquire the Okapi assets.

 

Cashprovided by financing activities was $2.6 million for fiscal 2005, $2.3 millionfor fiscal 2004, and $22.7 million for fiscal 2003. Cash provided by financingactivities was due to $2.9 million in proceeds from the issuance of commonstock under our Employee Stock Purchase Plan (ESPP) and upon exercise of stockoptions; offset by $309,000 used to repurchase shares of our common stock onthe open market under our share repurchase authorization plan. Proceeds fromthe issuance of common stock under our ESPP and the exercise of stock optionswere $6.3 million and $2.8 million in fiscal years 2004 and 2003, respectively.During fiscal 2003 we received proceeds of $20.6 million from the issuance ofcommon stock sold in a private placement. During fiscal 2003, principalpayments of $698,000 were made towards the term note and in fiscal 2004 theoutstanding balance of $4.0 million was paid in full.

 

We have a credit facilityconsisting of a $10.0 million revolving line of credit for working capitalpurposes that expires on November 30, 2006. The line of credit iscollateralized by a general security interest in our assets. Interest on theline of credit is set at the bank’s prime rate (6.50% on September 12, 2005)in effect from time to time minus 0.25% or, at our option, a rate equal toLIBOR plus 2.25%. The loan agreementgoverning the credit facility requires us to comply with several financial andnon-financial covenants. At the end of fiscal 2005, we were in compliance withall covenants under the facility. A violation of one or more of these covenantswould constitute a default under the credit facility, which would enable thelender, at its option without notice, to accelerate all then outstandingindebtedness under the credit facility and/or terminate the lender’s obligationto extend credit under the credit facility. Under the terms of thecredit facility, we have a financial covenant that states we cannot incur aloss for two consecutive quarters. We recorded a loss during the fourth quarterof fiscal 2005. If we record a loss in the first quarter of fiscal 2006, wewould be in default under the terms of the credit facility, absent a waiver ofsuch covenant. At the end of fiscal 2005, no amounts were outstanding under thecredit facility.

 

On August 11, 2004, our board of directorsauthorized the purchase of up to $10.0 million of our common stock on the openmarket or through negotiated transactions. This repurchase authority allows us toselectively repurchase our common stock from time to time in the open market orin privately negotiated transactions depending on market price and otherfactors. The share repurchase authorization has no stated expiration date. During fiscal 2005,an aggregate of 32,500 shares were repurchased at a total cost of $309,000.

 

In August 2005, we used $9.0 million of cash forthe purchase of Zetta Systems, Inc.

 

**Off-BalanceSheet Arrangements**

 

We have no off-balance sheet arrangements orsignificant guarantees to third parties not fully recorded in our BalanceSheets or fully disclosed in our Notes to Consolidated Financial Statements.

 

**ContractualObligations**

 

The following schedule summarizesour contractual obligations to make future payments (in thousands)**:**

 
| **Contractual Obligations**   | ** ** | **Total** | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **After 5  years** | ** ** |
|-------------------------------|------------|-----------|------------|-----------------------|------------|---------------|------------|---------------|------------|--------------------|------------|
| Operating lease obligations   |       | $         | 30,730     |                  | $          | 3,251         |       | $             | 6,471      |               | $          | 6,728 |   | $ | 14,280 |   |
| Purchase obligations          |       | 24,552    |       | 24,552                |       | —        |       | —        |       | —             |       |
| Total contractual obligations |       | $         | 55,282     |                  | $          | 27,803        |       | $             | 6,471      |               | $          | 6,728 |   | $ | 14,280 |   |
|                               |            |           |            |                       |            |               |            |               |            |                    |            |  |  |  |  |  |  |  |  |

 

22

----

 

**Inflation**

 

Inflationhas 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 rawmaterial prices caused by inflation. If at any time we cannot pass on suchincreases, our margins could suffer. Our exposure to the effects of inflation couldbe magnified by the concentration of OEM business.

 

**RecentlyIssued Accounting Pronouncements**

 

SeeNote 1 to Consolidated Financial Statements.

 

**ITEM 7A. *Quantitative and Qualitative Disclosures about Market Risk***

 

Market risk representsthe risk of loss that may impact our financial position, results of operationsor cash flows due to adverse changes in financial and commodity market pricesand rates. We are exposed to market risk in the areas of changes in UnitedStates interest rates and changes in foreign currency exchange rates asmeasured against the U.S. dollar. These exposures are directly related to ournormal operating and funding activities. Historically, we have not usedderivative instruments or engaged in hedging activities.

 

***InterestRate Risk.***Allof our fixed income investments are classified as available-for-sale andtherefore reported on the balance sheet at market value. Changes in the overalllevel of interest rates affect our interest income that is generated from ourinvestments. For fiscal 2005, total interest income was $1.6 million withinvestments yielding an annual average of 2.2% on a worldwide basis. Theinterest rate level was up approximately 120 basis points from 1.0% in fiscal2004. If a comparable decline in overall interest rates (120 basis points) wereto occur in fiscal 2006, our interest income would decline approximately $923,000,assuming consistent investment levels.

 

The table below presentsthe cash, cash equivalents and short-term investment balances and related weighted-averageinterest rates at the end of fiscal 2005. The cash, cash equivalents and short-terminvestment balances approximate fair value(in thousands):

 
| ** **                | ** ** | **Approximate  Market Value** | ** ** | **Weighted-Average  Interest Rate** | ** ** |
|---------------------------|------------|-------------------------------|------------|-------------------------------------|------------|
| Cash and cash equivalents |       | $                             | 5,498      |                                | 2.4        | % |
| Short-term investments:   |       |                          |       |                                |       |
| Less than 1 year          |       | 2,937                         |       | 2.1                                 | %          |
| Due in 1 – 2 years   |       | 749                           |       | 6.3                                 | %          |
| Due in 2-5 years          |       | 1,931                         |       | 4.1                                 | %          |
| Due after 5 years         |       | 65,772                        |       | 3.2                                 | %          |
|                      |       | $                             | 76,887     |                                | 3.1        | % |

 

The table above includesthe United States dollar equivalent of cash, cash equivalents and short-terminvestments, including $117,000, and $903,000 equivalents denominated in theBritish Pound Sterling and the Euro, respectively.

 

***ForeignCurrency Risk.***Weconduct business on a global basis and essentially all of our products sold ininternational markets are denominated in U.S. dollars. Historically, exportsales have represented a significant portion of our sales and are expected tocontinue to represent a significant portion of sales.

 

Our wholly-ownedsubsidiaries in the United Kingdom, France and Germany incur costs and maintaininter-company balances which are denominated in local currencies. As exchangerates vary, these results when translated into U.S. dollars may vary fromexpectations and adversely impact overall expected results. The effect ofexchange rate fluctuations on our results during fiscal 2005 was not material.

 

**ITEM 8.  *Financial Statements andSupplementary Data***

 

Ourconsolidated financial statements and supplementary data required by this itemare set forth at the pages indicated in Item 15(a)(1) and 15(a)(2),respectively.

 

23

----

 

**ITEM 9.  *Changes in andDisagreements with Accountants on Accounting and Financial Disclosure***

 

None.

 

**ITEM 9A.  *Controls and Procedures***

 

**ConclusionRegarding the Effectiveness of Disclosure Controls and Procedures**

 

Underthe supervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, we conducted anevaluation of our disclosure controls and procedures, as such term is definedunder Rules 13a-15(e) and 15d-15(e) promulgated under the SecuritiesExchange Act of 1934, as amended (the Exchange Act). Based on this evaluation,our principal executive officer and our principal financial officer concludedthat our disclosure controls and procedures were effective as of the end of theperiod covered by this annual report.

 

**Management’sReport on Internal Control Over Financial Reporting**

 

Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and15d-15(f). Under the supervision and with the participation of our management,including our principal executive officer and principal financial officer, weconducted an evaluation of the effectiveness of our internal control overfinancial reporting based on the framework in *InternalControl - Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission. Based on our evaluation under theframework in *Internal Control - IntegratedFramework*, our management concluded that our internal control overfinancial reporting was effective as of July 3, 2005.

 

Our management’sassessment of the effectiveness of our internal control over financialreporting as of July 3, 2005 has been audited by PricewaterhouseCoopers LLP,the independent registered public accounting firm that also audited our consolidatedfinancial statements included in this annual report, as stated in their reportwhich is included herein.

 

**Changes in Internal Controls**

 

There we no changes inour internal control over financial reporting during our fiscal quarter endedJuly 3, 2005 that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting. 

 

**ITEM 9B.  *Other Information***

 

On September 6, 2005,Mr. John Matze, who served as Vice President and Chief Technical Officerof Overland Storage, Inc. (the Company), indicated his intention to resignfrom the Company effective September 9, 2005. Mr. Matze was anat-will employee whose employment could be terminated by him or by the Companyfor any reason, with or without notice. Mr. Matze earned an annual salaryof $240,000 per year and participated in the Company’s executive bonus plan.Upon the effective date of his resignation, Mr. Matze was no longereligible for benefits under his retention agreement dated effective June 25,2003, which were payable upon certain terminations following a change incontrol of the Company.

 

The foregoing disclosureis provided in lieu of disclosure under Item 1.02 of Form 8-K.

 

On September 9,2005, we entered into an employment agreement with Mr. W. MichaelGawarecki, our Vice President of Operations, which was effective as of May 16,2005. Under the agreement, Mr. Gawarecki is entitled to a base salary of $246,500per year and is eligible for discretionary quarterly bonuses under our MBO andBonus Plan, which bonuses may not exceed 40% of Mr. Gawarecki’s quarterlybase salary. Mr. Gawarecki was also eligible to receive a special bonusrelated to outsourcing of $100,000, but the conditions for receiving that bonuswere not satisfied. The term of the agreement will continue until June 30,2006 and will not renew unless agreed by the parties in writing. Mr. Gawarecki’semployment is at-will and may be terminated by us or by him at any time and forany reason, with or without cause. If Mr. Gawarecki is terminated withoutcause or resigns with good reason, he will be entitled to receive a severancepayment equal to 100% of his then annual base salary, subject to the executionby him of a general release of claims against us. This severance will be paidin either a lump-sum amount or in twelve equal monthly installments withoutinterest, at the election of Mr. Gawarecki. Our obligation to payseverance to Mr. Gawarecki under the agreement terminates upon theoccurrence of a change in control.

 

The foregoing disclosureis provided in lieu of disclosure under Item 1.01 of Form 8-K.

 

24

----

 

On September 14,2005, our board of directors designated Ms. Christie Huff, our VicePresident of Worldwide Marketing, to be an executive officer. Ms. Huffearns an annual salary of $195,000 per year. We also entered into our standardform of retention agreement with Ms. Huff. Under this agreement, Ms. Huffwill receive a severance payment if, within two years of the consummation of achange in control of the Company, she is terminated without cause or resignswith good reason. The severance payment would be based upon Ms. Huff’s basesalary at the time of the consummation of the change in control or thetermination date, whatever is higher, plus her target bonus for the year priorto the consummation of the change in control. This agreement provides that,upon a change in control, Ms. Huff would be entitled to an amount equal toher respective base salary plus target bonus. If any portion of any paymentunder the agreement would constitute an “excess parachute payment” within themeaning of Section 280G of the Internal Revenue Code, then that paymentwill be reduced to an amount that is one dollar less than the threshold fortriggering the tax imposed by Section 4999 of the Internal Revenue Code. Wealso entered into our standard indemnification agreement with Ms. Huff. Ms.Huff’s employment is at-will and may be terminated by us or her at any time andfor any reason, with or without cause.

 

The foregoing disclosureis provided in lieu of disclosure under Item 1.01 of Form 8-K.

 

On August 22, 2005, ourboard of directors established a Special Committee on Shareholder Value OnAugust 22, 2005, our Board established a Special Committee on ShareholderValue.  The members of the SpecialCommittee are Scott McClendon (Chair), Robert Degan and Michael Norkus.  The Special Committee will evaluate andrespond to any unsolicited third-party proposals to acquire the Company.  The Special Committee will also advise in thefuture regarding any Company-solicited transactions which are out of theordinary course of business and designed to increase shareholder value.  No such transactions are contemplated at thistime.  On September 14, 2005, the Boarddetermined that the directors serving on the Special Committee will receive$500 for each committee meeting attended (whether telephonically or in person)since formation of the Special Committee. Such fee will not be paid for committee meetings in joint session withthe full Board.

 

The foregoing disclosure is provided in lieu of disclosure under Item1.01 and Item 8.01 of Form 8-K.

 

25

----

 

**PART III**

 

**ITEM 10. *Directors and Executive Officers of the Registrant***

 

Theinformation required by this item is included under the captions entitled “Electionof Directors”, “Executive Officers”, and “Section 16(a) BeneficialOwnership Reporting Compliance” in our Proxy Statement to be filed for our 2005Annual Meeting of Shareholders and is incorporated herein by reference.

 

Wehave adopted the Overland Storage, Inc. Code of Business Conduct andEthics, a Code that applies to our directors, officers and employees. A copy ofthe Code of Business Conduct and Ethics is publicly available on our website atwww.overlandstorage.com. If we make any substantive amendments to the Code ofBusiness Conduct and Ethics or grant any waiver from a provision of the codeapplying to our principal executive officer or our principal financial oraccounting officer, we will disclose the nature of such amendment or waiver onour website or in a report on Form 8-K.

 

**ITEM 11.   *Executive Compensation***

 

Theinformation required by this item is included under the caption entitled “Compensationof Executive Officers”, “Non-Employee Director Compensation” and “Report of theCompensation Committee of the Board of Directors on Executive Compensation” inour Proxy Statement to be filed for our 2005 Annual Meeting of Shareholders andis incorporated herein by reference.

 

**ITEM 12.   *Security Ownership ofCertain Beneficial Owners and Management***

 

The information required by this item is includedunder the caption entitled “Security Ownership of Certain Beneficial Owners andManagement” in our Proxy Statement to be filed for our 2005 Annual Meeting ofShareholders and is incorporated herein by reference.

 

**ITEM 13.   *Certain Relationships andRelated Transactions***

 

Theinformation required by this item is included under the caption entitled “CertainRelationships and Related Transactions” in our Proxy Statement to be filed forour 2005 Annual Meeting of Shareholders and is incorporated herein byreference.

 

**ITEM 14.   *Principal Accountant Feesand Services***

 

Theinformation required by this item is included under the caption entitled “PrincipalAccountant Fees and Services” in our Proxy Statement to be filed for our 2005Annual Meeting of Shareholders and is incorporated herein by reference.

 

26

----

 

**PART IV**

** **

**ITEM 15.   *Exhibits and FinancialStatement Schedules***

 

(a)(1) **Financial Statements**.The following Consolidated Financial Statements of Overland Storage, Inc.and Report of Independent Registered Public Accounting Firm are included in aseparate section of this Report at the page numbers so indicated:

 
| Report of Independent Registered Public Accounting  Firm                                                                          |   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|
| Consolidated Balance Sheets as of June 30, 2005  and 2004                                                                    |   |
| Consolidated Statements of Operations for the Years  Ended June 30, 2005, 2004 and 2003                                      |   |
| Consolidated Statements of Shareholders’ Equity and Comprehensive  Income for Years Ended June 30, 2005, 2004, and 2003 |   |
| Consolidated Statements of Cash Flows for the Years  Ended June 30, 2005, 2004 and 2003                                      |   |
| Notes to Consolidated Financial Statements                                                                                        |   |

 

(a)(2) **Financial Statement Schedule.**

 

Schedules not listedabove have been omitted because they are not applicable or are not required orthe information required to be set forth therein is included in theConsolidated Financial Statements or Notes thereto.

 

(a)(3) **Exhibits**

 
| 2.1    |   |   | Agreement and Plan of  Merger dated June 20, 2003 among Overland, Okapi Acquisition Co., Inc.  and Okapi Software, Inc. (15) ++ |
|--------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                |
| 2.2    |   |   | Agreement and Plan of  Merger dated August 8, 2005 among Overland, Zeppole Acquisition Corp.  and Zetta Systems, Inc. ++             |
|   |   |   |                                                                                                                                                |
| 3.1    |   |   | Amended and Restated  Articles of Incorporation. (11)                                                                                               |
|   |   |   |                                                                                                                                                |
| 3.2    |   |   | Amended and Restated  Bylaws. (20)                                                                                                                  |
|   |   |   |                                                                                                                                                |
| 4.1    |   |   | Specimen stock  certificate. (11)                                                                                                                   |
|   |   |   |                                                                                                                                                |
| 4.2    |   |   | Shareholder Rights  Agreement dated August 22, 2005 between Overland and Wells Fargo Bank,  N.A., as Transfer Agent. (20)                      |
|   |   |   |                                                                                                                                                |
| 10.1   |   |   | Build-to-Suit Single  Tenant Lease dated October 12, 2000 between Overland and LBA-VIF One,  LLC. (5)                                          |
|   |   |   |                                                                                                                                                |
| 10.2   |   |   | First Amendment to Lease  dated January 18, 2001 between Overland and LBA Overland, LLC, as  successor-in-interest to LBA-VIF One, LLC. (8)    |
|   |   |   |                                                                                                                                                |
| 10.3   |   |   | Second Amendment to Lease  dated March 8, 2001 between Overland and LBA Overland, LLC. (8)                                                     |
|   |   |   |                                                                                                                                                |
| 10.4   |   |   | Business Loan Agreement  dated November 28, 2001 between Overland and Comerica Bank-California.  (10)                                          |
|   |   |   |                                                                                                                                                |
| 10.5   |   |   | Security Agreement dated November 28,  2001 between Overland and Comerica Bank-California. (10)                                                |
|   |   |   |                                                                                                                                                |
| 10.6   |   |   | Master Revolving Note  dated November 28, 2001 between Overland and Comerica Bank-California.  (10)                                            |
|   |   |   |                                                                                                                                                |
| 10.7   |   |   | Variable Rate-Single  Payment Note dated November 28, 2001 between Overland and Comerica  Bank-California. (10)                                |

 

27

----

 
| 10.8   |   | First  Modification to Business Loan Agreement dated August 13, 2002 between  Overland and Comerica Bank-California. (12)                                  |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                            |
| 10.9   |   | Loan  Modification to Business Loan Agreement dated August 30, 2002 between  Overland and Comerica Bank-California. (21)                                   |
|   |   |                                                                                                                                                            |
| 10.10  |   | Second  Modification to Business Loan Agreement and Addendum A dated September 10,  2003 between Overland and Comerica Bank-California. (17)               |
|   |   |                                                                                                                                                            |
| 10.11  |   | Loan Revision/Extension Agreement dated September 10,  2003 between Overland and Comerica Bank-California. (17)                                            |
|   |   |                                                                                                                                                            |
| 10.12  |   | Third Modification to  Business Loan Agreement dated October 25, 2004 between Overland and  Comerica Bank-California. (18)                                 |
|   |   |                                                                                                                                                            |
| 10.13  |   | Loan Revision/Extension Agreement dated October 22,  2004 between Overland and Comerica Bank-California. (18)                                              |
|   |   |                                                                                                                                                            |
| 10.14  |   | Design Purchase and  Services Agreement dated June 15, 2001 between Overland and Seagate  Removable Storage Solutions LLC. (7) +                      |
|   |   |                                                                                                                                                            |
| 10.15  |   | Supply Agreement dated June 15,  2001 between Overland and Seagate Removable Storage Solutions LLC. (7) +                                             |
|   |   |                                                                                                                                                            |
| 10.16  |   | VR2 Technology License Agreement dated April 27, 2000 between  Overland and Storage Technology Corp. (2) +                                            |
|   |   |                                                                                                                                                            |
| 10.17  |   | Amendment to VR2 Technology License Agreement dated June 18,  2002 between Overland and Storage Technology Corp. (11) +                                    |
|   |   |                                                                                                                                                            |
| 10.18  |   | Second Amendment  to VR2 Technology License Agreement dated November 7, 2003  between Overland and Storage Technology Corp. (17) +                         |
|   |   |                                                                                                                                                            |
| 10.19  |   | Amendment Three to VR2  Technology License Agreement dated March 29, 2004 between Overland and  Storage Technology Corp. (21) +                            |
|   |   |                                                                                                                                                            |
| 10.20  |   | Base Agreement #4902RL1317  dated November 1, 2002 between Overland and International Business  Machines Corporation. (17) +                               |
|   |   |                                                                                                                                                            |
| 10.21  |   | Product Purchase Agreement  No. 1585-042103 dated July 31, 2003 between Overland and Hewlett  Packard Company. (17) +                            |
|   |   |                                                                                                                                                            |
| 10.22  |   | Manufacturing Services Agreement between Overland  Storage, Inc. and Sanmina-SCI Corporation effective as of November 23,  2004. (18) +               |
|   |   |                                                                                                                                                            |
| 10.23  |   | Amendment No. 1 to Manufacturing  Services Agreement between Overland Storage, Inc. and Sanmina-SCI  Corporation effective as of May 30, 2005. + |
|   |   |                                                                                                                                                            |
| 10.24* |   | Form of  Indemnification Agreement entered into between Overland and each of its  directors and officers. (10)                                             |
|   |   |                                                                                                                                                            |
| 10.25* |   | Form of Retention  Agreement entered into between Overland and each of its executive officers.  (8)                                                        |
|   |   |                                                                                                                                                            |
| 10.26* |   | Employment Agreement dated  March 12, 2001 between Overland and Christopher Calisi. (5)                                                                    |
|   |   |                                                                                                                                                            |
| 10.27* |   | Employment Agreement dated  December 4, 2000 between Overland and Vernon A. LoForti. (5)                                                                   |
|   |   |                                                                                                                                                            |
| 10.28* |   | Offer Letter dated June 27, 2005 between the  Company and George Karabatsos. (19)                                                                          |
|   |   |                                                                                                                                                            |
| 10.29* |   | Second Amendment to 1995  Stock Option Plan. (1)                                                                                                                |
|   |   |                                                                                                                                                            |
| 10.30* |   | Form of Stock Option  Agreement for options granted under the 1995 Stock Option Plan. (8)                                                                  |

 

28

----

 
| 10.31* |   | First Amendment to 1997  Executive Stock Option Plan. (1)                                                                                                                                                                                                                       |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                            |
| 10.32* |   | Form of Stock Option  Agreement for options granted under the 1997 Executive Stock Option Plan. (8)                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.33* |   | 2000 Stock Option Plan, as  amended and restated. (11)                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.34* |   | Form of Notice of  Stock Option Award and Stock Option Award Agreement for options granted under  2000 Stock Option Plan. (6)                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.35* |   | 2001 Supplemental Stock  Option Plan. (9)                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.36* |   | Form of Notice of  Stock Option Award and Stock Option Award Agreement for options granted under  2001 Supplemental Stock Option Plan. (11)                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.37* |   | 2003 Equity Incentive Plan, as amended. (18)                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.38* |   | Form of  Stock Option Agreement for options granted to senior officers under the 2003  Equity Incentive Plan. (17)                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.39* |   | Form of  Stock Option Agreement for options granted to outside directors under the  2003 Equity Incentive Plan. (17)                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.40* |   | Form of  Standard Stock Option Agreement for options granted under the 2003 Equity  Incentive Plan. (17)                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.41* |   | Form of  Restricted Stock Agreement for restricted stock granted under the 2003 Equity  Incentive Plan.                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.42* |   | Amended and Restated 1996  Employee Stock Purchase Plan.                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.43* |   | Summary Sheet of Director and Executive Officer Compensation.                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                            |
| 10.44* |   | Employment Agreement dated May 16, 2005 between Overland and W.  Michael Gawarecki.                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                            |
| 14.1   |   | Code of Business Conduct  and Ethics. (21)                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                            |
| 21.1   |   | Subsidiaries of the  Registrant.                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                            |
| 23.1   |   | Consent of  PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm.                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                            |
| 24.1   |   | Power of Attorney  (included on signature page).                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                            |
| 31.1   |   | Certification of  Christopher Calisi, President and Chief Executive Officer, pursuant to Rule 13a-14(a) or  15d-14(a) of the Securities and Exchange Act of 1934, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                    |
|   |   |                                                                                                                                                                                                                                                                            |
| 31.2   |   | Certification of Vernon A.  LoForti, Vice President and Chief Financial Officer, pursuant to Rule 13a-14(a) or  15d-14(a) of the Securities and Exchange Act of 1934, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                |
|   |   |                                                                                                                                                                                                                                                                            |
| 32.1   |   | Certification pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002, executed by Christopher Calisi, President and  Chief Executive Officer, and Vernon A. LoForti, Vice President and Chief  Financial Officer. |

 

----

| (1) |   | Incorporated by reference  to the Company’s Form S-8 Registration Statement No. (333-41754)  filed July 19, 2000.   |
|-----|--------|-----------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Incorporated by reference  to the Company’s Form 8-K filed July 25, 2000.                                                |
| (3) |   | Incorporated by reference  to the Company’s Form 10-K filed September 28, 2000.                                          |
| (4) |   | Incorporated by reference to  the Company’s Form S-8 Registration Statement No. (333-53380) filed  January 8, 2001. |
| (5) |   | Incorporated by reference  to the Company’s Form 10-Q filed February 14, 2001.                                           |
| (6) |   | Incorporated by reference  to the Company’s Form 10-Q filed May 15, 2001.                                                |

 

29

----

 
| (7)    |   | Incorporated by reference  to the Company’s Form 8-K filed July 2, 2001.                                                                                                                                            |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (8)    |   | Incorporated by reference  to the Company’s Form 10-K filed September 28, 2001.                                                                                                                                     |
| (9)    |   | Incorporated by reference  to the Company’s Form S-8 Registration Statement No. (333-75060)  filed December 13, 2001.                                                                                          |
| (10)   |   | Incorporated by reference  to the Company’s Form 10-Q filed February 13, 2002.                                                                                                                                      |
| (11)   |   | Incorporated by reference  to the Company’s Form 10-K filed September 27, 2002.                                                                                                                                     |
| (12)   |   | Incorporated by reference  to the Company’s Form 10-Q filed November 13, 2002.                                                                                                                                      |
| (13)   |   | Incorporated by reference  to the Company’s Form 10-Q filed May 12, 2003.                                                                                                                                           |
| (14)   |   | Number intentionally not  used.                                                                                                                                                                                                    |
| (15)   |   | Incorporated by reference  to the Company’s Form 10-K filed September 26, 2003.                                                                                                                                     |
| (16)   |   | Incorporated by reference  to the Company’s Form 10-Q filed November 12, 2003.                                                                                                                                      |
| (17)   |   | Incorporated by reference  to the Company’s Form 10-Q filed February 10, 2004.                                                                                                                                      |
| (18)   |   | Incorporated by reference  to the Company’s Form 10-Q filed February 11, 2005.                                                                                                                                      |
| (19)   |   | Incorporated by reference  to the Company’s Form 8-K filed August 12, 2005.                                                                                                                                         |
| (20)   |   | Incorporated by reference  to the Company’s Form 8-K filed August 26, 2005.                                                                                                                                         |
| (21)   |   | Incorporated by reference  to the Company’s Form 10-K filed September 10, 2004.                                                                                                                                     |
|   |   |                                                                                                                                                                                                                               |
| +      |   | The Company has requested  confidential treatment for certain portions of this Exhibit.                                                                                                                                            |
|   |   |                                                                                                                                                                                                                               |
| ++     |   | Certain schedules and similar attachments have been  omitted pursuant to Item 601(b)(2) of Regulation S-K. A copy of the  omitted schedules and similar attachments will be provided supplementally to  the SEC upon request. |
|   |   |                                                                                                                                                                                                                               |
| *      |   | Management contract or  compensation plan or arrangement.                                                                                                                                                                          |

 

30

----

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 
|                            | OVERLAND  STORAGE, INC.                |
|---------------------------------|----------------------------------------|
|                            |                                   |
| Dated: September 15,  2005 | By:                                    | /s/ CHRISTOPHER  CALISI |   |
|                            | Christopher  Calisi                    |
|                            | President and  Chief Executive Officer |

 

### **POWER OF ATTORNEY**

### ** **

KNOW ALL MEN BY THESE PRESENTS, that each person whosesignature appears below constitutes and appoints Christopher Calisi and VernonA. LoForti, jointly and severally, as his attorney-in-fact, each with the powerof substitution, for him in any and all capacities, to sign any amendments tothis Annual Report on Form 10-K and to file the same, with exhibitsthereto and other documents in connection therewith, with the Securities andExchange Commission, hereby ratifying and confirming all that each of saidattorneys-in-fact, or his substitute or substitutes, may do or cause to be doneby virtue hereof. Pursuant to the requirements of the Securities Exchange Actof 1934, this report has been signed below by the following persons on behalfof the registrant and in the capacities and on the dates indicated.

 
| **Signature**           | ** ** | **Title**                       | ** **                  | **Date** |
|-------------------------|------------|---------------------------------|-----------------------------|----------|
|                    |       |                            |                        |     |
| /s/  CHRISTOPHER CALISI |       |                            | President,  Chief Executive |     | September 15,  2005 |
| Christopher  Calisi     |       | Officer and  Director           |                        |     |
|                    |       | (Principal  Executive Officer)  |                        |     |
|                    |       |                            |                        |     |
| /s/ VERNON A.  LoFORTI  |       |                            | Vice President,  Chief      |     | September 15,  2005 |
| Vernon A.  LoForti      |       | Financial  Officer and          |                        |     |
|                    |       | Secretary  (Principal Financial |                        |     |
|                    |       | and Accounting  Officer)        |                        |     |
|                    |       |                            |                        |     |
| /s/ ROBERT A. DEGAN     |       |                            | Director                    |     | September 15,  2005 |
| Robert A. Degan         |       |                            |                        |     |
|                    |       |                            |                        |     |
| /s/ SCOTT  McCLENDON    |       |                            | Chairman of the  Board      |     | September 15,  2005 |
| Scott McClendon         |       |                            |                        |     |
|                    |       |                            |                        |     |
| /s/ MICHAEL  NORKUS     |       |                            | Director                    |     | September 15,  2005 |
| Michael Norkus          |       |                            |                        |     |
|                    |       |                            |                        |     |
| /s/ PETER PREUSS        |       |                            | Director                    |     | September 15,  2005 |
| Peter Preuss            |       |                            |                        |     |

 

31

----

 

 

**REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Shareholders of Overland Storage, Inc.:

 

Wehave completed an integrated audit of Overland Storage, Inc.’s 2005consolidated financial statements and of its internal control over financialreporting as of July 3, 2005 and audits of its 2004 and 2003 consolidatedfinancial statements in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

 

Consolidated financial statements

 

Inour opinion, the consolidated financialstatements listed in the indexappearing under Item 15(a)(1) present fairly, in all materialrespects, the financial position of Overland Storage, Inc. and its subsidiariesat July 3, 2005 and June 27, 2004, and the results of theiroperations and their cash flows for each of the three years in the period endedJuly 3, 2005 in conformity with accounting principles generally acceptedin the United States of America. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on the financial statements based onour audits. We conducted our audits of these statements in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit of financial statements includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

 

Internal control over financial reporting

 

Also,in our opinion, management’s assessment, included in Management’s Report onInternal Control Over Financial Reporting appearing under Item 9A, that theCompany maintained effective internal control over financial reporting as of July 3,2005 based on criteria established in *Internal Control -Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO), is fairly stated, in allmaterial respects, based on those criteria. Furthermore, in our opinion, theCompany maintained, in all material respects, effective internal control overfinancial reporting as of June 30, 2005, based on criteria established in *Internal Control - Integrated Framework*issued by the COSO. TheCompany’s management is responsible for maintaining effective internal controlover financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting. Our responsibility is to expressopinions on management’s assessment and on the effectiveness of theCompany’s internal control over financial reporting based on our audit. Weconducted our audit of internal control over financial reporting in accordancewith the standards of the Public Company Accounting Oversight Board (UnitedStates). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether effective internal control over financialreporting was maintained in all material respects. An audit of internal controlover financial reporting includes obtaining an understanding of internalcontrol over financial reporting, evaluating management’s assessment, testingand evaluating the design and operating effectiveness of internal control, andperforming such other procedures as we consider necessary in the circumstances.We believe that our audit provides a reasonable basis for our opinions.

 

Acompany’s internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. A company’s internal control overfinancial reporting includes those policies and procedures that (i) pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (ii) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (iii) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the financialstatements.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

 

PricewaterhouseCoopersLLP

SanDiego, California

September 14,2005

 

F-1

----

 

**OVERLAND STORAGE, INC.**

##### **CONSOLIDATEDBALANCE SHEETS**

(in thousands)

 
| ** **                                                                                                           | ** ** | **Fiscal Year** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|
| ** **                                                                                                           | ** ** | **2005**        | ** ** | **2004** | ** ** |
| **Assets**                                                                                                           |       |            |       |   |   |
| Current assets:                                                                                                      |       |            |       |   |   |
| Cash and cash equivalents                                                                                            |       | $               | 5,498      |   | $ | 12,643 |   |
| Short-term investments                                                                                               |       | 71,389          |       | 57,014 |   |
| Accounts receivable, less allowance for doubtful  accounts of $298 and $296, respectively                            |       | 37,703          |       | 33,794 |   |
| Inventories                                                                                                          |       | 19,108          |       | 15,126 |   |
| Deferred tax assets                                                                                                  |       | 3,741           |       | 4,300 |   |
| Other current assets                                                                                                 |       | 11,456          |       | 6,515 |   |
| Total current assets                                                                                                 |       | 148,895         |       | 129,392 |   |
|                                                                                                                 |       |            |       |   |   |
| Property and equipment, net                                                                                          |       | 8,758           |       | 7,945 |   |
| Intangible assets                                                                                                    |       | 5,193           |       | 6,924 |   |
| Other assets                                                                                                         |       | 1,708           |       | 590 |   |
| Total assets                                                                                                         |       | $               | 164,554    |   | $ | 144,851 |   |
|                                                                                                                 |       |            |       |   |   |
| **Liabilities and Shareholders’ Equity**                                                                        |       |            |       |   |   |
| Current liabilities:                                                                                                 |       |            |       |   |   |
| Accounts payable                                                                                                     |       | $               | 17,015     |   | $ | 11,166 |   |
| Accrued liabilities                                                                                                  |       | 13,436          |       | 8,535 |   |
| Accrued payroll and employee compensation                                                                            |       | 3,973           |       | 3,107 |   |
| Income taxes payable                                                                                                 |       | 926             |       | 1,058 |   |
| Accrued warranty                                                                                                     |       | 3,182           |       | 2,282 |   |
| Total current liabilities                                                                                            |       | 38,532          |       | 26,148 |   |
|                                                                                                                 |       |            |       |   |   |
| Deferred tax liabilities                                                                                             |       | 1,454           |       | 3,134 |   |
| Other liabilities                                                                                                    |       | 3,074           |       | 2,055 |   |
| Total liabilities                                                                                                    |       | 43,060          |       | 31,337 |   |
|                                                                                                                 |       |            |       |   |   |
| Commitments and contingencies (Note 12)                                                                              |       |            |       |   |   |
|                                                                                                                 |       |            |       |   |   |
| Shareholders’ equity:                                                                                           |       |            |       |   |   |
| Common stock, no par value, 25,000 shares  authorized; 14,123 and 13,694 shares issued and outstanding, respectively |       | 77,494          |       | 73,573 |   |
| Accumulated other comprehensive loss                                                                                 |       | (312            | )          | (256 | ) |
| Deferred compensation                                                                                                |       | (463            | )          | — |   |
| Retained earnings                                                                                                    |       | 44,775          |       | 40,197 |   |
| Total shareholders’ equity                                                                                      |       | 121,494         |       | 113,514 |   |
| Total liabilities and shareholders’ equity                                                                      |       | $               | 164,554    |   | $ | 144,851 |   |

 

See accompanying notes to consolidated financial statements.

 

F-2

----

 

**OVERLAND STORAGE, INC.**

##### **CONSOLIDATEDSTATEMENTS OF OPERATIONS**

(in thousands, except per share amounts)

 
| ** **                                     | ** ** | **Fiscal Year** | ** ** |
|------------------------------------------------|------------|-----------------|------------|
| ** **                                     | ** ** | **2005**        | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net revenue:                                   |       |            |       |   |   |   |   |
| Product sales                                  |       | $               | 233,695    |   | $ | 236,341 |   | $ | 193,169 |   |
| Royalty fees                                   |       | 1,992           |       | 1,798 |   | 2,712 |   |
|                                           |       | 235,687         |       | 238,139 |   | 195,881 |   |
| Cost of revenue                                |       | 174,770         |       | 173,485 |   | 141,863 |   |
| Gross profit                                   |       | 60,917          |       | 64,654 |   | 54,018 |   |
|                                           |       |            |       |   |   |   |   |
| Operating expenses:                            |       |            |       |   |   |   |   |
| Sales and marketing                            |       | 34,382          |       | 30,848 |   | 26,700 |   |
| Research and development                       |       | 10,687          |       | 7,259 |   | 7,376 |   |
| General and administrative                     |       | 12,324          |       | 10,949 |   | 9,632 |   |
|                                           |       | 57,393          |       | 49,056 |   | 43,708 |   |
| Income from operations                         |       | 3,524           |       | 15,598 |   | 10,310 |   |
|                                           |       |            |       |   |   |   |   |
| Other income (expense):                        |       |            |       |   |   |   |   |
| Interest income                                |       | 1,613           |       | 601 |   | 427 |   |
| Interest expense                               |       | (76             | )          | (68 | ) | (212 | ) |
| Other income (expense), net                    |       | 7               |       | 68 |   | (332 | ) |
| Income before income taxes                     |       | 5,068           |       | 16,199 |   | 10,193 |   |
| Provision for income taxes                     |       | 490             |       | 5,574 |   | 3,511 |   |
| Net income                                     |       | $               | 4,578      |   | $ | 10,625 |   | $ | 6,682 |   |
|                                           |       |            |       |   |   |   |   |
| Net income per share:                          |       |            |       |   |   |   |   |
| Basic                                          |       | $               | 0.33       |   | $ | 0.79 |   | $ | 0.59 |   |
| Diluted                                        |       | $               | 0.32       |   | $ | 0.74 |   | $ | 0.54 |   |
|                                           |       |            |       |   |   |   |   |
| Shares used in computing net income per share: |       |            |       |   |   |   |   |
| Basic                                          |       | 13,899          |       | 13,384 |   | 11,318 |   |
| Diluted                                        |       | 14,429          |       | 14,404 |   | 12,314 |   |

 

See accompanying notes to consolidated financial statements.

 

F-3

----

 

**OVERLAND STORAGE, INC.**

**CONSOLIDATED STATEMENTS OFSHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME**

(in thousands)

 
| ** **                                                    | ** ** | **Common Stock** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Deferred**      | ** ** | **Retained**     | ** ** | **Total  Shareholders’** | ** ** |
|---------------------------------------------------------------|------------|------------------|------------|---------------------------------------|------------|-------------------|------------|------------------|------------|-------------------------------|------------|
| ** **                                                    | ** ** | **Shares**       | ** ** | **Amount**                            | ** ** | **Income (Loss)** | ** ** | **Compensation** | ** ** | **Earnings**                  | ** ** | **Equity** | ** ** |
| Balance at June 30, 2002                                 |       | 11,003           |       | $                                     | 36,654     |              | $          | (278             | )          | $                             | —     |   | $ | 22,890 |   | $ | 59,266 |   |
| Stock option and purchase plans                               |       | 391              |       | 2,807                                 |       | —            |       | —           |       | —                        |       | 2,807 |   |
| Sale of common stock                                          |       | 1,430            |       | 20,623                                |       | —            |       | —           |       | —                        |       | 20,623 |   |
| Stock issued for acquisition of Okapi                         |       | 135              |       | 2,705                                 |       | —            |       | —           |       | —                        |       | 2,705 |   |
| Tax benefits from exercise of stock options                   |       | —           |       | 1,095                                 |       | —            |       | —           |       | —                        |       | 1,095 |   |
| Comprehensive income:                                         |       |             |       |                                  |       |              |       |             |       |                          |       |   |   |
| Net income                                                    |       | —           |       | —                                |       | —            |       | —           |       | 6,682                         |       | 6,682 |   |
| Foreign currency translation                                  |       | —           |       | —                                |       | 86                |       | —           |       | —                        |       | 86 |   |
| Total comprehensive income                                    |       | —           |       | —                                |       | —            |       | —           |       | —                        |       | 6,768 |   |
| Balance at June 30, 2003                                 |       | 12,959           |       | 63,884                                |       | (192              | )          | —           |       | 29,572                        |       | 93,264 |   |
| Stock option and purchase plans                               |       | 735              |       | 6,251                                 |       | —            |       | —           |       | —                        |       | 6,251 |   |
| Tax benefits from exercise of stock options                   |       | —           |       | 3,438                                 |       | —            |       | —           |       | —                        |       | 3,438 |   |
| Comprehensive income:                                         |       |             |       |                                  |       |              |       |             |       |                          |       |   |   |
| Net income                                                    |       | —           |       | —                                |       | —            |       | —           |       | 10,625                        |       | 10,625 |   |
| Foreign currency translation                                  |       | —           |       | —                                |       | (31               | )          | —           |       | —                        |       | (31 | ) |
| Unrealized loss on short-term investments, net of  tax of $21 |       | —           |       | —                                |       | (33               | )          | —           |       | —                        |       | (33 | ) |
| Total comprehensive income                                    |       | —           |       | —                                |       | —            |       | —           |       | —                        |       | 10,561 |   |
| Balance at June 30, 2004                                 |       | 13,694           |       | 73,573                                |       | (256              | )          | —           |       | 40,197                        |       | 113,514 |   |
| Stock option and purchase plans                               |       | 362              |       | 2,943                                 |       | —            |       | —           |       | —                        |       | 2,943 |   |
| Issuance of restricted stock                                  |       | 100              |       | —                                |       | —            |       | —           |       | —                        |       | — |   |
| Deferred compensation                                         |       | —           |       | 543                                   |       | —            |       | (463             | )          | —                        |       | 80 |   |
| Stock options issued to consultant                            |       | —           |       | 29                                    |       | —            |       | —           |       | —                        |       | 29 |   |
| Repurchase of common stock                                    |       | (33              | )          | (309                                  | )          | —            |       | —           |       | —                        |       | (309 | ) |
| Tax benefits from exercise of stock options                   |       | —           |       | 715                                   |       | —            |       | —           |       | —                        |       | 715 |   |
| Comprehensive income:                                         |       |             |       |                                  |       |              |       |             |       |                          |       |   |   |
| Net income                                                    |       | —           |       | —                                |       | —            |       | —           |       | 4,578                         |       | 4,578 |   |
| Foreign currency translation                                  |       | —           |       | —                                |       | 24                |       | —           |       | —                        |       | 24 |   |
| Unrealized loss on short-term investments, net of  tax of $50 |       | —           |       | —                                |       | (80               | )          | —           |       | —                        |       | (80 | ) |
| Total comprehensive income                                    |       | —           |       | —                                |       | —            |       | —           |       | —                        |       | 4,522 |   |
| Balance at June 30, 2005                                 |       | 14,123           |       | $                                     | 77,494     |              | $          | (312             | )          | $                             | (463       | ) | $ | 44,775 |   | $ | 121,494 |   |

 

See accompanying notes to consolidated financial statements.

 

F-4

----

 

**OVERLAND STORAGE, INC.**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

(in thousands)

 
| ** **                                                                                                | ** ** | **Fiscal Year** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|-----------------|------------|
| ** **                                                                                                | ** ** | **2005**        | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Operating activities:**                                                                                 |       |            |       |   |   |   |   |
| Net income                                                                                                |       | $               | 4,578      |   | $ | 10,625 |   | $ | 6,682 |   |
| Adjustments to reconcile net income to cash provided  by operating activities:                            |       |            |       |   |   |   |   |
| Depreciation and amortization                                                                             |       | 4,289           |       | 4,164 |   | 2,354 |   |
| Deferred tax provision                                                                                    |       | (1,071          | )          | (885 | ) | (843 | ) |
| Provision for losses on accounts receivable                                                               |       | 97              |       | 10 |   | 146 |   |
| Tax benefits from exercise of stock options                                                               |       | 715             |       | 3,438 |   | 1,095 |   |
| Stock-based compensation                                                                                  |       | 109             |       | — |   | — |   |
| Realized gain on short-term investments                                                                   |       | (2              | )          | — |   | — |   |
| Amortization of discount on short-term investments                                                        |       | 147             |       | 29 |   | — |   |
| Changes in operating assets and liabilities:                                                              |       |            |       |   |   |   |   |
| Accounts receivable                                                                                       |       | (4,006          | )          | (1,954 | ) | (10,577 | ) |
| Inventories                                                                                               |       | (3,982          | )          | 4,136 |   | (1,756 | ) |
| Accounts payable and accrued liabilities                                                                  |       | 11,650          |       | (218 | ) | 10,747 |   |
| Accrued payroll and employee compensation                                                                 |       | 866             |       | (87 | ) | 476 |   |
| Other assets and liabilities, net                                                                         |       | (5,172          | )          | (4,660 | ) | 709 |   |
| Net cash provided by operating activities                                                                 |       | 8,218           |       | 14,598 |   | 9,033 |   |
|                                                                                                      |       |            |       |   |   |   |   |
| **Investing activities:**                                                                                 |       |            |       |   |   |   |   |
| Purchases of short-term investments                                                                       |       | (114,218        | )          | (132,666 | ) | — |   |
| Proceeds from maturities of short-term investments                                                        |       | 95,252          |       | 75,569 |   | — |   |
| Proceeds from sales of short-term investments                                                             |       | 4,316           |       | — |   | — |   |
| Capital expenditures                                                                                      |       | (3,406          | )          | (2,141 | ) | (1,354 | ) |
| Loss on disposal of property and equipment                                                                |       | 35              |       | — |   | — |   |
| Payments made in association with acquisition of  Okapi                                                   |       | —          |       | — |   | (2,361 | ) |
| Net cash used in investing activities                                                                     |       | (18,021         | )          | (59,238 | ) | (3,715 | ) |
|                                                                                                      |       |            |       |   |   |   |   |
| **Financing activities:**                                                                                 |       |            |       |   |   |   |   |
| Payments on long-term debt                                                                                |       | —          |       | (3,957 | ) | (698 | ) |
| Proceeds from the sale of common stock                                                                    |       | —          |       | — |   | 20,623 |   |
| Proceeds from the exercise of stock options and the  sale of stock under the employee stock purchase plan |       | 2,943           |       | 6,251 |   | 2,807 |   |
| Repurchase of common stock                                                                                |       | (309            | )          | — |   | — |   |
| Net cash provided by financing activities                                                                 |       | 2,634           |       | 2,294 |   | 22,732 |   |
| Effect of exchange rate changes on cash                                                                   |       | 24              |       | (31 | ) | 86 |   |
| Net (decrease) increase in cash and cash equivalents                                                      |       | (7,145          | )          | (42,377 | ) | 28,136 |   |
| Cash and cash equivalents, beginning of year                                                              |       | 12,643          |       | 55,020 |   | 26,884 |   |
| Cash and cash equivalents, end of year                                                                    |       | $               | 5,498      |   | $ | 12,643 |   | $ | 55,020 |   |
|                                                                                                      |       |            |       |   |   |   |   |
| **Supplemental disclosure of cash flow information:**                                                     |       |            |       |   |   |   |   |
| Cash paid for income taxes                                                                                |       | $               | 2,555      |   | $ | 4,590 |   | $ | 1,649 |   |
| Cash paid for interest                                                                                    |       | $               | —     |   | $ | 75 |   | $ | 199 |   |
| **Non-cash investing activities:**                                                                        |       |            |       |   |   |   |   |
| Common stock issued for acquisition of Okapi                                                              |       | $               | —     |   | $ | — |   | $ | 2,705 |   |
| Change in net unrealized loss on short-term  investments                                                  |       | $               | 80         |   | $ | 33 |   | $ | — |   |

 

See accompanying notes to consolidated financial statements

 

F-5

----

 

**OVERLAND STORAGE, INC.**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE 1 -OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**General**

 

OverlandStorage, Inc. (We, Overland or the Company) was incorporated on September 8,1980 under the laws of the State of California. For 25 years we have delivered data protection solutions designed forbackup and recovery to ensure business continuity. Historically, we havefocused on delivering a portfolio of tape automation solutions including loaderand library systems designed for small business and midrange computingenvironments. Beginning with the June 2003 acquisition of OkapiSoftware, Inc. (Okapi), a privately-owned company based in San Diego,California, we expanded our productofferings to include a family of intelligent disk-based backup and recoveryappliances to complement our tape solutions.

 

TheCompany operates and reports using a 52-53 week fiscal year ending on theSunday closest to June 30. For ease of presentation, the Company’s fiscal year-endis deemed to be June 30. For example, references to fiscal 2005 refer tothe fiscal year ending on July 3, 2005. Fiscal year 2005 included 53weeks. Fiscal years 2004 and 2003 each included 52 weeks.

 

**Principlesof Consolidation**

 

Theconsolidated financial statements include the accounts of the Company and itswholly owned subsidiaries, Overland Storage (Europe) Ltd., Overland StorageSARL, Overland Storage GmbH, Tecmar, Inc., Okapi Acquisition Co., Inc.and Overland Storage Export Limited, a foreign sales corporation. Allsignificant intercompany accounts and transactions have been eliminated.

 

**ManagementEstimates and Assumptions**

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and reported amounts of revenue andexpenses during the reporting period. Estimates have been prepared on the basisof the most current and best available information and actual results coulddiffer from those estimates. Significant estimates made by management includerevenue recognition, allowance for doubtful accounts, warranty accrual,valuation of intangible assets, long-lived assets and valuation allowance ondeferred tax assets.

 

**Reclassificationof Prior Year Presentation**

 

Certain prior year amounts have been reclassified forconsistency with the current year presentation. These reclassifications had noeffect on the reported results of operations. During fiscal 2005, the Companyconcluded that it was appropriate to classify its auction rate municipal bondsas short-term investments. Previously, such investments had been classified ascash and cash equivalents. Accordingly, the Company has revised theclassification to report these securities under the short-term investmentscaption in the Consolidated Balance Sheets for fiscal years 2005 and 2004.Corresponding adjustments have also been made to the Consolidated Statements ofCash Flows for fiscal years 2005 and 2004, to reflect the gross purchases andsales of these securities as investing activities rather than as a component ofcash and cash equivalents. This change in classification does not affectpreviously reported cash flows from operations or from financing activities inthe Consolidated Statements of Cash Flows, or the previously reportedConsolidated Statements of Operations for any period.

 

For fiscal 2004, $46.0 million of these short-terminvestments were previously classified as cash and cash equivalents.

 

F-6

----

 

**RevenueRecognition**

 

Revenueon direct product sales (excluding sales to distributors and certain OEMcustomers) is recognized upon shipment of products to such customers. Thesecustomers are not entitled to any specific right of return or price protection,except for any defective product that may be returned under the Company’swarranty policy. Title and risk of loss transfer to the customer when theproduct leaves the Company’s dock. Product sales to distribution customers aresubject to certain rights of return, stock rotation privileges and priceprotection. Because we are unable to estimate our exposure for returned productor price adjustments, revenue from shipments to these customers is notrecognized until the related products are in turn sold to the ultimate customerby the distributor. As part of our existing agreements with certain OEMcustomers, the Company ships products to various distribution hubs around theworld and retains ownership of that inventory until it is pulled by these OEMcustomers to fulfill their customer orders, at which time, generally the samebusiness day, the Overland sale is recorded.

 

The Company has entered into various licensingagreements relating to its Variable Rate Randomizer (VR2) technology. These agreements typically call for royaltyfees based on sales by licensees of products containing VR2.Royalties on sales by licensees of products containing VR2 are recorded when earned, generally in theperiod during which the licensee ships the products containing VR2 technology. In certain instances, thecustomer has elected to purchase, from the Company, the Applications SpecificIntegrated Circuit (ASIC) chips embodying VR2,which are priced to include the cost of the chip plus an embedded royalty fee. Inthese instances, revenue on ASIC chip sales are recorded as product revenuewhen earned, which is upon the shipment of the underlying ASIC chipincorporating the VR2 technology to the customer.

 

#### **Shipping and Handling**

#### ** **

Amountsbilled to customers for shipping and handling are included in product sales andcosts incurred related to shipping and handling are included in cost of revenue.

 

**Researchand Development Costs**

 

Researchand development costs are expensed as incurred. The costs for the developmentof new software products and substantial enhancements to existing softwareproducts are expensed until technological feasibility has been established, atwhich time any additional costs would be capitalized in accordance withFinancial Accounting Standards Board (FASB) Statement of Financial Standards(SFAS) No. 86, *Accounting for the Costsof Software to be Sold, Leased or Otherwise Marketed*. Because webelieve our current process for developing software is essentially completedconcurrently with the establishment of technological feasibility, which occursupon the completion of a working model, no costs have been capitalized for anyof the periods presented.

 

#### **Advertising Costs**

#### ** **

Advertising costs are expensed as incurred. Advertisingexpenses for fiscal years 2005, 2004 and 2003 were $1.5 million, $1.7 million and$1.2 million, respectively.

 

F-7

----

 

**WarrantyCosts**

 

The Company generally provides a three-year advancereplacement return-to-factory warranty on its NEO SERIES, PowerLoader andLoaderXpress products and a one year advance replacement return-to-factorywarranty on its REO SERIES. The Company also provides on-site service for the firstwarranty year of the NEO SERIES products for which it contracts withthird-party service providers. For most products, the Company offers a programcalled XchangeNOW as part of its return-to-factory warranty which enablescustomers to receive an advance replacement unit shipped within two businessdays after placing a service request. The customer ships the defective unitback to the Company using the shipping materials from the replacement unit. TheCompany records a provision for estimated future warranty costs at the time ofshipment for both the return-to-factory and on-site warranties. Separatelypriced on-site warranties are offered for sale to customers of other productlines. The Company contracts with outside vendors to provide service relatingto all on-site warranties. Warranty revenue and amounts paid in advance tooutside service organizations are recognized in the financial statements in revenueand cost of revenue, respectively, over the warranty period.

 

#### **Fair Value of FinancialInstruments**

#### ** **

The Company’s financial instruments consist of cash andcash equivalents, short-term investments, accounts receivable and accountspayable. The carrying amounts of these instruments approximate fair valuebecause of their short-term maturities and variable interest rates. Fair valuesof the investments in debt securities are estimated based on quoted marketprices for these securities.

 

#### **Accumulated OtherComprehensive Loss**

#### ** **

**Comprehensive income for the Company includes net income,foreign currency translation adjustments and unrealized losses onavailable-for-sale securities, which are charged or credited to accumulatedother comprehensive income within shareholders’ equity. For fiscal years 2005, 2004and 2003, the components of other accumulated comprehensive loss were as follow(in thousands):**

 
| ** **                                                                          | ** ** | **Fiscal Year** | ** ** |
|-------------------------------------------------------------------------------------|------------|-----------------|------------|
| ** **                                                                          | ** ** | **2005**        | ** ** | **2004** | ** ** | **2003** | ** ** |
| Foreign currency translation adjustments                                            |       | $               | (199       | ) | $ | (223 | ) | $ | (192 | ) |
| Unrealized loss on short-term investments, net of  tax of $71 and $21, respectively |       | (113            | )          | (33 | ) | — |   |
| Total other accumulated comprehensive loss                                          |       | $               | (312       | ) | $ | (256 | ) | $ | (192 | ) |

** **

**Segment Data**

** **

TheCompany reports segment data based on the management approach. The managementapproach designates the internal reporting that is used by management formaking operating and investment decisions and evaluating performance as thesource of the Company’s reportable segments. The Company uses one measurementof profitability and does not disaggregate its business for internal reporting.Based on the criteria of SFAS No. 131, *Disclosures about Segmentsof an Enterprise and Related Information*, the Company has determinedthat it operates in one segment providing data storage solutions for mid-rangecomputer networks. The Company discloses information about products and services,geographic areas and major customers.

 

#### **Concentration of Credit Risks**

#### ** **

Financial instruments which potentially subject theCompany to concentrations of credit risk consist primarily of cash equivalents,short-term investments and trade accounts receivable, which are generally notcollateralized. The Company limits its exposure to credit loss by placing itscash equivalents and short-term investment with high credit quality financialinstitutions and investing in high quality short-term debt instruments. TheCompany performs ongoing credit evaluations of its customers, generallyrequires no collateral and maintains allowances for potential credit losses andsales returns.

 

F-8

----

 

The Company’s largest single customer accounted forapproximately 54.3%, 58.8% and 58.4% of sales in fiscal years 2005, 2004 and2003, respectively, and approximately 48.9%, 44.2% and 51.9% of accountsreceivable as of the end of fiscal years 2005, 2004 and 2003, respectively. Noother customer accounted for 10% or more of sales in any of the three yearspresented.

 

#### **Information aboutGeographic Areas**

#### ** **

TheCompany markets its products domestically and internationally, with itsprincipal international market being Europe. The tables below containinformation about the geographical areas in which the Company operates. Revenueis attributed to the location to which the product was shipped. Long-livedassets are based on location of domicile.

 
| ** **              | ** ** | **Net Revenue**    | ** ** | **Long-Lived  Assets** | ** ** |
|-------------------------|------------|--------------------|------------|------------------------|------------|
| ** **              | ** ** | **(in thousands)** | ** ** |
| **Fiscal 2005**         |       |               |       |                   |       |
| United States           |       | $                  | 97,156     |                   | $          | 13,276 |   |
| United Kingdom          |       | 65,845             |       | 667                    |       |
| Rest of Europe          |       | 28,464             |       | 8                      |       |
| Singapore               |       | 21,822             |       | —                 |       |
| Other foreign countries |       | 22,400             |       | —                 |       |
|                    |       | $                  | 235,687    |                   | $          | 13,951 |   |
| **Fiscal 2004**         |       |               |       |                   |       |
| United States           |       | $                  | 121,641    |                   | $          | 14,048 |   |
| United Kingdom          |       | 67,209             |       | 821                    |       |
| Rest of Europe          |       | 24,355             |       | —                 |       |
| Singapore               |       | 9,415              |       | —                 |       |
| Other foreign countries |       | 15,519             |       | —                 |       |
|                    |       | $                  | 238,139    |                   | $          | 14,869 |   |
| **Fiscal 2003**         |       |               |       |                   |       |
| United States           |       | $                  | 110,790    |                   | $          | 16,335 |   |
| United Kingdom          |       | 52,176             |       | 819                    |       |
| Rest of Europe          |       | 20,611             |       | —                 |       |
| Singapore               |       | 2,702              |       | —                 |       |
| Other foreign countries |       | 9,602              |       | —                 |       |
|                    |       | $                  | 195,881    |                   | $          | 17,154 |   |

 

**CashEquivalents and Short-Term Investments**

 

Highlyliquid investments with insignificant interest rate risk and originalmaturities of three months or less, when purchased, are classified as cashequivalents. Cash equivalents are comprised of money market funds. The carryingamounts approximate fair value due to the short maturities of theseinstruments.

 

F-9

----

 

Investmentswith maturities greater than three months are classified as short-terminvestments. The Company manages its cash equivalents and short-terminvestments as a single portfolio of highly marketable securities, all of whichare intended to be available for the Company’s current operations. As such, allof the Company’s short-term investments are classified as available-for-saleand are reported at fair value, generally as determined by quoted marketprices, with any unrealized gains and losses, net of tax, recorded as aseparate component of accumulated other comprehensive income (loss) inshareholders’ equity.  The cost ofsecurities sold is based on the specific identification method. Investments inauction rate securities are recorded at cost, which approximates fair value dueto their variable interest rates, which typically reset every 27 to 34 days,and, despite the long-term nature of their stated contractual maturities, theCompany has the ability to quickly liquidate these securities.

 

**AccountsReceivable and Allowance for Doubtful Accounts**

 

TheCompany records accounts receivable at invoice amount and does not chargeinterest thereon. The Company estimates itsallowance for doubtful accounts based on an assessment of the collectibility ofspecific accounts and the overall condition of the accounts receivableportfolio. When evaluating the adequacy of the allowance for doubtful accounts,the Company analyzes specific trade and other receivables, historical baddebts, customer credits, customer concentrations, customer credit-worthiness,current economic trends and changes in customers’ payment terms and/orpatterns. The Company reviews the allowance for doubtful accounts on aquarterly basis and records adjustments as considered necessary. Customeraccounts are written-off against the allowance for doubtful accounts when anaccount is considered uncollectible.

 

**Inventories**

 

Inventories are stated at the lower of cost(first-in-first-out method) or market.

 

#### **Property and Equipment**

#### ** **

Propertyand equipment are recorded at cost. Depreciation expense is computed using thestraight-line method. Leasehold improvements are depreciated over the shorterof the estimated useful life of the asset or the term of the lease. Estimateduseful lives are as follows:

 
| Machinery and  equipment |   | 3-5 years |   |
|--------------------------|--------|-----------|--------|
| Furniture and  fixtures  |   | 5 years   |   |
| Computer  equipment      |   | 1-5 years |   |

 

Expendituresfor normal maintenance and repair are charged to expense as incurred, andimprovements are capitalized. Upon the sale or retirement of property orequipment, the asset cost and related accumulated depreciation are removed fromthe respective accounts and any gain or loss is included in the results ofoperations.

 

#### **Long-Lived Assets**

#### ** **

The Company evaluates therecoverability of long-lived assets, including property and equipment andcertain identifiable intangible assets, in accordance with SFAS No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*,which it adopted on July 1, 2002. SFAS No. 144 requires the Companyto review for impairment of long-lived assets whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. Factors considered important which could trigger an impairmentreview include: 

 

•                  significantunderperformance relative to historical or projected future operating results;

•                  significantchanges in the manner of use of the assets or the strategy for our overallbusiness;

•                  significantdecrease in the market value of the assets; and

•                  significantnegative industry or economic trends.

 

F-10

----

 

When the Company determines that the carrying amountof long-lived assets may not be recoverable based upon the existence of one ormore of the above indicators, it assesses the assets for impairment based onthe estimated future undiscounted cash flows expected to result from the use ofthe asset and its eventual disposition. If the carrying amount of an assetexceeds its estimated future undiscounted cash flows, an impairment loss isrecorded for the excess of the asset’s carrying amount over its fair value.Fair value is generally determined based on the estimated future discountedcash flows over the remaining useful life of the asset using a discount rate determinedby management to be commensurate with the risk inherent in the Company’scurrent business model. The assumptions supporting the cash flows, includingthe discount rates, are determined using management’s best estimates as of thedate of the impairment review. If these estimates or their related assumptionschange in the future, the Company may be required to record additionalimpairment charges for these assets and future results of operations could beadversely affected. The Company has not recorded any material impairmentlosses.

 

#### **Deferred Rent**

#### ** **

Rent expense is recorded on a straight-line basis overthe term of the lease. The difference between rent expense and amounts paidunder the lease agreements is recorded in other liabilities in the accompanyingbalance sheets.

 

**ForeignCurrency Translation**

 

The financial statements of foreign subsidiaries, forwhich the functional currency is the local currency, are translated into U.S.dollars using the exchange rate at the balance sheet date for assets andliabilities and a weighted-average exchange rate during the year for revenue,expenses, gains and losses. Translation adjustments are recorded as accumulatedother comprehensive income within shareholders’ equity. Gains or losses fromforeign currency transactions are recognized currently in income. Suchtransactions resulted in a gain of $62,000, a gain of $69,000 and a loss of$338,000 for the fiscal years 2005, 2004 and 2003, respectively.

 

#### **Income Taxes**

#### ** **

TheCompany provides for income taxes utilizing the liability method. Under theliability method, a deferred tax asset and/or liability is computed for boththe expected future impact of differences between the financial statement andtax basis of assets and liabilities, and for the expected future tax benefit tobe derived from tax credits and loss carryforwards. Current income tax expenseor benefit represents the amount of income taxes expected to be payable orrefundable for the current year. A valuation allowance is established when, inthe opinion of management, it is more likely than not that some portion or allof the deferred tax assets will not be realized.

 

**NetIncome per Share**

 

Basicearnings per share is computed based on the weighted-average number of sharesof common stock outstanding during the period. Diluted earnings per share iscomputed based on the weighted-average number of shares of common stockoutstanding during the period increased by the weighted-average number ofdilutive common stock equivalents outstanding during the period, using thetreasury stock method. Anti-dilutive common stock equivalents excluded from thecomputation of diluted earnings per share amounted to 1.3 million, 512,000 and6,000 in fiscal years 2005, 2004 and 2003, respectively.

 

F-11

----

 

Areconciliation of the calculation of basic and diluted earnings per share is asfollows:

 
| ** **                                                | ** ** | **Fiscal Year**                               | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                | ** ** | **2005**                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                | ** ** | **(in thousands, except per share  amounts)** | ** ** |
| ** **                                                | ** ** | ** **                                    | ** ** |
| Net income                                                |       | $                                             | 4,578      |   | $ | 10,625 |   | $ | 6,682 |   |
| Basic:                                                    |       |                                          |       |   |   |   |   |
| Weighted-average number of common shares outstanding      |       | 13,899                                        |       | 13,384 |   | 11,318 |   |
| Basic net income per share                                |       | $                                             | 0.33       |   | $ | 0.79 |   | $ | 0.59 |   |
|                                                      |       |                                          |       |   |   |   |   |
| Diluted:                                                  |       |                                          |       |   |   |   |   |
| Weighted-average number of common shares outstanding      |       | 13,899                                        |       | 13,384 |   | 11,318 |   |
| Common stock equivalents using the treasury stock  method |       | 530                                           |       | 1,020 |   | 996 |   |
| Shares used in computing diluted net income per  share    |       | 14,429                                        |       | 14,404 |   | 12,314 |   |
| Diluted net income per share                              |       | $                                             | 0.32       |   | $ | 0.74 |   | $ | 0.54 |   |

 

**Stock-BasedCompensation**

 

Duringfiscal 2005, the Company had stock-based compensation plans as described indetail in Note 9. The Company accounts for options issued to employees,directors and officers under those plans under the recognition and measurementprinciples of Accounting Principles Board (APB) No. 25, *Accounting for Stock Issued to Employees*, and relatedinterpretations. Generally, no stock-based employee compensation expense isrecognized, as all options granted under those plans have an exercise priceequal to the fair market value of the underlying common stock at the date ofgrant. No compensation expense has been recognized for purchase rights underthe Company’s Employee Stock Purchase Plan (ESPP) as they have been granted inaccordance with the terms of the ESPP.****The Companyaccounts for stock option grants and similar equity instruments granted tonon-employees under the fair value method, in accordance with Emerging IssuesTask Force (EITF) Issue No. 96-18, *Accounting for EquityInstruments That are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services*and SFAS No. 123, *Accounting and Disclosure of Stock-Based Compensation*.

 

Compensationexpense related to issuances of fixed restricted stock awards are recorded, ona ratable basis over the vesting period, at the fair market value of the stockat the date of grant. No compensation expense is recorded for restricted stockawards in which the exercise price equals or exceeds the market price of theunderlying stock on the date of grant.

 

TheCompany measures compensation expense for its stock-based employee compensationplans using the intrinsic value method and provides pro forma disclosures ofnet income (loss) and earnings per share as if the fair value-based method hadbeen applied in measuring compensation expense.

 

The fair values of options granted and each sharepurchase right under the ESPP during the years ended, as reported below, wereestimated at the date of grant using a Black-Scholes option pricing model withthe following weighted average assumptions:

 

F-12

----

 
| ** **               | ** ** | **Stock Option Plans** | ** ** | **ESPP** | ** ** |
|--------------------------|------------|------------------------|------------|----------|------------|
| ** **               | ** ** | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Expected volatility      |       | 77.0                   | %          | 79.0     | %          | 82.0 | % | 38.4 | % | 57.0 | % | 79.0 | % |
| Risk-free interest rate  |       | 3.7                    |       | 4.2      |       | 3.7 |   | 1.9 |   | 3.7 |   | 3.7 |   |
| Dividend yield           |       | 0.0                    |       | 0.0      |       | 0.0 |   | 0.0 |   | 0.0 |   | 0.0 |   |
| Expected term (in years) |       | 5.7                    |       | 7.0      |       | 7.0 |   | 0.5 |   | 0.5 |   | 0.5 |   |

 

Theweighted-average estimated fair value of employee stock options, granted withan exercise price equal to the fair value of the underlying common stock on thedate of grant during fiscal years 2005, 2004 and 2003 were $8.92, $13.76 and $10.02per share, respectively. The weighted-average estimated fair value of employeestock options, granted with an exercise price above the fair value of theunderlying common stock on the date of grant during 2005 was $8.18. Theweighted-average estimated fair value of each share purchase right grantedduring fiscal years 2005, 2004 and 2003 was $3.24, $4.71 and $4.65 per share,respectively.

 

Hadcompensation expense for the Company’s employee stock-based compensation awardsissued during fiscal years 2005, 2004 and 2003 been determined based on a fairvalue method, the Company’s net income and net income per share would have beenreduced to the pro forma amounts indicated below:

 
| ** **                                                                                                                              | ** ** | **Fiscal Year**                               | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                              | ** ** | **2005**                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                              | ** ** | **(in thousands, except per share  amounts)** | ** ** |
| Net income, as reported                                                                                                                 |       | $                                             | 4,578      |   | $ | 10,625 |   | $ | 6,682 |   |
| Deduct: Stock-based employee compensation expense  determined under fair value based method for all awards, net of related tax  effects |       | (8,293                                        | )          | (4,941 | ) | (4,862 | ) |
| Pro forma net (loss) income                                                                                                             |       | $                                             | (3,715     | ) | $ | 5,684 |   | $ | 1,820 |   |
|                                                                                                                                    |       |                                          |       |   |   |   |   |
| Earnings (loss) per share:                                                                                                              |       |                                          |       |   |   |   |   |
| Basic – as reported                                                                                                                |       | $                                             | 0.33       |   | $ | 0.79 |   | $ | 0.59 |   |
| Basic – pro forma                                                                                                                  |       | $                                             | (0.27      | ) | $ | 0.42 |   | $ | 0.16 |   |
|                                                                                                                                    |       |                                          |       |   |   |   |   |
| Diluted – as reported                                                                                                              |       | $                                             | 0.32       |   | $ | 0.74 |   | $ | 0.54 |   |
| Diluted – pro forma                                                                                                                |       | $                                             | (0.27      | ) | $ | 0.39 |   | $ | 0.15 |   |

 

On July 1,2005, the Company’s Board of Directors approved the accelerated vesting of allunvested stock options, held by the Company’s officers and employees, with anexercise price at or above $12.00 per share, effective July 3, 2005. Thestock option acceleration program does not apply to stock options held by theCompany’s non-employee directors. The accelerated options were issued under the2000 Stock Option Plan, the 2001 Supplemental Stock Option Plan and the 2003Equity Incentive Plan. This accelerated vesting affected options to purchase upto an aggregate of 509,192 shares of the Company’s common stock, held by 147employees, all of which became exercisable immediately. In connection with theacceleration of vesting of options held by the Company’s executive officers,each executive officer agreed not to sell or transfer any shares subject toaccelerated vesting until the original vesting date would have occurred basedon the original vesting schedule (without giving effect to any futuretermination of service). The primary purpose of the accelerated vesting was toeliminate future stock-based employee compensation expense of approximately$4.5 million, net of estimated forfeitures, the Company would otherwise have torecord in the income statement over a period of three years beginning in fiscalyear 2006 pursuant to the Company’s adoption of SFAS No. 123 (revised 2004)(123(R)), *Share-Based Payment*. For fiscal 2005,the Company’s pro forma net loss includes a pro-forma charge of $4.1 million,net of statutory taxes of $723,000, related to this acceleration.

 

F-13

----

 

**RecentlyIssued Accounting Pronouncements**

 

In November 2004,the FASB issued SFAS No. 151, *InventoryCosts – an Amendment of ARB No. 43, Chapter 4*. SFAS No. 151clarifies that abnormal amounts of idle facility expense, freight, handlingcosts and spoilage should be expensed as incurred and not included in overhead.Further, SFAS No. 151 requires that allocation of fixed productionoverhead to conversion costs should be based on normal capacity of theproduction facilities. The provisions in SFAS No. 151 are effective forinventory costs incurred during fiscal years beginning after June 15, 2005and must be applied prospectively. The Company believes that its currentaccounting policies comply with the new rules and the adoption of thisstatement will not have a material impact on the Company’s consolidatedfinancial position or results of operations.

 

In December 2004,the FASB issued FSP 109-2, *Accounting and DisclosureGuidance for the Foreign Earnings Repatriation Provision within the AmericanJobs Creation Act of 2004*, effective upon issuance. The AmericanJobs Creation Act of 2004 provides for an elective one-time tax deduction of85% on certain foreign earnings that are repatriated. The adoption of FSP 109-2is not expected to have an impact on the Company’s consolidated financialposition or results of operations.

 

In December 2004,the FASB issued SFAS No. 123(R) to expand and clarify SFAS No. 123, *Accounting for Stock-Based Compensation*, in several areas.SFAS No. 123(R) requires companies to measure the cost of employeeservices received in exchange for an award of an equity instrument based on thegrant-date fair value of the award. The cost is recognized over the requisiteservice period (usually the vesting period) for the estimated number ofinstruments where service is expected to be rendered. The Company is requiredto adopt SFAS No. 123(R) in the first quarter of fiscal 2006.

 

SFAS No. 123(R)permits public companies to adopt its requirements using one of two methods:

 

•                  A “modified prospective” method inwhich compensation cost is recognized beginning with the effective date (a) basedon the requirements of SFAS No. 123(R) for all share-based paymentsgranted after the effective date and (b) based on the requirements of SFASNo. 123(R) for all awards granted to employees prior to the effective dateof SFAS No. 123(R) that remain unvested on the effective date; or

•                  A “modified retrospective” methodwhich includes the requirements of the modified prospective method describedabove, but also permits entities to restate based on the amounts previouslyrecognized under SFAS No. 123 for purposes of pro forms disclosures either(a) all prior periods or (b) prior interim periods of the year ofadoption.

 

We adoptedSFAS No. 123(R) using the modified prospective method effective July 4,2005.

 

Aspermitted by SFAS No. 123, we currently account for share-based paymentsto employees using APB No. 25’s intrinsic value method and, as such,generally recognize no compensation cost for employee stock options.Accordingly, the adoption of SFAS No. 123(R)’s fair value method will havea significant impact on our results of operations, although it will have noimpact on our cash position. The impact of adoption of SFAS No. 123(R)cannot be predicted at this time because it will depend on levels ofshare-based payments granted in the future. SFAS No. 123(R) also requiresthe benefits of tax deductions in excess of recognized compensation cost to bereported as a financing cash flow, rather than as an operating cash flow asrequired under current literature. This requirement may reduce net operatingcash flows and increase net financing cash flows in the periods after adoption.We cannot estimate what those amounts will be in the future because they dependon, among other things, when employees exercise stock options, and whether wehave a sufficient Additional Paid-In-Capital windfall pool to cover potentialexpense.

 

F-14

----

 

In December 2004,the FASB issued SFAS No. 153, *Exchanges of NonmonetaryAssets – an Amendment of APB Opinion No. 29*, which eliminatesthe exception for nonmonetary exchanges of similar productive assets andreplaces it with a general exception for exchanges of nonmonetary assets thatdo not have commercial substance. A nonmonetary exchange has commercialsubstance if the future cash flows of the entity are expected to changesignificantly as a result of the exchange. SFAS No. 153 will be effectivefor nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,2005. The Company believes that adoption of SFAS No. 153 will have noimpact on the Company’s financial position or results of operations.

 

**NOTE 2 –ACQUISITION OF CERTAIN ASSETS**

 

In June 2003, the Companyacquired all of the assets and assumed all of the liabilities of Okapi Software, Inc.,a privately held company based in San Diego, California. This acquisition wasaccounted for as an asset acquisition in accordance with SFAS No. 142, *Goodwill and Other Intangible Assets*. The Company’sConsolidated Statements of Operations include the results of Okapi from thedate of acquisition.

 

**The aggregate purchase price for the assets of Okapiof $5.4 million was comprised of the issuance of 134,551 shares of Overlandstock valued at $2.7 million, cash of $2.5 million, and $159,000 of acquisitionrelated costs. Of the $5.4 million purchase price, $41,000 was allocated to thenet tangible liabilities acquired and $9.0 million, which includes a deferredtax liability, was allocated to acquired technology. As this transaction wasaccounted for as a tax-free exchange, the Company recorded a deferred taxliability of $3.6 million. The acquired technology represented by theintangible asset is amortized over a five year life.**

** **

Duringfiscal 2004, the Company was able to claim certain tax benefits related to theOkapi acquisition on its fiscal year 2003 tax return that were not allocated atthe time of the purchase. As a result, in fiscal 2004, the purchase price of theintangible asset was reduced by $263,000 to reflect these tax benefitsincluding a reduction of the related deferred tax liability. The adjustedpurchase price of the intangible asset will be amortized over four years, theremaining useful life of the asset.

 

**NOTE 3 – SHORT-TERMINVESTMENTS**

 

Thefollowing table summarizes short-term investments by security type (inthousands):

 

**Fiscal2005**

 
| ** **                                     | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
|------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------------|------------|
| Asset-backed securities                        |       | $                   | 18,208     |                         | $          | —                        |       | $                         | 155        |   | $ | 18,053 |   |
| United States government and agency securities |       | 2,000               |       | —                       |       | 22                            |       | 1,978                     |       |
| State and municipal securities                 |       | 51,365              |       | 1                            |       | 8                             |       | 51,358                    |       |
|                                           |       | $                   | 71,573     |                         | $          | 1                             |       | $                         | 185        |   | $ | 71,389 |   |

 

**Fiscal2004**

 
| ** **                                     | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|----------------------------|------------|
| Asset-backed securities                        |       | $                   | 3,255      |                         | $          | —                        |       | $                          | 21         |   | $ | 3,234 |   |
| United States government and agency securities |       | 2,000               |       | —                       |       | 22                            |       | 1,978                      |       |
| State and municipal securities                 |       | 51,813              |       | —                       |       | 11                            |       | 51,802                     |       |
|                                           |       | $                   | 57,068     |                         | $          | —                        |       | $                          | 54         |   | $ | 57,014 |   |

 

F-15

----

 

Thefollowing table summarizes the contractual maturities of the Company’sshort-term investments (in thousands):

 

| ** **               | ** ** | **Fiscal Year** | ** ** |
|--------------------------|------------|-----------------|------------|
| ** **               | ** ** | **2005**        | ** ** | **2004** | ** ** |
| Less than one year       |       | $               | 2,937      |   | $ | 4,001 |   |
| Due in one to two years  |       | 749             |       | 3,754 |   |
| Due in two to five years |       | 1,931           |       | — |   |
| Due after five years     |       | 65,772          |       | 49,259 |   |
|                     |       | $               | 71,389     |   | $ | 57,014 |   |

 

Asset-backedsecurities have been allocated within the contractual maturities table basedupon the set maturity date of the security. Gross realized gains on short-terminvestments are included in interest income and were approximately $2,000 in fiscal2005. In fiscal 2005, the Company did not record any realized losses on itsshort-term investments. In fiscal 2004, the Company did not record any realizedgains or losses on its short-term investments.

 

As of the end of fiscal 2005, the Company had one investmentthat has been in a continuous unrealized loss position for a period of 12months. The Company determined that the impairment was not considered to beother-than-temporary, in accordance with EITF 03-1, *The Meaningof Other-Than-Temporary Impairment and Its Application to Certain Investments,*andas such, the cost of the investment was not adjusted at the balance sheet date.

 

**NOTE 4 - COMPOSITION OFCERTAIN FINANCIAL STATEMENT CAPTIONS**

** **

***The following table summarizesinventories (in thousands):***

 
| ** **      | ** ** | **Fiscal Year** | ** ** |
|-----------------|------------|-----------------|------------|
| ** **      | ** ** | **2005**        | ** ** | **2004** | ** ** |
| Raw materials   |       | $               | 8,550      |   | $ | 6,266 |   |
| Work in process |       | 1,997           |       | 2,444 |   |
| Finished goods  |       | 8,561           |       | 6,416 |   |
|            |       | $               | 19,108     |   | $ | 15,126 |   |

 

The following tablesummarizes other current assets (in thousands):

 
| ** **                           | ** ** | **Fiscal Year** | ** ** |
|--------------------------------------|------------|-----------------|------------|
| ** **                           | ** ** | **2005**        | ** ** | **2004** | ** ** |
| Income tax receivable                |       | $               | 4,177      |   | $ | 3,108 |   |
| Non-trade accounts receivable        |       | 3,071           |       | 710 |   |
| Prepaid third party service contract |       | 2,896           |       | 1,232 |   |
| Prepaid insurance and services       |       | 1,213           |       | 990 |   |
| Other                                |       | 99              |       | 475 |   |
|                                 |       | $               | 11,456     |   | $ | 6,515 |   |

 

***The following table summarizesproperty and equipment (in thousands):***

 
| ** **                                | ** ** | **Fiscal Year** | ** ** |
|-------------------------------------------|------------|-----------------|------------|
| ** **                                | ** ** | **2005**        | ** ** | **2004** | ** ** |
| Machinery and equipment                   |       | $               | 6,368      |   | $ | 5,542 |   |
| Computer equipment                        |       | 9,414           |       | 8,764 |   |
| Furniture and fixtures                    |       | 1,309           |       | 1,194 |   |
| Leasehold improvements                    |       | 3,814           |       | 3,815 |   |
|                                      |       | 20,905          |       | 19,315 |   |
| Accumulated depreciation and amortization |       | (12,147         | )          | (11,370 | ) |
|                                      |       | $               | 8,758      |   | $ | 7,945 |   |

 

F-16

----

 

Depreciation and amortization expense was $2.6million, $2.4 million and $2.4 million in fiscal years 2005, 2004 and 2003,respectively.

 

The following tablesummarizes other assets (in thousands):

 
| ** **                           | ** ** | **Fiscal Year** | ** ** |
|--------------------------------------|------------|-----------------|------------|
| ** **                           | ** ** | **2005**        | ** ** | **2004** | ** ** |
| Prepaid third party service contract |       | $               | 1,301      |   | $ | 553 |   |
| Software license                     |       | 350             |       | — |   |
| Other                                |       | 57              |       | 37 |   |
|                                 |       | $               | 1,708      |   | $ | 590 |   |

 

The following tablesummarizes accrued liabilities (in thousands):

 
| ** **                                | ** ** | **Fiscal Year** | ** ** |
|-------------------------------------------|------------|-----------------|------------|
| ** **                                | ** ** | **2005**        | ** ** | **2004** | ** ** |
| Accrued operating expenses                |       | $               | 3,838      |   | $ | 2,253 |   |
| Deferred revenue – Service contracts |       | 3,484           |       | 1,807 |   |
| Third-party service contracts payable     |       | 3,238           |       | 1,295 |   |
| Deferred revenue – Distributors      |       | 1,186           |       | 1,333 |   |
| Accrued Market Development Funds          |       | 621             |       | 1,105 |   |
| VAT & Sales taxes payable        |       | 251             |       | 419 |   |
| Other                                     |       | 818             |       | 323 |   |
|                                      |       | $               | 13,436     |   | $ | 8,535 |   |
|                                           |            |                 |            |  |  |  |  |  |  |

 

The following tablesummarizes other liabilities (in thousands):

 
| ** **                                | ** ** | **Fiscal Year** | ** ** |
|-------------------------------------------|------------|-----------------|------------|
| ** **                                | ** ** | **2005**        | ** ** | **2004** | ** ** |
| Deferred revenue – Service contracts |       | $               | 1,978      |   | $ | 1,284 |   |
| Deferred rent                             |       | 990             |       | 771 |   |
| Other                                     |       | 106             |       | — |   |
|                                      |       | $               | 3,074      |   | $ | 2,055 |   |

 

***As of fiscal 2005 and 2004, theaccounts receivable balances consist entirely of accounts receivable tradebalances, net of allowance for doubtful accounts. The following tablesummarizes the changes in allowance for doubtful accounts (in thousands):***

 
| **Fiscal year** | ** ** | **Balance at  Beginning of  Year** | ** ** | **Additions  Charged to  Income** | ** ** | **Write-offs,  Net of  Recoveries** | ** ** | **Deductions  Credited to  Income** | ** ** | **Balance  at End  of Year** | ** ** |
|-----------------|------------|------------------------------------|------------|-----------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|------------------------------|------------|
| 2005            |       | $                                  | 296        |                              | $          | 97                                  |       | $                                   | 95         |                         | $          | — |   | $ | 298 |   |
| 2004            |       | 413                                |       | 114                               |       | 126                                 |       | 105                                 |       | 296                          |       |
| 2003            |       | 652                                |       | 267                               |       | 506                                 |       | —                              |       | 413                          |       |
|                 |            |                                    |            |                                   |            |                                     |            |                                     |            |                              |            |  |  |  |  |  |

 

F-17

----

 

**NOTE 5 –INTANGIBLE ASSETS**

 

Intangible assets consistof the following (in thousands): 

 
| ** **               | ** ** | **Fiscal Year** | ** ** |
|--------------------------|------------|-----------------|------------|
| ** **               | ** ** | **2005**        | ** ** | **2004** | ** ** |
| Acquired technology      |       | $               | 8,720      |   | $ | 8,720 |   |
| Accumulated amortization |       | (3,527          | )          | (1,796 | ) |
|                     |       | $               | 5,193      |   | $ | 6,924 |   |

 

Amortizationexpense of intangible assets was $1.7 million and $1.8 million, during fiscalyears 2005 and 2004, respectively. The technology acquired from Okapi is beingamortized over five years. Estimated amortization expense for this intangibleasset will be approximately $1.7 million in each of the Company’s fiscalyears 2006, 2007 and 2008.

 

**NOTE 6 -LONG-TERM DEBT**

 

The Company has a credit facility consisting of a $10.0million revolving line of credit for working capital purposes that expires on November 30,2006. The line of credit is collateralized by substantially all of the Company’sassets. Interest on the line of credit is set at the bank’s prime rate (6.25%on June 30, 2005) in effect from time to time minus 0.25% or, at theCompany’s option, a rate equal to LIBOR plus 2.25%. The loan agreement thatgoverns the credit facility contains certain financial and non-financialcovenants. At June 30, 2005, the Company was in compliance with allcovenants under the agreement. At the end of fiscal years 2005 and 2004, noamounts were outstanding under the credit facility.

 

**NOTE 7 -INCOME TAXES**

 

The components of income before income taxes were asfollows (in thousands):

 
| ** ** | ** ** | **Fiscal Year** | ** ** |
|------------|------------|-----------------|------------|
| ** ** | ** ** | **2005**        | ** ** | **2004** | ** ** | **2003** | ** ** |
| Domestic   |       | $               | 3,493      |   | $ | 15,003 |   | $ | 8,371 |   |
| Foreign    |       | 1,575           |       | 1,196 |   | 1,822 |   |
|       |       | $               | 5,068      |   | $ | 16,199 |   | $ | 10,193 |   |

 

The provision for income taxes includes the following(in thousands):

 
| ** **                       | ** ** | **Fiscal Year** | ** ** |
|----------------------------------|------------|-----------------|------------|
| ** **                       | ** ** | **2005**        | ** ** | **2004** | ** ** | **2003** | ** ** |
| Current:                         |       |            |       |   |   |   |   |
| Federal                          |       | $               | 131        |   | $ | 5,293 |   | $ | 3,176 |   |
| State                            |       | 115             |       | 1,171 |   | 653 |   |
| Foreign                          |       | 713             |       | 377 |   | 525 |   |
| Total current                    |       | 959             |       | 6,841 |   | 4,354 |   |
|                             |       |            |       |   |   |   |   |
| Deferred                         |       |            |       |   |   |   |   |
| Federal                          |       | (366            | )          | (1,054 | ) | (679 | ) |
| State                            |       | (59             | )          | (213 | ) | (164 | ) |
| Foreign                          |       | (44             | )          | — |   | — |   |
| Total deferred                   |       | (469            | )          | (1,267 | ) | (843 | ) |
| Total provision for income taxes |       | $               | 490        |   | $ | 5,574 |   | $ | 3,511 |   |

 

F-18

----

 

A reconciliation of income taxes computed by applyingthe federal statutory income tax rate of 34%****toincome before income taxes to the total income tax provision reported in theConsolidated Statements of Operations is as follows (in thousands):

 
| ** **                                       | ** ** | **Fiscal Year** | ** ** |
|--------------------------------------------------|------------|-----------------|------------|
| ** **                                       | ** ** | **2005**        | ** ** | **2004** | ** ** | **2003** | ** ** |
| U.S. Federal income tax at statutory rate        |       | $               | 1,723      |   | $ | 5,493 |   | $ | 3,466 |   |
| State income taxes, net of federal benefit       |       | 37              |       | 633 |   | 383 |   |
| Extraterritorial income exclusion benefit        |       | (503            | )          | (374 | ) | (246 | ) |
| Tax exempt interest                              |       | (363            | )          | (68 | ) | — |   |
| Favorable IRS settlement and statute expirations |       | (345            | )          | — |   | — |   |
| California R&D tax credit                    |       | (136            | )          | — |   | — |   |
| Permanent differences                            |       | 43              |       | 53 |   | 45 |   |
| Other, net                                       |       | 34              |       | (163 | ) | (137 | ) |
| Total provision for income taxes                 |       | $               | 490        |   | $ | 5,574 |   | $ | 3,511 |   |

 

Deferred income taxes comprised (in thousands):

 
| ** **                          | ** ** | **Fiscal Year** | ** ** |
|-------------------------------------|------------|-----------------|------------|
| ** **                          | ** ** | **2005**        | ** ** | **2004** | ** ** |
| Deferred tax assets:                |       |            |       |   |   |
| Inventory                           |       | $               | 1,152      |   | $ | 1,645 |   |
| Warranty reserves                   |       | 1,951           |       | 2,078 |   |
| Tax credits                         |       | 573             |       | — |   |
| Vacation and deferred compensation  |       | 608             |       | 441 |   |
| State income taxes                  |       | 8               |       | 190 |   |
| Restructuring reserve               |       | 243             |       | — |   |
| Allowance for doubtful accounts     |       | 114             |       | 115 |   |
| Intangible assets                   |       | 43              |       | 60 |   |
| Other                               |       | 101             |       | 80 |   |
| Gross deferred tax asset            |       | 4,793           |       | 4,609 |   |
|                                |       |            |       |   |   |
| Deferred tax liabilities:           |       |            |       |   |   |
| Purchased intangible assets         |       | (1,975          | )          | (2,678 | ) |
| Property and equipment depreciation |       | (531            | )          | (721 | ) |
| Other                               |       | —          |       | (44 | ) |
| Gross deferred tax liability        |       | (2,506          | )          | (3,443 | ) |
| Net deferred tax asset              |       | $               | 2,287      |   | $ | 1,166 |   |

 

No valuation allowance was recorded as of fiscal 2005or 2004, as the Company believes it is more likely than not the deferred taxassets will be realized.

 

At June 30, 2005,the Company has a California research and development tax credit carryforwardtotaling approximately $30,000 which can be carried forward indefinitely. Inaddition, the Company has a Federal foreign tax credit carryforward totalingapproximately $555,000, which will begin expiring in 2025, unless previouslyutilized.

 

F-19

----

 

**NOTE 8 - COMMON STOCK**

** **

On August 11, 2004,the Company’s Board of Directors authorized the purchase of up to $10.0 millionof its common stock on the open market or through negotiated transactions. Thisrepurchase authority allows the Company to selectively repurchase its commonstock from time to time in the open market or in privately negotiatedtransactions depending on market price and other factors. During fiscal 2005,an aggregate of 32,500 shares were repurchased at a cost of approximately $309,000pursuant to this authority.

 

**On May 15, 2003, the Company sold 1.4 million sharesof common stock in a private placement transaction. The stock was sold at$15.39, a 10 percent discount to the closing market price on May 12, 2003.Gross proceeds to the Company were $22.0 million with net proceeds aftercommission and offering expenses of $20.6 million. Proceeds have been and willbe used by the Company to fund working capital needs in support of the growthof its business and for general corporate purposes.**

** **

**NOTE 9 – EQUITY BASEDCOMPENSATION**

** **

***StockOption Plans***

 

The Company has eight active stock option plans, administeredby a Committee of the Board of Directors, which provide for the issuance ofoptions to employees, officers, directors and consultants. As of June 30,2005, the Company had reserved 7.2 million shares of common stock for issuanceunder the 1991 Non-Qualified Stock Option Plan (1991 Plan), 1993 Stock OptionPlan, 1993-A Stock Option Plan, 1995 Stock Option Plan, 1997 Executive StockOption Plan, 2000 Stock Option Plan, 2001 Supplemental Stock Option Plan (2001Plan), and the 2003 Equity Incentive Plan (2003 Plan) (collectively, the OptionPlans). The Option Plans provide for the granting of stock options; inaddition, the 2003 Plan provides for the granting of restricted stock and stockappreciation rights (collectively, stock awards). The exercise price ofincentive stock options must be equal to at least the fair market value of theCompany’s common stock on the date the option is granted, and the exerciseprice of non-statutory stock options may be no less than 85% of the fair marketvalue of the Company’s common stock on the date of grant. The exercise price ofany option granted to a 10% shareholder may not be less than 110% of the fairmarket value of the Company’s common stock on the date of grant. The OptionPlans have been approved by shareholders with the exception of the 1991 Planand the 2001 Plan. Currently, the Company may grant new awards only from the2003 Plan. Certain options issued under selected plans call for 100% vesting ofoutstanding options upon a change of control of the Company or upon death ordisability of the optionee. Options granted during the last four fiscal yearsgenerally vest over a three year period. Options granted in prior yearsgenerally vested at a rate of 25% per year over a four-year period from thedate of grant. On July 1, 2005, the Board of Directors approved theaccelerated vesting of certain outstanding options (Note 1). Options generallyexpire after a period not to exceed ten years, except in the event oftermination, whereupon vested shares must be exercised generally within threemonths under the 2003 Plan and within 30 days under the other Option Plans, orupon death or disability, where an extended six- or twelve-month exerciseperiod is specified. As of June 30, 2005, approximately 3.1 million shareswere reserved for issuance upon exercise of outstanding options andapproximately 452,000 were available for grant under the Option Plans.

 

F-20

----

 

The stock option activityis summarized below (shares in thousands):

 
| ** **                         | ** ** | **Shares** | ** ** | **Weighted-Average  Exercise Price** | ** ** |
|------------------------------------|------------|------------|------------|--------------------------------------|------------|
| Options outstanding at fiscal 2002 |       | 2,791      |       | $                                    | 7.83       |   |
| Granted                            |       | 923        |       | 13.41                                |       |
| Exercised                          |       | (351       | )          | 6.85                                 |       |
| Canceled/forfeited                 |       | (108       | )          | 8.96                                 |       |
| Options outstanding at fiscal 2003 |       | 3,255      |       | 9.48                                 |       |
| Granted                            |       | 403        |       | 18.83                                |       |
| Exercised                          |       | (683       | )          | 8.19                                 |       |
| Canceled/forfeited                 |       | (142       | )          | 13.42                                |       |
| Options outstanding at fiscal 2004 |       | 2,833      |       | 10.92                                |       |
| Granted                            |       | 757        |       | 13.28                                |       |
| Exercised                          |       | (288       | )          | 7.89                                 |       |
| Canceled/forfeited                 |       | (189       | )          | 14.80                                |       |
| Options outstanding at fiscal 2005 |       | 3,113      |       | 11.54                                |       |
|                                    |            |            |            |                                      |            |  |

 

The following table summarizes information about stockoptions outstanding as of fiscal 2005 (shares in thousands):

 
| ** **                    | ** **       | **Options Outstanding** | ** ** | **Options Exercisable**          | ** ** |
|-------------------------------|------------------|-------------------------|------------|----------------------------------|------------|
| ** **                    | ** **       | ** **              | ** ** | **Weighted-Average**             | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Range of  Exercise Prices** | ** **       | **Shares  Outstanding** | ** ** | **Remaining  Contractual  Life** | ** ** | **Exercise  Price** | ** ** | **Shares  Exercisable** | ** ** | **Weighted-  Average  Exercise Price** | ** ** |
| $                             | 2.00 – 8.66 |                    | 1,143      |                             | 5.08       |   | $ | 7.41 |   | 1,143 |   | $ | 7.41 |   |
| 9.31 – 11.83             |             | 543                     |       | 7.28                             |       | 10.16 |   | 379 |   | 9.85 |   |
| 12.37 – 19.33            |             | 1,337                   |       | 8.27                             |       | 15.05 |   | 1,309 |   | 15.06 |   |
| 19.75 – 21.76            |             | 90                      |       | 8.20                             |       | 20.21 |   | 90 |   | 20.21 |   |
| 2.00 – 21.76             |             | 3,113                   |       | 6.92                             |       | 11.54 |   | 2,921 |   | 11.55 |   |
|                               |                  |                         |            |                                  |            |  |  |  |  |  |  |  |  |  |

 

***RestrictedStock Awards***

 

In April 2005,the Company issued two restricted stock awards for 50,000 shares each to itsCEO. At June 30, 2005, no shares were vested and 100,000 shares weresubject to repurchase. The awards are described separately below:

 

Thefirst award vests as follows: 16,667 shares, 16,667 shares and 16,666 shares onJuly 1, 2006, 2007 and 2008, respectively (the Service Award). Inaccordance with APB No. 25, the Service award is a fixed award and, assuch, compensation expense is recorded for the fair value of the Company’scommon stock less any amounts paid by the employee. The fair value of theService Award is $10.86 per share (the market value of the stock on the date ofissuance) or $543,000, which was recorded as deferred compensation associatedwith this issuance and is being amortized to compensation expense ratably overthe service period. Compensation expense recorded in the accompanyingConsolidated Statements of Operations for fiscal 2005 totaled approximately$80,000. The weighted-average grant date fair value of this restricted stockaward was $10.86, as calculated under SFAS No. 123.

 

F-21

----

 

Thesecond award vests as follows: 12,500 shares, 12,500 shares and 25,000 shares,if the volume weighted daily average stock price of the Company for tenconsecutive trading days reaches $20.00, $25.00 and $30.00 (collectively thetarget stock price), respectively, on or before January 1, 2008 (theMarket Award). Based upon the market values of the Company’s common stock,through June 30, 2005, satisfaction of the vesting conditions were notdeemed probable by management; therefore no compensation expense was recordedduring fiscal 2005. At such time as management determines that it is probablethat a target stock price will be met, the Company will record the fair valueof the corresponding vesting tranche of the Market Award and will recognize compensationexpense, on a straight-line basis, through the remaining vesting period. Theweighted-average grant date fair value of this restricted stock award was estimatedat $5.73, as calculated under SFAS No. 123, using a trinomial optionpricing model based on the following assumptions: expected volatility of 54.2%,risk-free interest rate of 3.8%, dividend yield of 0% and an expected term of978 days.

 

***1996Employee Stock Purchase Plan***

 

In February 1997, the Company adopted the 1996Employee Stock Purchase Plan (ESPP). A total of 600,000 shares of common stock havebeen reserved under the ESPP, as amended, for issuance and purchase byemployees of the Company to assist them in acquiring a stock ownership interestin the Company and to encourage them to remain employees of the Company. TheESPP is qualified under Section 423 of the Internal Revenue Code andpermits eligible employees to purchase common stock at a discount throughpayroll deductions during specified six-month offering periods. No employee maypurchase more than $25,000 worth of stock in any calendar year or 1,500 sharesin any one offering period. The ESPP is administered by the CompensationCommittee appointed by the Board of Directors and provides generally that thepurchase price must not be less than 85% of the fair market value of the commonstock on the first or last day of the offering period, whichever is lower. SeeNote 14 for discussion of subsequent event.

 

During fiscal years 2005, 2004 and 2003, a total of73,594, 51,850 and 40,720 shares, respectively, were issued for combinedproceeds of $673,000, $658,000 and $405,000, respectively. As of June 30,2005 approximately 82,000 shares were available under the ESPP.

 

#### **NOTE 10 - 401(k) PLAN**

#### ** **

In January 1994, the Company adopted an employeesavings and retirement plan (the 401(k) Plan) covering all of the Company’semployees. The 401(k) Plan permits but does not require matching contributionsby the Company on behalf of all participants. The Company matches employeecontributions at 75%, for up to 6% of an employee’s pretax income. The totalsof these employer contributions were $819,000, $660,000 and $520,000 in fiscalyears 2005, 2004 and 2003, respectively.

 

**NOTE 11 – ACCRUEDRESTRUCTURING CHARGES**

** **

*Outsourceof Manufacturing*Operations

 

Duringthe first quarter of fiscal year 2005, the Company approved a restructuringplan to discontinue manufacturing operations at their California location andtransfer such operations to Sanmina-SCI Corporation (Sanmina), a contractmanufacturer. The Company began transferring the manufacturing of all of itsproduct lines to Sanmina in the second quarter of fiscal 2005. The Company completedthe transition in August 2005.

 

Underthe restructuring plan, the Company terminated 69 employees and expects toterminate an additional 22 full-time employees, in early fiscal 2006. Inaddition, the Company expects to incur charges associated with excessfacilities and other transition expenses. In total, the Company expects toincur between $2.5 million and $3.0 million of pretax charges related to thetransition with the bulk of theses costs occurring during fiscal 2005. Theremaining one-time employee termination benefits are expected to be paid duringthe first quarter of fiscal 2006 and the excess facility costs will be paidover the remaining life of the lease, approximately nine years.

 

F-22

----

 

One-timetermination benefits are measured at fair value at the communication date andcharged to expense ratably over the remaining employee service period asemployees are required to work through the service period in order to obtainthe termination benefit. During fiscal 2005, the Company recorded charges of$2.1 million in cost of revenue associated with the transition. These chargeswere primarily comprised of accruals for the one-time termination benefits andother out of pocket transition costs which were recorded as incurred.

 

**The following table summarizes the activity and balances ofthe accrued restructuring charges through fiscal 2005 (in thousands):**

 
| ** **                    | ** ** | **Employee  Related** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-------------------------------|------------|-----------------------|------------|-----------|------------|-----------|------------|
| Accrued restructuring charges |       | 1,532                 |       | 523       |       | 2,055     |       |
| Cash Payments                 |       | (1,009                | )          | (523      | )          | (1,532    | )          |
| Balance at fiscal 2005        |       | $                     | 523        |      | $          | —    |       | $ | 523 |   |
|                               |            |                       |            |           |            |           |            |  |  |  |

 

**NOTE 12 -COMMITMENTS AND CONTINGENCIES**

 

**Leases**

 

The Company leases itsoffice, production and sales facilities under non-cancelable operating leases,which expire in various years through fiscal year 2018. The leases provide forbiennial or annual rent escalations intended to approximate increases in costof living indices, and certain of the leases provide for rent abatement. TheCompany has a one five-year option to renew its lease on its San Diegoheadquarters facility. Future minimum lease payments under these arrangementsare as follows (in thousands):

 
| ** **  | ** ** | **Minimum  Lease  Payments** | ** ** |
|-------------|------------|------------------------------|------------|
| Fiscal 2006 |       | $                            | 3,251      |   |
| Fiscal 2007 |       | 3,229                        |       |
| Fiscal 2008 |       | 3,242                        |       |
| Fiscal 2009 |       | 3,339                        |       |
| Fiscal 2010 |       | 3,389                        |       |
| Thereafter  |       | 14,280                       |       |
|        |       | $                            | 30,730     |   |

 

Rentalexpense is recognized ratably over the respective lease terms and aggregated$3.8 million in each of the Company’s fiscal years 2005, 2004 and 2003.

 

#### **Guarantees**

#### ** **

TheCompany’s standard warranty is a three year advance replacementreturn-to-factory warranty that covers both parts and labor. For products thatit distributes and for drives and tapes used in its products that aremanufactured by a third party, the Company passes on to the customer thewarranty provided by the manufacturer. The Company also provides on-siteservice for the first warranty year of its higher-end products, for which itcontracts with third-party service providers.

 

TheCompany provides for the estimated cost of product warranties at the timerevenue is recognized. The Company’s product warranty liability reflects itsbest estimate of probable liability under its product warranties. The Companyestimates the warranty based on expected product failure rates, historicalexperience, and other currently available information.

 

F-23

----

 

TheCompany also sells extended on-site warranties for certain products for whichrevenue is deferred and recognized over the warranty period.

 

Changesin the liability for product warranty and deferred revenue associated withextended warranties were as follows (in thousands):

 
| ** **                                                   | ** ** | **Product  Warranty** | ** ** | **Deferred  Revenue** | ** ** |
|--------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| Liability at fiscal 2003                                     |       | $                     | 1,390      |                  | $          | 1,458 |   |
| Settlements made during the period                           |       | (1,290                | )          | (2,211                | )          |
| Change in liability for warranties issued during the  period |       | 2,067                 |       | 3,936                 |       |
| Change in liability for preexisting warranties               |       | 115                   |       | (92                   | )          |
| Liability at fiscal 2004                                     |       | 2,282                 |       | 3,091                 |       |
| Settlements made during the period                           |       | (1,674                | )          | (3,975                | )          |
| Change in liability for warranties issued during the  period |       | 2,319                 |       | 6,311                 |       |
| Change in liability for preexisting warranties               |       | 255                   |       | 35                    |       |
| Liability at fiscal 2005                                     |       | $                     | 3,182      |                  | $          | 5,462 |   |

 

**Litigation**

 

The Company is from timeto time involved in various lawsuits and legal proceedings that arise in theordinary course of business. In the opinion of management, the amount of anyultimate liability with respect to these ordinary course actions will notmaterially affect the Company’s consolidated financial statements or results ofoperations.

 

**NOTE 13 –SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)**

 

Thefollowing table presents selected quarterly financial information for theperiods indicated. This information has been derived from the Company’sunaudited quarterly consolidated financial statements, which in the opinion ofmanagement include all adjustments (consisting only of normal recurringadjustments) necessary for a fair statement of such information. The quarterlyper share amounts presented below were calculated separately and may not sum tothe annual figures presented in the Consolidated Statements of Operations.These operating results are also not necessarily indicative of results for anyfuture period.

 
| ** **                        | ** ** | **Fiscal 2005**                               | ** ** |
|-----------------------------------|------------|-----------------------------------------------|------------|
| ** **                        | ** ** | **Q1**                                        | ** ** | **Q2** | ** ** | **Q3** | ** ** | **Q4** | ** ** | **Total** | ** ** |
| ** **                        | ** ** | **(in thousands, except per share  amounts)** | ** ** |
| Net revenue                       |       | $                                             | 59,526     |   | $ | 62,525 |   | $ | 58,282 |   | $ | 55,354 |   | $ | 235,687 |   |
| Gross profit                      |       | 16,017                                        |       | 17,818 |   | 14,886 |   | 12,196 |   | 60,917 |   |
| Income (loss) from operations     |       | 2,664                                         |       | 3,544 |   | 952 |   | (3,636 | ) | 3,524 |   |
| Income (loss) before income taxes |       | 3,007                                         |       | 3,921 |   | 1,389 |   | (3,249 | ) | 5,068 |   |
| Net income (loss)                 |       | 1,900                                         |       | 2,603 |   | 1,357 |   | (1,282 | ) | 4,578 |   |
|                              |       |                                          |       |   |   |   |   |   |   |   |   |
| Net income (loss) per share:      |       |                                          |       |   |   |   |   |   |   |   |   |
| Basic                             |       | $                                             | 0.14       |   | $ | 0.19 |   | $ | 0.10 |   | $ | (0.09 | ) | $ | 0.33 |   |
| Diluted                           |       | 0.13                                          |       | 0.18 |   | 0.09 |   | (0.09 | ) | 0.32 |   |

 

F-24

----

 
| ** **                 | ** ** | **Fiscal 2004**                               | ** ** |
|----------------------------|------------|-----------------------------------------------|------------|
| ** **                 | ** ** | **Q1**                                        | ** ** | **Q2** | ** ** | **Q3** | ** ** | **Q4** | ** ** | **Total** | ** ** |
| ** **                 | ** ** | **(in thousands, except per share  amounts)** | ** ** |
| Net revenue                |       | $                                             | 56,569     |   | $ | 67,750 |   | $ | 58,789 |   | $ | 55,031 |   | $ | 238,139 |   |
| Gross profit               |       | 15,577                                        |       | 17,672 |   | 16,167 |   | 15,238 |   | 64,654 |   |
| Income from operations     |       | 3,334                                         |       | 5,188 |   | 4,103 |   | 2,973 |   | 15,598 |   |
| Income before income taxes |       | 3,420                                         |       | 5,312 |   | 4,325 |   | 3,142 |   | 16,199 |   |
| Net income                 |       | 2,223                                         |       | 3,453 |   | 2,876 |   | 2,073 |   | 10,625 |   |
|                       |       |                                          |       |   |   |   |   |   |   |   |   |
| Net income per share:      |       |                                          |       |   |   |   |   |   |   |   |   |
| Basic                      |       | $                                             | 0.17       |   | $ | 0.26 |   | $ | 0.21 |   | $ | 0.15 |   | $ | 0.79 |   |
| Diluted                    |       | 0.16                                          |       | 0.24 |   | 0.20 |   | 0.14 |   | 0.74 |   |

 

**NOTE 14 –SUBSEQUENT EVENTS**

 

***Acquisition***

 

In August 2005,the Company acquired Zetta Systems, Inc., a privately held developer ofreal-time data protection software for digital storage solutions for $9.0million in cash.

 

***ESPP***

 

In August 2005, the Board of Directors amendedthe ESPP so that effective with the offering period beginning in August 2005,the purchase price shall be determined as either (i) a percentage not lessthan 85%, subject to the Compensation Committee’s discretion (the DesignatedPercentage) of the fair market value of the common stock on the last day of theoffering period or (ii) the lower of (a) the Designated Percentage ofthe fair market value of the common stock on the first day of the offeringperiod or (b) the Designated Percentage of the fair market value of thecommon stock on the last day of the offering period. On August 10,2005,the Compensation Committee of the Board of Director’s determined the purchaseprice to be 95% of the fair market value of the common stock on the last day ofeach offering period, beginning with the August 2005 offering.

 

***HPContract***

 

In August 2005,Hewlett-Packard Company (HP), our largest customer, informed the Company of itsdecision not to purchase its next-generation, mid-range tape automationproduction line from Overland. HP will continue to purchase the tape automationproducts currently supplied by the Company for some time; however, new productsprovided by other suppliers will eventually replace the majority of thosepurchases. The Company cannot predict how quickly this transition will occur,but believes the impact to the Company’s revenue during fiscal 2006 will beminimal. In light of this anticipated loss in future revenue, the Companyintends to focus heavily on the delivery of new higher-margin products to itsbranded channel during fiscal 2006. The Company’s current three-year contractwith HP expires in July 2006. The contract does not commit HP to buyspecific quantities of product at any time.

 

F-25

----

 

***ShareholderRights Agreement***

 

In August 2005,the Company’s Board of Directors adopted a Shareholder Rights Plan (the RightsPlan). In connection with the Rights Plan, the Company declared a dividend ofone common share purchase right for each share of common stock outstanding atthe close of business on August 25, 2005. Rights will generally attach tonew shares of common stock issued by the Company in the future. Initially, the rightsare attached to, and automatically trade with, the outstanding shares of theCompany’s common stock. Under certain circumstances, the rights will detachfrom the common stock and become exercisable for one-third of a share of theCompany’s common stock at a purchase price of $37 per share, subject toadjustment.  In the event that a personor group (subject to certain exceptions) acquires 15% or more of the Company’scommon stock, each right will entitle its holder (other than the person orgroup which acquired the 15% interest) to purchase from the Company commonstock having a market value equal to twice the exercise price of the right. Inaddition, if after such an acquisition, the Company is involved in a merger orother business combination with that person or group, or with any person if allCompany shareholders are not treated alike, each right will entitle its holder(other than the person or group which acquired the 15% interest) to purchasecommon shares of the acquiring company or its parent having a market valueequal to twice the exercise price of the right. The rights expire in August 2015unless earlier redeemed or exchanged. The Company is entitled to redeem theRights at $0.001 per right at any time or to exchange the rights for one-thirdof a share of the Company’s common stock prior to a business combinationreferred to above. The rights do not have voting, dividend or distributionrights. The adoption of the Rights Plan has no impact on the financial positionor results of operations of the Company.

 

F-26

----