10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2006

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 92123-1599

(Address of principal executive offices, including zip code)

(858) 571-5555

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x   No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  o Accelerated filer  x Non-accelerated filer  o

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Act). Yes  o   No  x

As of January 26, 2007, there were 12,742,650 shares of the registrant’s common stock, no par value, issued and outstanding.

OVERLAND STORAGE, INC.

FORM 10-Q

For the quarterly period ended December 31, 2006

Table of Contents

PART I — FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Consolidated Condensed Statement of Operations (unaudited) – Three and six months ended December 31, 2006 and 2005
	Consolidated Condensed Balance Sheet (unaudited) – December 31, 2006 and June 30, 2006
	Consolidated Condensed Statement of Cash Flows (unaudited) – Six months ended December 31, 2006 and 2005
	Notes to Consolidated Condensed Financial Statements (unaudited)
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II -OTHER INFORMATION
Item 1.		Legal Proceedings
Item 1A.		Risk Factors
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds
Item 4.		Submission of Matters to a Vote of Security Holders
Item 6.		Exhibits
		Signature

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PART I — FINANCIAL INFORMATION

Item 1. — Financial Statements

Overland Storage, Inc.

Consolidated Condensed Statement of Operations

(In thousands, except per share amounts)

	Three Months Ended December 31,						Six Months Ended December 31,
	2006			2005			2006			2005
	(Unaudited)						(Unaudited)
Net revenue:
Product sales	$	46,210		$	60,014		$	87,786		$	117,873
Royalty fees	550			624			801			1,267
	46,760			60,638			88,587			119,140
Cost of revenue	38,901			47,251			75,430			92,334
Gross profit	7,859			13,387			13,157			26,806
Operating expenses:
Sales and marketing	9,472			10,066			18,225			19,430
Research and development	4,167			4,173			9,049			8,597
General and administrative	3,435			3,702			7,274			7,710
Impairment of acquired technology	—			—			8,411			—
Acquired in-process research and development	—			—			—			1,121
	17,074			17,941			42,959			36,858
Loss from operations	(9,215		)	(4,554		)	(29,802		)	(10,052		)
Other income (expense):
Interest income, net	482			717			1,179			1,275
Other income (expense), net	(227		)	30			(322		)	(14		)
Loss before income taxes	(8,960		)	(3,807		)	(28,945		)	(8,791		)
Benefit from income taxes	(71		)	(1,094		)	(59		)	(3,178		)
Net loss	$	(8,889	)	$	(2,713	)	$	(28,886	)	$	(5,613	)
Net loss per share:
Basic and Diluted	$	(0.70	)	$	(0.19	)	$	(2.25	)	$	(0.40	)
Shares used in computing net loss per share:
Basic and Diluted	12,735			13,932			12,850			13,989

See accompanying notes to consolidated condensed financial statements.

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Overland Storage, Inc.

Consolidated Condensed Balance Sheet

(In thousands)

	December 31, 2006			June 30, 2006
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	6,546		$	20,315
Short-term investments	22,864			42,197
Accounts receivable, less allowance for doubtful accounts of $341 and $436, respectively	31,845			30,321
Inventories	25,699			14,978
Deferred tax assets	567			2,147
Other current assets	8,841			9,114
Total current assets	96,362			119,072
Property and equipment, net	12,390			11,026
Intangible assets, net	2,597			12,615
Other assets	2,050			2,056
Total assets	$	113,399		$	144,769
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable	$	17,147		$	17,399
Accrued liabilities	16,391			15,330
Accrued payroll and employee compensation	4,534			4,277
Income taxes payable	354			278
Accrued warranty	6,049			5,407
Total current liabilities	44,475			42,691
Deferred tax liabilities	567			2,147
Other liabilities	4,675			4,493
Total liabilities	49,717			49,331
Commitments and contingencies (Note 8)
Shareholders’ equity:
Common stock, no par value, 45,000 shares authorized; 12,743 and 13,230 shares issued and outstanding, respectively	67,399			70,496
Accumulated other comprehensive loss	(120		)	(347		)
(Accumulated deficit) retained earnings	(3,597		)	25,289
Total shareholders’ equity	63,682			95,438
Total liabilities and shareholders’ equity	$	113,399		$	144,769

See accompanying notes to consolidated condensed financial statements.

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Overland Storage, Inc.

Consolidated Condensed Statement of Cash Flows

(In thousands)

	Six Months Ended December 31,
	2006			2005
	(Unaudited)
Operating activities:
Net loss	$	(28,886	)	$	(5,613	)
Adjustments to reconcile net loss to cash (used in) provided by operating activities:
Impairment of acquired technology	8,411			—
Depreciation and amortization	3,094			3,364
Deferred income taxes	(134		)	(1,302		)
Acquired in-process research and development	—			1,121
Excess tax benefits from share-based payment arrangements	—			(154		)
Share-based compensation	(464		)	1,132
Changes in operating assets and liabilities, net of effects of acquisition:
Accounts receivable	(1,524		)	(4,055		)
Inventories	(10,721		)	3,688
Accounts payable and accrued liabilities	1,451			6,303
Accrued payroll and employee compensation	257			282
Other assets and liabilities, net	580			2,437
Net cash (used in) provided by operating activities	(27,936		)	7,203
Investing activities:
Purchases of short-term investments	(44,025		)	(52,781		)
Proceeds from maturities of short-term investments	60,936			55,506
Proceeds from sales of short-term investments	2,576			2,832
Capital expenditures	(2,851		)	(1,637		)
Net cash payments to acquire Zetta	—			(8,857		)
Net cash provided by (used in) investing activities	16,636			(4,937		)
Financing activities:
Proceeds from the exercise of stock options under stock option plans and the purchase of common stock under the employee stock purchase plan	89			1,221
Repurchase of common stock	(2,722		)	(4,652		)
Excess tax benefits from share-based payment arrangements	—			154
Net cash used in financing activities	(2,633		)	(3,277		)
Effect of exchange rate changes on cash	164			42
Net decrease in cash and cash equivalents	(13,769		)	(969		)
Cash and cash equivalents, beginning of period	20,315			5,498
Cash and cash equivalents, end of period	$	6,546		$	4,529

See accompanying notes to consolidated condensed financial statements.

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OVERLAND STORAGE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

Note 1 — Basis of Presentation

The accompanying consolidated condensed financial statements of Overland Storage, Inc. and its subsidiaries (the Company) have been prepared without audit pursuant to the rules and regulations of the Securities and Exchange Commission for Form 10-Q. The Company operates its business in one operating segment. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted pursuant to such rules and regulations.

The Company operates and reports using a 52-53 week fiscal year with each quarter ending on the Sunday closest to the calendar quarter. For ease of presentation, the Company’s last fiscal year is considered to have ended June 30, 2006. The Company’s second quarter of fiscal 2007 ended December 31, 2006. The Company’s second quarter of fiscal 2006 ended January 1, 2006; however, for ease in presentation it is considered to have ended December 31, 2005. For example, references to the second quarter of fiscal 2006, the three months ended December 31, 2005, the first half of 2006 and the six months ended December 31, 2005 refer to the fiscal period ended December 31, 2005. The second quarter of fiscal 2007 and the second quarter of fiscal 2006 each contained 13 weeks.

In the opinion of management, these statements include all the normal recurring adjustments necessary to state fairly our consolidated condensed results of operations, financial position and cash flows as of December 31, 2006 and for all periods presented. These consolidated condensed financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s annual report on Form 10-K for the year ended July 2, 2006. The consolidated condensed results of operations and statement of cash flows for the three and six months ended December 31, 2006 are not necessarily indicative of the results or cash flows expected for the full year.

The year end consolidated condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

Note 2 — Asset Impairment and Restructuring

Asset Impairment

On August 8, 2005, the Company acquired all of the outstanding stock of Zetta Systems (Zetta). Zetta developed data protection software that was incorporated into the Company’s ULTAMUSTM Pro storage appliance that was launched in the first quarter of fiscal 2007. ULTAMUS Pro did not generate revenue subsequent to its launch. On October 25, 2006, the Company’s Board of Directors approved the closure of the Zetta related software development office near Seattle, Washington and an elimination of the ULTAMUS Pro product from future forecasts and sales commission goals.

In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company evaluated the acquired technology intangible asset for impairment as of September 30, 2006 due to the significant underperformance of the ULTAMUS Pro product subsequent to its launch. Based on the Company’s revised forecasts, the Company concluded that the carrying amount of the asset was not recoverable and an impairment loss should be recognized. An impairment charge equal to the remaining intangible asset balance of $8.4 million was recorded in the first quarter of 2007 as the acquired technology was not considered to have any remaining value. In addition, in the first quarter of 2007, the Company recorded a write-down of $350,000 to cost of revenue against specific inventory associated with the ULTAMUS Pro product which can no longer be used in production.

Restructuring

In the second quarter of fiscal 2007, the Company recorded $962,000 in severance for the termination of 28 employees in the October 2006 reduction in workforce. As of December 31, 2006, severance of $585,000 remains unpaid and  no adjustments were made to this liability. The entire $962,000 of severance is included in research and development expense and sales and marketing expense in the accompanying consolidated condensed statement of operations.

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The Company expects to have a cease use date of the software development facility near Seattle, Washington in the third quarter of fiscal 2007 at which time it will accrue any necessary costs as required by Statement of Financial Accounting Standards (SFAS) No. 146, Accounting for Costs Associated with Exit or Disposal Activities. Management does not expect these costs to be material to its financial position or results of operations.

Note 3 — Short-Term Investments

The following table summarizes short-term investments by security type (in thousands):

	December 31, 2006
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
State and municipal securities	$	11,300	$	—	$	—	$	11,300
Asset-backed securities	11,722		1		159		11,564
	$	23,022	$	1	$	159	$	22,864

	June 30, 2006
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
State and municipal securities	$	25,300	$	—	$	—	$	25,300
Asset-backed securities	14,653		—		356		14,297
Corporate bonds	2,600		—		—		2,600
	$	42,553	$	—	$	356	$	42,197

The following table summarizes the contractual maturities of the Company’s short-term investments (in thousands):

	December 31, 2006		June 30, 2006
Less than one year	$	—	$	—
Due in one to two years	—		2,600
Due in two to five years	1,634		1,919
Due after five years	21,230		37,678
	$	22,864	$	42,197

Asset-backed securities have been allocated within the contractual maturities table based upon the set maturity date of the security. Realized gains and losses on short-term investments are included in other income, net, in the accompanying consolidated condensed statement of operations. The following table summarizes gross realized gains and gross realized losses on the Company’s short-term investments (in thousands):

	Three months ended December 31,					Six months ended December 31,
	2006			2005		2006			2005
Realized losses	$	(23	)	$	—	$	(23	)	$	(24	)
Realized gains	—			—		—			1
	$	(23	)	$	—	$	(23	)	$	(23	)

As of December 31, 2006, the Company had 28 individual securities in an unrealized loss position. The following table shows the gross unrealized losses and the fair value of the Company’s investments with unrealized losses that are not considered to be other-than-temporarily impaired (in thousands), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2006.

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	Less Than 12 Months				12 Months or Greater				Total
Description of Securities	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Asset-backed securities	$	766	$	4	$	9,269	$	155	$	10,035	$	159

Asset-backed securities

Unrealized losses on the Company’s investments in mortgage-backed securities guaranteed by a federal agency or government-sponsored enterprise were caused by interest rate increases. The contractual cash flows of those investments are either guaranteed by an agency of the U.S. government or entities with a line of credit to the U.S. Treasury. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of the Company’s investment. Because the decline in market value is attributable to changes in interest rates and not credit quality and because the Company has the ability and the intent to hold those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2006.

Note 4 — Composition of Certain Financial Statement Captions

The following table summarizes inventories (in thousands):

	December 31, 2006		June 30, 2006
Raw materials	$	16,374	$	8,202
Work in process	1,734		1,332
Finished goods	7,591		5,444
	$	25,699	$	14,978

Note 5 — Net Loss Per Share

Basic net loss per share is computed based on the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share is computed based on the weighted-average number of shares of common stock outstanding during the period increased by the weighted-average number of dilutive common stock equivalents outstanding during the period, using the treasury stock method. Dilutive securities are comprised of options granted and restricted stock awards issued under the Company’s stock option plans and ESPP share purchase rights. For all periods presented, there is no difference in the number of shares used to calculate basic and diluted shares outstanding due to the Company’s net loss position.

Anti-dilutive common stock equivalents excluded from the computation of diluted net loss per share were as follows (in thousands):

	Three Months Ended December 31,		Six Months Ended December 31,
	2006	2005	2006	2005
Options outstanding and ESPP purchase rights	2,033	2,980	2,289	3,041
Restricted stock awards outstanding	28	104	58	103

Note 6 — Comprehensive Loss

Comprehensive loss for the Company includes net loss, foreign currency translation adjustments and unrealized losses on available-for-sale securities, which are charged or credited to accumulated other comprehensive income within shareholders’ equity. Comprehensive loss was as follows (in thousands):

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	Three Months Ended December 31,						Six Months Ended December 31,
	2006			2005			2006			2005
Net loss	$	(8,889	)	$	(2,713	)	$	(28,886	)	$	(5,613	)
Change in foreign currency translation	40			72			104			42
Change in unrealized loss on short-term investments	27			(25		)	123			(39		)
Total comprehensive loss	$	(8,822	)	$	(2,666	)	$	(28,659	)	$	(5,610	)

Note 7 — Bank Borrowings and Debt Arrangements

On November 30, 2006, the Company’s $10.0 million revolving line of credit expired in accordance with its terms.

Note 8 — Commitments and Contingencies

Warranty and Extended Warranty

The Company generally provides a three-year advance replacement return-to-factory warranty on our NEO SERIES®, REO SERIES®, PowerLoader® and LoaderXpress® products. The Company also provides on-site service, where available, for the first warranty year of the NEO SERIES products, for which it contracts with third-party service providers. ARCvaultTM includes a one-year advance replacement return-to-factory warranty. For most products, the Company offers a program called XchangeNOW® as part of a return-to-factory warranty which enables customers to receive an advance replacement unit or field replacement part shipped within two business days after placing a service request. The customer ships the defective unit back to us using the shipping materials from the replacement unit.

The Company records a provision for estimated future warranty costs for both the return-to-factory and on-site warranties. If future actual costs to repair were to differ significantly from estimates, the impact of these unforeseen costs or cost reductions would be recorded in subsequent periods.

Separately priced extended on-site warranties are offered for sale to customers of all product lines. The Company contracts with third-party service providers to provide service relating to all on-site warranties. Extended warranty revenue and amounts paid in advance to outside service organizations are deferred and recognized as revenue and cost of revenue, respectively, over the period of the service agreement.

Changes in the liability for accrued warranty and deferred revenue associated with extended warranties were as follows (in thousands):

	Accrued Warranty			Deferred Revenue
Liability at June 30, 2006	$	5,407		$	8,822
Settlements made during the period	(921		)	(4,460		)
Change in liability for warranties issued during the period	1,401			5,426
Change in liability for preexisting warranties	162			3
Liability at December 31, 2006	$	6,049		$	9,791

Litigation

From time to time, the Company may be involved in various lawsuits, legal proceedings or claims that arise in the ordinary course of business. Management does not believe any such legal proceedings or claims will have, individually or in the aggregate, a material adverse effect on its business, liquidity, financial position or results of operations. Litigation, however, is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm the Company’s business.

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Note 9 — Intangible Assets

Intangible assets consist of the following (in thousands):

	December 31, 2006			June 30, 2006
Acquired technology	$	20,594		$	20,594
Impairment of Zetta acquired technology	(8,411		)	—
Adjusted cost basis	12,183			20,594
Accumulated amortization	(9,586		)	(7,979		)
	$	2,597		$	12,615

As a result of the impairment of the Zetta technology, intangible assets at December 31, 2006 consist of  the remaining unamortized balance of the technology acquired in the June 2003 Okapi acquisition. Amortization expense of intangible assets was approximately $433,000 and $1.2 million during the second quarter of fiscal 2007 and 2006, respectively. Amortization expense of intangible assets was approximately $1.6 million and $2.2 million during the first half of fiscal 2007 and 2006, respectively. The technology acquired from Okapi is being amortized over five years. The technology acquired from Zetta was being amortized over four years before its impairment in the first quarter of fiscal 2007. Estimated amortization expense for intangible assets will be approximately $866,000 during the remainder of fiscal 2007 and approximately $1.7 million in fiscal 2008 at which point it will be fully amortized.

Note 10 — Common Stock

Share repurchase program

On October 16, 2005, the Company’s Board of Directors expanded the Company’s share repurchase program to allow for the purchase of up to 2.5 million shares of its common stock with no fixed dollar amount. On October 25, 2006, the Company’s Board of Directors terminated the share repurchase program. There were no share repurchases in the second quarter of fiscal 2007. During the first half of fiscal 2007, an aggregate of approximately 373,000 shares were repurchased at a cost of approximately $2.7 million pursuant to the repurchase program.

Stock Options and Employee Stock Purchase Plan

There were no exercises of stock options or issuances under the Company’s 1996 Employee Stock Purchase Plan (1996 ESPP) or the Company’s 2006 Employee Stock Purchase Plan (2006 ESPP) in the second quarter of fiscal 2007. The 2006 ESPP replaced the 1996 ESPP effective December 1, 2006.  During the first half of fiscal 2007, the Company issued 3,000 shares of common stock upon exercise of stock options and approximately 10,000 shares of common stock purchased through the 1996 ESPP.

Restricted Stock Awards

During the second quarter and first half of fiscal 2007, approximately 93,000 and 127,000 shares of restricted stock were cancelled, respectively. No shares vested during the second quarter of fiscal 2007 and 9,000 shares vested during the first half of fiscal 2007.

Note 11 — Recent Accounting Pronouncements

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN No. 48). FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. This Interpretation prescribes a recognition threshold and measurement attribute of tax positions taken or expected to be taken on a tax return. This Interpretation is effective for the first fiscal year beginning after December 15, 2006 (fiscal 2008 for the Company). Management is currently evaluating the impact, if any, FIN No. 48 will have on its financial position and results of operations.

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In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the United States of America and expands disclosure about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 (fiscal 2009 for the Company). Management is currently evaluating the impact, if any, SFAS No. 157 will have on its consolidated financial position, results of operations and cash flows.

From time to time, new accounting pronouncements are issued by the FASB that are adopted by the Company as of the specified effective date. Unless otherwise discussed, management believes that the impact of recently issued standards, which are not yet effective, will not have a material impact on the Company’s consolidated financial statements upon adoption.

Item 2. — Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The discussion in this section contains statements of a forward-looking nature relating to future events or our future performance. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the only means of identifying forward-looking statements. Such statements are only predictions and actual events or results may differ materially. In evaluating such statements, you should specifically consider various factors identified in this report, including the matters set forth under the caption “Risk Factors”, in this report and in our Annual Report on Form 10-K which could cause actual results to differ materially from those indicated by such forward-looking statements.

Overview

Our strategy is to become a market leader and innovative supplier of a complete portfolio of tiered data storage solutions by providing intelligent appliances and software modules designed to work together to ensure that information is “automatically safe, readily available and always there.”  We intend to deliver products to address all three tiers of data storage:  primary protected disk, secondary disk-based backup and tertiary automated tape libraries for archival. Our focus is on mid-range solutions that can be easily sold worldwide through our indirect network of resellers and OEMs.

For many years we have held a leadership position in mid-range tape automation. Our most successful product has been our NEOTM line of tape automation solutions consisting of the NEO 2000, NEO 4000 and NEO 8000. NEO is sold to a number of OEMs under private label contracts as well as worldwide through our branded sales channel. Hewlett-Packard Company (HP) is our largest customer for this product. In August 2005, HP informed us of its decision not to purchase its next-generation, mid-range tape automation production line from Overland. HP will continue to purchase the NEO 2000 and NEO 4000 products currently supplied by us for some time and recently renewed their supply contract (which does not commit HP to buy specific quantities of product at any time) with us for an additional three years ending July 2009. We expect the new product HP is now buying, however, will eventually replace a significant portion of its NEO purchases. We cannot predict how quickly this transition will occur, but we believe the impact to our revenue during fiscal 2007 will be significant.

In November 2005, we announced Dell had selected us to supply it with our next generation tape library that was under development.  We spent considerable resources during the ensuing year to complete the development and to meet Dell’s specifications and other requirements.  In October 2006, however, we were notified by Dell of its intent to terminate the supply agreement.  Shipments of the tape libraries had not yet commenced but were expected to begin shortly.  The loss of this business had a material impact to our expected revenue, but a much smaller impact to our expected gross profit and results of operations because of the aggressive pricing demanded by Dell.

In light of this loss in revenue, we are focusing heavily on the delivery of new products to our branded channel, which historically has produced higher gross margins in comparison to OEM business. Such new products include ARCvaultTM, a new line of tape automation products that is the result of over a year of development. ARCvault was designed for a price-competitive marketplace with fewer features than NEO, but significantly higher density and a lower price per terabyte. The first ARCvault product was launched in July 2006 and we plan to introduce additional ARCvault products during the remainder of fiscal 2007.

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In the disk-based backup and recovery space, our REO products target the mid-range market and enable customers to scale their backup solution from one terabyte to 32 terabytes. In July 2006, we launched version 3.0 of our REO Protection OSTM. This data protection software is integrated with every REO Series product and significantly improves performance. In the second half of fiscal 2007, we intend to introduce new hardware platforms for each of the REO products that are compliant with the European Union directive on the Restriction of the use of Certain Hazardous substances in Electrical and Electronic Equipment (ROHS) to improve the competitiveness of our REO products in the international marketplace.

In the area of primary protected disk, we had planned to facilitate our entry into this space through our August 2005 acquisition of Zetta Systems. In August 2006, after a year of development, we launched a new version of the Zetta product called ULTAMUS Pro which failed to achieve market acceptance. We discontinued our R&D efforts on the Zetta-based software in October 2006 and recorded an impairment charge of $8.4 million in the first quarter of fiscal 2007. We then modified our product roadmap to focus on the delivery of a new line of ULTAMUS RAID primary storage products that do not contain the ULTAMUS Pro software. The introduction of these products was expected in the second quarter of fiscal 2007, but was delayed to the second half of fiscal 2007 due to the inability of certain suppliers to meet our delivery schedules. The two ULTAMUS RAID products to be introduced in the second half of fiscal 2007 will offer small to medium business customers an affordable alternative to costly high-end network attached storage (NAS) and storage area network (SAN) solutions.

In September 2004, we announced a plan to outsource all of our manufacturing to a U.S. third party manufacturer. We completed this transfer in August 2005. During fiscal 2006, however, we failed to achieve the customer service levels, product quality and cost reductions we expected from the outsourcing. Additionally, we incurred a significant amount of redundant costs to support the outsourcing, which eroded our gross margins during the year. Consequently, we decided to bring manufacturing back to our San Diego facility and entered into a transition agreement with our outsourced manufacturer, effective September 2006. As of the date of this report, the majority of the production lines have already been transferred back to San Diego, with the last two lines expected to be complete by mid-February 2007.

Critical Accounting Policies and Estimates

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

Business Acquisitions and Intangible Assets

Our business acquisitions typically result in recognition of intangible assets (acquired technology) and in certain cases non-recurring charges associated with in-process research and development (IPR&D), which affect the amount of current and future period charges and amortization expenses. We amortize our definite-lived intangible assets using the straight-line method over their estimated useful lives, while IPR&D is recorded as a non-recurring charge on the acquisition date.

The determination of the value of these components of a business combination, as well as associated asset useful lives, requires management to make various estimates and assumptions. Critical estimates in valuing intangible assets may include but are not limited to: future expected cash flows from product sales and services, maintenance agreements, and acquired development technologies and patents or trademarks; expected costs to develop the IPR&D into commercially viable products and estimating cash flows from projects when completed; the acquired company’s brand awareness and market position, as well as assumptions about the period of time the acquired products and services will continue to be used in our product portfolio; and discount rates. Management’s estimates of fair value and useful lives are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. Unanticipated events and circumstances may occur and assumptions may change. Estimates using different assumptions could also produce significantly different results.

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We continually review the events and circumstances related to our financial performance and economic environment for factors that would provide evidence of the impairment of our intangible assets. When impairment indicators are identified with respect to our previously recorded intangible assets, we would measure any required impairment loss as the amount by which the asset’s carrying value exceeds its fair value and we would record it as a reduction in the carrying value of the related assets and charge it to operations. Significant management judgment is required in estimating the fair value and should different conditions prevail, material write downs of net intangible assets and other long-lived assets could occur. We periodically review the estimated remaining useful lives of our acquired intangible assets. A reduction in our estimate of remaining useful lives, if any, could result in increased amortization expense in future periods.

During the first quarter of fiscal 2007, we recorded an $8.4 million impairment charge related to acquired technology. See Impairment of Acquired Technology under the discussion of Results of Operations below.

Results of Operations

The following table sets forth certain line items in our statement of operations as a percentage of net revenue for the periods presented. The data has been derived from our unaudited consolidated condensed financial statements.

	Three Months Ended December 31,				Six Months Ended December 31,
	2006		2005		2006		2005
Net revenue	100.0	%	100.0	%	100.0	%	100.0	%
Cost of revenue	83.2		77.9		85.1		77.5
Gross profit	16.8		22.1		14.9		22.5
Operating expenses:
Sales and marketing	20.3		16.6		20.6		16.3
Research and development	8.9		6.9		10.2		7.2
General and administrative	7.3		6.1		8.2		6.5
Impairment of acquired technology	—		—		9.5		—
Acquired in-process research and development	—		—		—		0.9
	36.5		29.6		48.5		30.9
Loss from operations	(19.7	)	(7.5	)	(33.6	)	(8.4	)
Other, net	0.5		1.2		0.9		1.1
Loss before income taxes	(19.2	)	(6.3	)	(32.7	)	(7.3	)
Benefit from income taxes	(0.2	)	(1.8	)	(0.1	)	(2.6	)
Net loss	(19.0	)	(4.5	)	(32.6	)	(4.7	)

The second quarter of fiscal 2007 compared to the second quarter of fiscal 2006

Net Revenue. Net revenue decreased to $46.8 million during the second quarter of fiscal 2007 from $60.6 million during the second quarter of fiscal 2006, a decrease of approximately $13.8 million, or 22.9%. Decreases in net revenue were reported in all regions (Americas, Europe, Middle East and Africa (EMEA) and Asia Pacific (APAC)), but were partially offset by a $700,000, or 43.6%, increase in extended warranty service revenue associated with an increase in the number of warranty contracts sold.

Net revenue from OEM customers decreased to $22.2 million in the second quarter of fiscal 2007 from $33.8 million in the second quarter of fiscal 2006. The decrease of $11.6 million, or 34.3%, is primarily associated with declining shipments to HP, as well as decreased volumes to IBM. Net revenue from HP represented approximately 45.7% of total net revenue in the second quarter of fiscal 2007 compared to 52.4% of total net revenue for the second quarter of fiscal 2006.  Net revenue from IBM represents less than 5% of total net revenue in all periods presented.

Net revenue from Overland branded products, excluding warranty service revenue, decreased to $21.7 million during the second quarter of fiscal 2007 from $24.6 million during the second quarter of fiscal 2006. The decrease of approximately $2.9 million, or 11.9%, was primarily associated with (i) a $3.4 million decrease in revenue due to the discontinuation of our PowerLoader product and (ii) a $1.8 million decrease in REO product sales, primarily due to a limited supply of ROHS-compliant product. These decreases were offset by $3.1 million of revenue generated from our new

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ARCvault product, introduced in early fiscal 2007.

VR2 revenue during the second quarter of fiscal 2007 of $550,000 declined from $624,000 during the second quarter of fiscal 2006. The decrease of approximately $73,000, or 11.8%, was the result of lower royalties occurring in the second quarter of fiscal 2007. VR2 revenue during the second quarter of fiscal 2006 and fiscal 2007 were comprised solely of royalties.

We expect sales to HP to continue to decline through the second half of fiscal 2007, as it transitions to alternative products provided by another supplier. We expect to offset at least, in part, this anticipated decline in revenue with increased sales through our branded channel, including (i) sales of new products such as ARCvault 48 and ULTAMUS RAID, (ii) increased sales of ARCvault 12 and 24, and (iii) increased sales of REO products, which we expect to benefit from new ROHS-compliant hardware platforms. We also expect our sales to benefit from more reliable deliveries and service resulting from the manufacturing transition back to San Diego.

A summary of the sales mix by product for the periods presented in the (unaudited) consolidated condensed statement of operations follows:

	Three Months Ended December 31,				Six Months Ended December 31,
	2006		2005		2006		2005
Tape based products:
NEO Series	70.8	%	68.8	%	70.0	%	70.9	%
ARCvault Series	6.6		—		6.0		—
Other	0.7		6.2		2.5		7.2
	78.1		75.0		78.5		78.1
Spare parts, non-warranty service, other	10.3		14.1		9.8		11.3
Disk based products	5.5		7.3		5.8		6.6
Warranty	4.9		2.6		5.0		2.6
VR2	1.2		1.0		0.9		1.4
	100.0	%	100.0	%	100.0	%	100.0	%

Gross Profit. Gross profit decreased to $7.9 million during the second quarter of fiscal 2007 from $13.4 million during the second quarter of fiscal 2006. The decrease of approximately $5.5 million, or 41.3%, is primarily due to an overall decrease in our net revenue of $13.8 million, as described above. The gross margin for the quarter of 16.8% was heavily impacted by approximately $1.8 million of under-absorbed manufacturing costs, which reflects inefficiencies related to the manufacturing start-up process in San Diego and the transfer of production lines from our outsourced contract manufacturer. The decrease in gross profit was also impacted by higher than expected scrap costs, which is a reflection of the production line transition. Gross profit was also reduced by a $610,000 increase in inventory reserves for the quarter related to obsolete inventories and components originally acquired for the Dell contract.

We expect gross profit and our gross margin to improve in the second half of fiscal 2007 as we expect to eliminate redundant manufacturing costs due to the outsourcing difficulties, and as the percentage of branded revenue is anticipated to grow in comparison to revenue from OEM customers, given that branded sales typically result in higher margins than OEM sales. We have also established a goal of achieving full-absorption of manufacturing costs during the fiscal 2007 fourth quarter, and intend to focus on other manufacturing cost reductions on our new ARCvault product line.

Stock-Based Compensation. During the second quarter of fiscal 2007, we had a net reversal of $227,000 of expense compared to $610,000 of share-based compensation charges in the second quarter of fiscal 2006. In the second quarter of fiscal 2007, the net reversal resulted from significant pre-vesting forfeitures (in excess of amounts previously estimated) related to the forfeiture of shares previously granted to our former president and chief executive officer and individuals terminated as part of the October 2006 restructuring. The pre-vesting forfeitures resulted in the reversal of previously recognized share-based compensation expense and such reversal exceeded the amount of expense recorded for other awards in the second quarter of fiscal 2007. Share-based compensation expense for the second half of fiscal 2007 is expected to be approximately $438,000.

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Share-based compensation was allocated as follows (in thousands):

	Three months ended December 31,
	2006			2005		Change
Cost of revenue	$	1		$	1	$	—
Sales and marketing	37			245		(208		)
Research and development	(25		)	59		(84		)
General and administrative	(240		)	305		(545		)
	$	(227	)	$	610	$	(837	)

Sales and Marketing Expense. Sales and marketing expense decreased to $9.5 million during the second quarter of fiscal 2007 from $10.1 million during the second quarter of fiscal 2006. The decrease of approximately $600,000, or 5.9%, is primarily due to (i) a decrease of approximately $834,000 in employee and related expenses due to a reduction in our average headcount by 33 employees associated with the October 2006 restructuring and additional realignment of our sales force, (ii) a $208,000 reduction in share-based compensation expense associated with a reversal of awards that cancelled prior to vesting and a reduction of related expense under FIN No. 28 associated with our accelerated amortization methodology, and (iii) approximately $164,000 reduction in public relations expenses related to the launch of new products. These reductions were partially offset by an approximately $810,000 increase in severance primarily associated with the October 2006 restructuring. We expect sales and marketing expense to decline on a quarterly basis, excluding the impact of the fiscal 2007 second quarter severance charges and reversal of share-based compensation.

Research and Development Expense. Research and development expense was flat at $4.2 million during both the second quarter of fiscal 2007 and the second quarter of fiscal 2006. R&D expense in the second quarter of fiscal 2007, when compared to the second quarter of fiscal 2006, was reduced by a $493,000 decrease in employee and related expenses associated with a decrease in average headcount by 21 employees, primarily associated with the closing of the office near Seattle, Washington and completion of R&D projects. These reductions, however, were offset by (i) increased development materials and tooling of $429,000, and (ii) increased severance of $131,000 associated with the October 2006 restructuring. We expect R&D spending to decline significantly in the second half of fiscal 2007 as we anticipate completing the development of the ARCvault 48 product and the testing of our new REO and ULTAMUS RAID products.

General and Administrative Expense. General and administrative expense decreased to $3.4 million during the second quarter of fiscal 2007 from $3.7 million during the second quarter of fiscal 2006. The decrease of approximately $300,000, or 7.2%, is primarily due to (i) a $544,000 reduction in share-based compensation expense associated with a reversal of awards that cancelled prior to vesting and a reduction of related expense under FIN No. 28 associated with our accelerated amortization methodology and (ii) a $208,000 reduction in legal fees (prior year legal fees were higher as a result of the accumulation of our shares by a competitor and related issues). These reductions in expense were offset by (i) severance expense of approximately $507,000 primarily related to the termination of our former president and chief executive officer, and (ii) a $77,000 increase in consulting fees, approximately $42,000 of which relates to consulting services provided by our former president and chief executive officer. We expect G&A spending in the fiscal 2007 third quarter to be relatively unchanged from the second quarter and to decline slightly in the fourth fiscal quarter.

Interest Income, net. Interest income decreased to $482,000 during the second quarter of fiscal 2007 from $717,000 during the second quarter of fiscal 2006. The decrease of approximately $235,000, or 32.8%, is due to lower cash and investment balances, as a result of our net losses and increases in inventory balances, when compared to the second quarter of fiscal 2006.

Benefit from Income Taxes. We recorded a benefit from income taxes of $71,000 during the second quarter of fiscal 2007 compared to a benefit from income taxes of $1.1 million for the second quarter of fiscal 2006. The nominal tax benefit in the second quarter of fiscal 2007 relates largely to a favorable resolution of a state income tax position taken in a prior period. The benefit in the second quarter of fiscal 2006 relates to our pre-tax loss and the then forecasted loss for the remainder of fiscal 2006.

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The first half of fiscal 2007 compared to the first half of fiscal 2006

Net Revenue. Net revenue decreased to $88.6 million during the first half of fiscal 2007 from $119.1 million during the first half of fiscal 2006, a decrease of approximately $30.5 million, or 25.6%. Decreases in net revenue were consistent throughout all of the regions (Americas, EMEA and APAC), but were partially offset by a $1.3 million, or 43.4%, increase in extended warranty service revenue associated with an increase in the number of warranty contracts sold since early fiscal 2006.

Net revenue from OEM customers decreased to $44.3 million during the first half of fiscal 2007 from $65.0 million during the first half of fiscal 2006. The decrease of $20.7 million, or 31.9%, is primarily associated with declining shipments to HP, as well as decreased volumes to IBM. Net revenue from HP represented approximately 48.0% of total net revenue during the first half of fiscal 2007 compared to 51.0% of total net revenue during the first half of fiscal 2006.  Net revenue from IBM represents less than 5% of total net revenue in all periods presented.

Net revenue from Overland branded products, excluding warranty service revenue, decreased to $39.1 million during the first half of fiscal 2007 from $49.4 million during the first half of fiscal 2006. The decrease of approximately $10.3 million, or 20.8%, was primarily associated with (i) a $6.3 million decrease in revenue due to the discontinuation of our PowerLoader product, (ii) a $7.5 million decrease in our NEO product sales, and (iii) a $2.6 million decrease in our REO product sales, primarily due to a limited supply of ROHS-compliant product. These decreases were offset by $5.3 million of revenue generated from sales of our new ARCvault product, introduced in early fiscal 2007.

VR2 revenue during the first half of fiscal 2007 of approximately $801,000 decreased from $1.7 million during the first half of fiscal 2006. This decrease of approximately $900,000, or 53.0%, was primarily the result of lower royalties and no chip sales occurring in the first half of fiscal 2007. Chip sales in the first half of fiscal 2006 were approximately $438,000 and there were no sales in the first half of fiscal 2007. Royalties totalled $1.3 million during the first half of fiscal 2006 compared to $801,000 during the first half of fiscal 2007.

Gross Profit. Gross profit decreased to $13.2 million during the first half of fiscal 2007 from $26.8 million during the first half of fiscal 2006. The decrease of approximately $13.6 million, or 50.9%, is primarily due to an overall decrease in our net revenue of $30.5 million, as described above. Overall gross margin of 14.9% for the first half of fiscal 2007 decreased from 22.5% for the first half of fiscal 2006 due to (i) an increase of approximately $4.2 million in employee and related costs from an increase in average headcount of 64 employees during the first half of fiscal 2007, due to bringing manufacturing back in house, (ii) an increase of $1.0 million of non-warranty services associated with an increase in out-of-warranty repaired items, and (iii) a $1.3 million increase in inventory reserves for the period related to obsolete inventories and components originally acquired for the Dell contract.

Stock-Based Compensation. During the first half of fiscal 2007, we had a net reversal of $464,000 of expense compared to $1.1 million of share-based compensation charges in the first half of fiscal 2006. In the first half of fiscal 2007, the net reversal resulted from significant pre-vesting forfeitures (in excess of amounts previously estimated) related to the forfeiture of shares previously granted to two executives and individuals terminated as part of the October 2006 restructuring. The pre-vesting forfeitures resulted in the reversal of previously recognized share-based compensation expense and such reversal exceeded the amount of expense recorded for other awards in the first half of fiscal 2007.

Share-based compensation was allocated as follows (in thousands):

	Six months ended December 31,
	2006			2005		Change
Cost of revenue	$	3		$	13	$	(10	)
Sales and marketing	(303		)	334		(637		)
Research and development	(89		)	110		(199		)
General and administrative	(75		)	675		(750		)
	$	(464	)	$	1,132	$	(1,596	)

Sales and Marketing Expense. Sales and marketing expense was $18.2 million during the first half of fiscal 2007, compared to $19.4 million during the first half of fiscal 2006. The decrease of approximately $1.2 million, or 6.2%, is

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primarily due to (i) a decrease of approximately $1.3 million in employee and related expenses associated with a decrease in average headcount by 20 employees primarily due to the October 2006 restructuring and additional realignment of our sales force, (ii) a $637,000 reduction in share-based compensation expense associated with a reversal of awards that cancelled prior to vesting and a reduction of related expense under FIN No. 28 associated with our accelerated amortization methodology. These reductions were partially offset by approximately a $964,000 increase in severance associated with the October 2006 restructuring and other severance costs recorded in the first quarter of fiscal 2007.

Research and Development Expense. Research and development expense was $9.0 million during the first half of fiscal 2007, compared to $8.6 million during the first half of fiscal 2006. The increase of approximately $400,000, or 5.3%, is primarily due to (i) increased development materials and tooling costs, of $1.0 million compared to the prior year, and  (ii) $115,000 in severance costs primarily associated with the October 2006 restructuring. These increases were offset by (i) a $435,000 decrease in employee and related expenses associated with a decrease in average headcount by 9 employees primarily due to the October 2006 restructuring (ii) a decrease of $199,000 of share-based compensation expense associated with a reversal of awards that cancelled prior to vesting and a reduction of related expense under FIN No. 28 associated with our accelerated amortization methodology.

General and Administrative Expense. General and administrative expense of $7.3 million during the first half of fiscal 2007, decreased from $7.7 million during the first half of fiscal 2006. The decrease of approximately $400,000, or 5.7%, is primarily due to (i) a $749,000 reduction in share-based compensation expense associated with a reversal of awards that cancelled prior to vesting and a reduction of related expense under FIN No. 28 associated with our accelerated amortization methodology, and (ii) a $269,000 net reduction in legal and other fees (prior year legal fees were higher as a result of the accumulation of our shares by a competitor and related issues). These reductions in expense/cost savings were offset by (i) severance expense of approximately $507,000 primarily related to the termination of our former president and chief executive officer and (ii) $233,000 in audit, tax and consulting fees related to the material weakness we reported at the end of fiscal 2006.

Impairment of Acquired Technology. In the first quarter of fiscal 2007, we recorded an impairment charge of $8.4 million related to the developed technology intangible asset acquired from Zetta Systems in August 2005. As more fully discussed in Note 2 in the accompanying unaudited consolidated condensed financial statements, management performed an impairment analysis of Zetta, in accordance with SFAS No. 144, and concluded that the asset was not recoverable and an impairment loss should be recognized as of September 30, 2006. The full amount of the remaining intangible asset balance as of September 30, 2006, or $8.4 million, was recorded as an impairment of acquired technology in the first quarter of fiscal 2007.

Acquired In-Process Research and Development. During the first half of fiscal 2006, a portion of the fair value of the assets acquired from Zetta was assigned to in-process research and development. We had no similar transactions in the first half of fiscal 2007.

Interest Income, net. During the first half of fiscal 2007, we generated net interest income of $1.1 million compared to $1.3 million during the same period of the prior fiscal year. The decrease of approximately $100,000 or 7.5% is due to lower cash and investment balances when compared to the same period in fiscal 2006.

Benefit from Income Taxes. We recorded a benefit from income taxes of $59,000 during the first half of fiscal 2007 compared to a benefit from income taxes of $3.2 million for the first half of fiscal 2006. The nominal tax benefit in the first half of fiscal 2007 relates largely to a favorable resolution of a state income tax position taken in a prior period. The benefit in the first half of fiscal 2006 relates to our pre-tax loss in the first half of 2006 and the forecasted loss for the remainder of fiscal 2006.

Liquidity and Capital Resources. At December 31, 2006, we had $29.4 million of cash, cash equivalents and short-term investments, compared to $62.5 million at June 30, 2006. We have no other unused sources of liquidity at this time.

Historically, our primary source of liquidity has been cash generated from operations. However, we have incurred losses in recent periods and negative cash flows during the current fiscal year. For the six months ended December 31, 2006, we incurred a net loss of $28.9 million and the balance of cash and short-term investments declined by $33.1 million compared to the balance at June 30, 2006. However, our inventory balance reached a record high level of $25.7 million on a quarter-end basis due to the transition of manufacturing back to us from our contract manufacturer.  Over the next three

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quarters, we expect to increase our inventory turns and reduce inventory levels to approximately $16 million.  Management expects that this reduction in working capital consumption together with our current balance of cash and short-term investments, will be sufficient to fund our operations for at least the next 12 months. Failure to achieve profitability, or maintain profitability if achieved, may require us to raise additional funding which could have a material negative impact on the market value of our common stock.

During the first half of fiscal 2007, we used cash in operating activities of approximately $27.9 million compared to cash provided from operating activities of $7.2 million during the first half of fiscal 2006. The change of $35.1 million is primarily attributed to our increased net loss. Although net loss for the fiscal 2007 period included a non-cash impairment of acquired technology of $8.4 million, such adjustment to cash used in operating activities was offset by a $10.7 million increase in inventories during the fiscal 2007 period compared to a decrease of $3.7 million during the fiscal 2006 period. Inventories increased due to our transition back to in-house manufacturing. In the first half of fiscal year 2006, operating cash flows were provided by an overall reduction of operating assets and liabilities due to the outsourcing of manufacturing.

During the first half of fiscal 2007, we generated cash from investing activities of $16.6 million compared to cash used in investing activities of $4.9 million for the first half of fiscal 2006. During the first half of fiscal 2007 we liquidated some of our investments to support our operations. Capital expenditures during the first half of fiscal 2007 and 2006 totaled $2.9 million and $1.6 million, respectively. During the first half of fiscal 2007, such expenditures were primarily associated with computers, machinery and equipment to support new product development and transitioning manufacturing in-house. During the first quarter of fiscal 2006, capital expenditures were comprised primarily of purchases of computer and related equipment.

We used cash in our financing activities of $2.6 million during the first half of fiscal 2007 compared to $3.3 million during the first half of fiscal 2006. Cash used in financing activities during fiscal 2007, was primarily the result of the repurchase of 373,000 shares of our stock under our repurchase program for $2.7 million. This use of cash was slightly offset by the exercise of options under our stock option plans and the purchase of shares of our stock under our 1996 Employee Stock Purchase Plan (1996 ESPP) which generated proceeds of $89,000. Cash provided by financing activities during the first half of fiscal 2006 included proceeds of $1.2 million from the issuance of common stock under our 1996 ESPP and upon exercise of stock options, offset by $4.7 million used to repurchase 576,000 shares of our common stock under our share repurchase program.

On October 16, 2005, our board of directors expanded our share repurchase program to allow for the purchase of up to 2.5 million shares of our common stock on the open market or through negotiated transactions. On October 25, 2006, our board of directors terminated our share repurchase program. During fiscal 2007 and fiscal 2006, an aggregate of approximately 373,000 shares and 1.3 million shares were repurchased at a cost of approximately $2.7 million and $10.8 million, respectively. No shares were repurchased during the second quarter of fiscal 2007.

Inflation has not had a significant impact on our operations during the periods presented. Historically we have been able to pass on to our customers increases in raw material prices caused by inflation. If at any time we cannot pass on such increases, our margins could suffer. Our exposure to the effects of inflation could be magnified by the concentration of OEM business, where our margins tend to be lower.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements or significant guarantees to third parties that are not fully recorded in our (unaudited) consolidated condensed balance sheets or fully disclosed in the notes to our (unaudited) consolidated condensed financial statements.

Recent Accounting Pronouncements

See Note 11 to consolidated condensed financial statements.

Item 3. — Quantitative and Qualitative Disclosures About Market Risk

Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due

18

to adverse changes in financial and commodity market prices and rates. We are exposed to market risk with respect to interest rates and foreign currency exchange rates. These exposures are directly related to our normal operating and funding activities. Historically, we have not used derivative instruments or engaged in hedging activities.

Interest Rate Risk. All of our fixed income investments are classified as available-for-sale, and therefore, reported on the balance sheet at market value. Changes in the overall level of interest rates affect our interest income that is generated from our investments. For the first half of fiscal 2007, total interest income was $1.2 million with investments yielding an annual average of 5.2% on a worldwide basis. The interest rate level was up approximately 160 basis points from 3.6% in the first half of fiscal 2006. If a comparable change in overall interest rates (160 basis points) were to occur in the remainder of fiscal 2007, our interest income would increase approximately $355,000, assuming consistent investment levels.

The table below presents the cash, cash equivalents and short-term investment balances and related weighted-average interest rates at the end of the first half of fiscal 2007. The cash, cash equivalents and short-term investment balances approximate fair value (in thousands, except percentages):

	Approximate Market Value		Weighted- Average Interest Rate
Cash and cash equivalents	$	6,546	6.6	%
Short-term investments:
Less than 1 year	—		—
Due in 1 - 2 years	—		—
Due in 2 - 5 years	1,634		4.1
Due after 5 years	21,230		4.8
	$	29,410	5.1

The table above includes the United States dollar equivalent of cash, cash equivalents and short-term investments, including $513,000, and $125,000 equivalents denominated in the British Pound Sterling and the Euro, respectively.

Foreign Currency Risk. We conduct business on a global basis and essentially all of our products sold in international markets are denominated in U.S. dollars. Historically, export sales have represented a significant portion of our sales and are expected to continue to represent a significant portion of sales.

Our wholly-owned subsidiaries in the United Kingdom, France and Germany incur costs which are denominated in local currencies. As exchange rates vary, these results when translated into U.S. dollars may vary from expectations and adversely impact overall expected results. The effect of exchange rate fluctuations on our results during the first half of fiscal 2007 was not material.

Item 4. — Controls and Procedures

Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this quarterly report due to the material weakness in internal control over financial reporting identified in the section “Management’s Report on Internal Control over Financial Reporting” set forth in our annual report on Form 10-K. This material weakness was ongoing at December 31, 2006. Notwithstanding this material weakness, our management concluded that the financial statements included in this quarterly report fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles.

As described more fully in our Management’s Report On Internal Control Over Financial Reporting set forth in our annual report on Form 10-K for the fiscal year ended June 30, 2006, management assessed the effectiveness of our internal

19

control over financial reporting as of June 30, 2006. This assessment identified control deficiencies which constituted a material weakness in our internal control over financial reporting. Management currently is implementing certain remedial measures identified in Part II, Item 9A (Controls and Procedures) of our annual report on Form 10-K for the year ended June 30, 2006, and intends to implement the remaining remedial measures during the course of fiscal 2007. While we are implementing changes to our control environment, there remains a risk that the transitional procedures on which we are currently relying will fail to be sufficiently effective to address the internal control deficiencies identified in Management’s Report On Internal Control Over Financial Reporting. For more information, please read the risk factor entitled “Our internal controls and procedures related to accounts payable cut-off need to be improved” set forth in Part I, Item 1A (Risk Factors) of our annual report on Form 10-K for the fiscal year ended June 30, 2006.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during our fiscal quarter ended December 31, 2006 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II — OTHER INFORMATION

Item 1. — Legal Proceedings

We are from time to time involved in various lawsuits, legal proceedings or claims that arise in the ordinary course of business. We do not believe any such legal proceedings or claims will have, individually or in the aggregate, a material adverse effect on our business, liquidity, results of operations or financial position. Litigation, however, is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business.

Item 1A. — Risk Factors

An investment in our company involves a high degree of risk. In addition to the other information included in this report, you should carefully consider the following risk factors and the risk factors set forth in our annual report on Form 10-K for the fiscal year ended June 30, 2006 and Form 10-Q for the quarter ended September 30, 2006  in evaluating an investment in our company. You should consider these matters in conjunction with the other information included or incorporated by reference in this report.

We have a recent history of net losses. We expect to continue to incur net losses for some time and we may not achieve or maintain profitability.

We have incurred significant operating losses in recent periods and anticipate continued losses in fiscal 2007. At December 31, 2006 we had an accumulated deficit of $3.6 million. We need to generate additional revenue, improve our gross profit margins and reduce operating expenses to be profitable in future periods. Failure to achieve profitability, or maintain profitability if achieved, may require us to raise additional funding which could have a material negative impact on the market value of our common stock.

We outsourced all of our manufacturing to Sanmina-SCI Corporation (Sanmina), but now are in the process of returning manufacturing to our San Diego facility. If we are unable to complete the transition efficiently, or obtain our products from Sanmina in a cost effective and timely manner that meets our customers’ expectations, our business, financial condition and results of operations could be materially and adversely affected.

In August 2005, we completed the outsourcing of all our manufacturing to Sanmina. During fiscal 2006, we failed to achieve the customer service levels, product quality and cost reductions expected from the outsourcing.  We also incurred a significant amount of redundant costs to support the outsourcing which eroded our gross margins during the year. As a consequence, we decided to bring manufacturing back to our San Diego facility.  At December 31, 2006, the majority of the production lines were already transferred back to San Diego, with the last two lines to be returned by mid-February 2007.

Our agreement with Sanmina commits us to purchase finished goods and component parts from them based upon our forecast of customer demand. If such forecasts prove to be higher than current customer demand, we may experience higher than normal inventory carrying costs and some of the inventory may become obsolete, either of which could reduce

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our gross margins.  In addition, we recently terminated discussions with a Sanmina subsidiary regarding an unrelated program for which Sanmina believes they are owed liquidated damages.  Management believes that no agreement was formed between the parties and there is no basis for their claim.

The failure to attract, retain and motivate key personnel could have a significant adverse impact on our operations.

We have experienced significant changes in our senior management. Most recently, on November 1, 2006, our board of directors appointed Scott McClendon as our interim president and chief executive officer, replacing Christopher P. Calisi, who served in those roles since March 2001. We have commenced a search for a permanent chief executive officer. The transition from a permanent to an interim chief executive officer, and a subsequent transition to a new permanent chief executive officer, may be a distraction to senior management, business operations, commercial partners and customers. Additionally, we have experienced a prolonged period of operating losses and declines in our stock price and cash position which could affect employee morale and retention. Turnover, particularly among senior management, can also create distractions as we search for replacement personnel, which could result in significant recruiting, relocation, training and other costs, and can cause operational inefficiencies as replacement personnel become familiar with our business and operations. In addition, manpower in certain areas may be constrained, which could lead to disruptions over time. There can be no assurance that we will continue to successfully attract or retain the management we need, or be able to maintain an optimal workforce size. Any inability to attract, retain or motivate such personnel or address manpower constraints as needed could materially adversely affect our future operating results and financial position.

Item 2. — Unregistered Sales of Equity Securities and Use of Proceeds

Share repurchase program. On October 16, 2005, our Board of Directors expanded our share repurchase program to allow for the purchase of up to 2.5 million shares of our common stock with no fixed dollar amount. On October 25, 2006, our Board of Directors terminated the share repurchase program. During fiscal 2007 and fiscal 2006, an aggregate of approximately 373,000 shares and 1.3 million shares, respectively, were repurchased at a cost of approximately $2.7 million and $10.8 million, respectively, pursuant to the repurchase program. No shares were repurchased during the second quarter of fiscal 2007.

Item 4. — Submission of Matters to a Vote of Security Holders

On November 14, 2006, we held our Annual Meeting of Shareholders in San Diego, California. At the meeting the shareholders elected management’s slate of directors and approved two additional proposals with the following vote distribution:

Item	Affirmative	Negative	Withheld	Broker Non-vote
Election of Board Members
Mark J. Barrenechea	11,422,723	—	480,680	—
Robert A Degan	11,306,254	—	597,149	—
Scott McClendon	8,871,594	—	3,031,809	—
William J. Miller	11,422,223	—	481,180	—
Michael Norkus	11,345,553	—	557,850	—
Other Matters
Approve our 2006 Employee Stock Purchase Plan	6,809,479	1,409,988	10,778	3,673,158
Reappoint PricewaterhouseCoopers LLP as our Independent Registered Public Accounting Firm for fiscal 2007	11,588,036	310,328	5,039	—

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Item 6. — Exhibits

(a)Exhibits

10.1*	2006 Employee Stock Purchase Plan (incorporated by reference to Exhibit 99.1 to the Company’s Form S-8 Registration Statement No. (333-139064) filed December 1, 2006).
10.2*	Summary Sheet of Director and Executive Officer Compensation.
10.3*	Separation Agreement, General Release and Consulting Agreement with Christopher P. Calisi dated November 6, 2006 (incorporated by reference to Exhibit 99.1 to Form 8-K Filed November 7, 2006).
31.1	Certification of Scott McClendon, Interim 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 Scott McClendon, Interim President and Chief Executive Officer, and Vernon A. LoForti, Vice President and Chief Financial Officer.

* Management contract or compensation plan or arrangement.

SIGNATURE

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	OVERLAND STORAGE, INC.
Date: February 2, 2007	By:	/s/ Vernon A. LoForti
		Vernon A. LoForti
		Vice President,      Chief Financial Officer      and Secretary

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EX-10.2

Exhibit 10.2

OVERLAND STORAGE, INC.

SUMMARY SHEET
OF
DIRECTOR AND EXECUTIVE OFFICER COMPENSATION

Non-Employee Director Compensation

Our compensation plan for non-employee directors consists of both a cash component and an equity component. We pay each non-employee director $5,000 per quarter, plus $2,500 for each Board meeting attended ($1,250 if held telephonically), plus reimbursement for expenses. The Chairman of the Board receives an additional $2,500 per quarter in addition to the non-employee director fee of $5,000 per quarter.  However, Scott McClendon will not receive a Chairman of the Board fee or other fees paid to non-employee directors while serving as Interim President and Chief Executive Officer.  Members of the Audit Committee and the Compensation Committee receive a retainer of $500 per quarter in lieu of a fee for committee meetings attended during a quarter and members of the Nominating and Governance Committee receive $500 for each committee meeting attended ($250 if held telephonically and no fee if held the same day as a Board meeting).  Members of the Shareholder Value Committee will receive $500 for each committee meeting attended (whether telephonically or in person).  Such fee will not be paid for committee meetings in joint session with the full board.

In addition to the cash component of compensation, each non-employee director receives stock options.  Under our 2003 Equity Incentive Plan, which we refer to as the 2003 Incentive Plan, each non-employee director receives a ten-year nonqualified stock option to purchase 18,000 shares on the same date as the company’s annual meeting of shareholders.  These options are exercisable at fair market value on the date of grant and vest in equal monthly installments over a 12-month period, as measured from the grant date.  When a new non-employee director joins the board, such director will be awarded a new option for a number of shares determined by multiplying 1,500 by the number of months remaining until the next scheduled annual meeting date, giving credit for any partial month.  Such option will vest at the rate of 1,500 shares per month and will be fully vested at the next annual meeting date, at which time the director will receive the normal annual grant.

On November 14, 2006, the date of our last annual meeting of shareholders, Mark Barrenechea, Robert Degan, Bill Miller and Michael Norkus each received an option for 18,000 shares.

On December 20, 2006, in connection with Mr. Barrenechea’s appointment as Chairman of the Strategy Committee of the Board of Directors, he received an option to purchase up to 60,000 shares of the Company’s common stock at the purchase price of $4.29 per share (the closing price of the Company’s common stock on the date of grant) pursuant to the 2003 Incentive Plan.  The option is immediately vested as to 10,000 shares (reflecting the commencement of service as Chairman of the Strategy Committee on November 1, 2006), with the remainder vesting at a rate of 10,000 shares on the first day of each month commencing January 1, 2007 through May 1, 2007 so long as Mr. Barrenechea is serving as the Chairman of the Strategy Committee.  The option will accelerate upon a “Change in Control” as defined in the 2003 Incentive Plan.  The option has a ten-year life, subject to continuous service to the Company.

Compensation of Executive Officers

Our executive officers serve at the discretion of the Board of Directors. From time to time, the Compensation Committee of the Board of Directors reviews and determines the salaries that are paid to our executive officers. The following table sets forth the annual salary rates for our current executive officers as of the date of this report on Form 10-Q:

Scott McClendon	$	395,000
W. Michael Gawarecki	$	246,500
Christie Huff	$	195,000
Michael S. Kerman	$	225,000
Vernon A. LoForti	$	297,750
Robert J. Scroop	$	220,500

Employment Arrangements with Current Executive Officers

The following discussion summarizes the employment arrangements between us and our current executive officers as of the date of this report on Form 10-Q:

Scott McClendon.   On November 1, 2006, the Board appointed Mr. McClendon as our Interim President and Chief Executive Officer effective immediately. The Compensation Committee has approved a compensation package for Mr. McClendon that consists of a monthly salary of $32,916.67. The base salary is equivalent to the base salary earned by Christopher Calisi at the time of his departure. Mr. McClendon will also be entitled to participate in the company’s employee benefit plans. Mr. McClendon will not receive fees paid to the company’s non-employee directors or the Chairman of the Board fee while serving as Interim President and Chief Executive Officer.

On December 20, 2006, in connection with his appointment as our Interim President and Chief Executive Officer, Mr. McClendon received an option to purchase up to 75,000 shares of the Company’s common stock at the purchase price of $4.29 per share (the closing price of the Company’s common stock on the date of grant) pursuant to the 2003 Incentive Plan.  The option is immediately vested as to 6,250 shares (reflecting the commencement of service as interim President and Chief Executive Officer on November 1, 2006), with the remainder vesting at a rate of 6,250 shares on the first day of each month commencing January 1, 2007 through November 1, 2007, so long as Mr. McClendon is providing services to the Company.  The option will accelerate upon a “Change in Control” as defined in the Incentive Plan.  The option has a ten-year life, subject to continuous service to the Company.

W. Michael Gawarecki.   Mr. Gawarecki, our Vice President of Operations is an at-will employee and may be terminated by us for any reason, with or without notice.  Mr. Gawarecki currently earns an annual salary of $246,500.

Christie Huff.  Ms. Huff, our Vice President of Worldwide Marketing, is an at-will employee and may be terminated by us for any reason, with or without notice.  Ms. Huff currently earns an annual salary of $195,000 per year.

Michael S. Kerman.  Mr. Kerman, our Vice President and General Manager of the Appliance Business Unit, is an at-will employee and may be terminated by us for any reason, with or without notice.  Mr. Kerman currently earns an annual salary of $225,000 per year.

Vernon A. LoForti.  We entered into an employment agreement with Mr. LoForti on December 4, 2000, pursuant to which Mr. LoForti is employed as our Vice President and Chief Financial Officer. The employment agreement has a one-year term, automatically renews for successive one-year terms, and provides that our Board may unilaterally modify Mr. LoForti’s compensation at any time.  If we terminate Mr. LoForti’s employment without cause, then we are obligated to pay him a severance payment equal to his base salary, payable on a pro-rated basis according to our normal payroll cycle for the 12 months following his termination. In addition, he is entitled to receive accelerated vesting for any stock options that would otherwise have vested during the 12-month period following his termination. He is also entitled to receive the cash severance payment if he resigns for good reason because of any of the following events: (i) reduction in compensation of more than 10%; (ii) change in position or duties so that his duties are no longer consistent with his previous position; or (iii) change in principal place of work to more than 50 miles from our current facility without his approval.  Mr. LoForti currently earns a salary of $297,750 per year.

Robert J. Scroop.  Mr. Scroop, our Vice President, New Product Delivery (formerly known as our Vice President, Engineering), is an at-will employee and may be terminated by us for any reason, with or without notice.  Mr. Scroop currently earns an annual salary of $220,500 per year.  Mr. Scroop’s title changed in January 2007 to encompass his expanded role managing operations for all activities on new product programs.  Mr. Scroop continues to be responsible for our engineering team.

Stock Option Acceleration Program

In July 2005, our Board of Directors approved the accelerated vesting of all unvested stock options, held by the company’s officers and employees, with an exercise price at or above $12.00 per share, effective July 3, 2005. The stock option acceleration program does not apply to stock options held by our non-employee directors. The accelerated options were issued under the 2000 Stock Option Plan, the 2001 Supplemental Stock Option Plan and the 2003 Incentive Plan.  In connection with the acceleration of vesting of options held by our executive officers, each executive officer agreed not to sell or transfer any shares subject to accelerated vesting until the original vesting date would have occurred based on the original vesting schedule (without giving effect to any future termination of service). The primary purpose of the accelerated vesting was to eliminate future stock-based employee compensation expense.

Retention Agreements

We entered into retention agreements with Messrs. LoForti, Scroop and Gawarecki effective January 27, 2000, with Mr. Kerman effective August 30, 2004 and with Ms. Huff effective September 14, 2005.   These agreements provide that the officer will receive a severance payment if, within two years of the consummation of a change in control of Overland, he or she is terminated without cause or resigns with good reason. These severance payments are based on the officer’s base salary at the time of the consummation of the change in control or the termination date, whichever is higher, plus his or her target bonus for the year prior to the consummation of the change in control. The agreements provide that, upon a change in control, Mr. LoForti would be entitled to receive an amount equal to 2.0 times his base salary plus target bonus; and Ms. Huff, and Messrs. Gawarecki, Kerman, and Scroop each would be entitled to an amount equal to his or her respective base salary plus target bonus. If any portion of any payment under any of the agreements would constitute an “excess parachute payment” within the meaning of Section 280G of the Internal Revenue Code, then that payment will be reduced to an amount that is one dollar less than the threshold for triggering the tax imposed by Section 4999 of the Internal Revenue Code.

EX-31.1

Exhibit 31.1

Certifications

I, Scott McClendon, certify that:

1.I have reviewed this Form 10-Q of Overland Storage, Inc.;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: February 2, 2007

/s/ Scott McClendon

Scott McClendon,

Interim President and Chief Executive Officer

(Principal Executive Officer)

EX-31.2

Exhibit 31.2

Certifications

I, Vernon A. LoForti, certify that:

1.I have reviewed this Form 10-Q of Overland Storage, Inc.;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: February 2, 2007

/s/ Vernon A. LoForti

Vernon A. LoForti,

Vice President and Chief Financial Officer

(Principal Financial Officer)

EX-32.1

Exhibit 32.1

CERTIFICATION REQUIRED BY

SECTION 1350 OF TITLE 18 OF THE UNITED STATES CODE

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, each of the undersigned hereby certifies in his capacity as an officer of Overland Storage, Inc. (the Company) that, to the best of his knowledge, the quarterly report of the Company on Form 10-Q for the fiscal quarter ended December 31, 2006 fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934, and that the information contained in such report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods presented in the financial statements included in such report.

Dated: February 2, 2007

/s/ Scott McClendon

Name: Scott McClendon

Title: Interim President and Chief Executive Officer (Principal Executive Officer)

Dated: February 2, 2007

/s/ Vernon A. LoForti

Name: Vernon A. LoForti

Title: Vice President and Chief Financial Officer (Principal Financial Officer)

A signed original of this written statement required by Section 906 has been provided to Overland Storage, Inc. and will be retained by Overland Storage, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.