Fiscal 2005 was a year of many challenges, and there is no doubt that fiscal 2006 will be a building year for Overland Storage. We have outlined a strategy for 2006 that will refresh our entire product line, add new products, put us into new markets, and position us for future growth.

The recent announcement by HP that it intends to purchase its next generation mid-range tape automation product line from an alternate supplier presents a formidable challenge. At the same time, it presents an incredible opportunity. In fiscal 2005, HP represented 54 percent of our revenue, and it will be difficult to replace that revenue. We estimate that we have about a year before the HP revenue begins a steep decline. That is why our strategy to invest in new products in fiscal 2006 is so important. By the end of fiscal 2006 we should be shipping all of these new products and the ramp of sales will already be in progress to minimize the HP revenue erosion in fiscal 2007.

We now have a unique opportunity to completely transform our financial model. For more than 10 years Overland has had the luxury and the burden of having a single large OEM customer that represented a majority of our revenue. The resulting dependence has been a cause of concern for both management and investors, and the low gross margins on that business have depressed our overall gross margin. Our strategy is to replace that revenue with sales at significantly higher margins generated by our powerful branded channel, selling to new and existing customers. Although we will spend a higher percentage of revenue on sales and marketing, it will be funded by the higher gross margins and ultimately will improve our bottom line.

Admittedly, there is risk in our strategy, though we believe it is manageable. We are in development of a completely new tape automation platform, we’ve just completed the acquisition of Zetta Systems, and we are working to integrate its software into our new primary storage offering. We are also developing a scalable version of our REO backup and recovery appliance. When these developments are complete, we will launch the new products with the intent of a quick sales ramp. Regarding our new tape development, Overland possesses one of the best tape R&D teams in the entire industry. We are extremely confident in their abilities and they are on schedule. During most of fiscal 2005, we searched for an acquisition that would enable us to enter the primary storage market. Our due diligence with Zetta was significant and resulted in our firm belief that their software is the right engine for ULTAMUS, our new protected primary storage appliance. The Zetta development team, though small, is extremely experienced and is already working well with both product management and our REO development team. We have invested and continue to dedicate resources to train our sales team and our VAR partners on our new products. And, best of all, our customers are requesting these products.

Overland’s board of directors and the entire management team strongly back this strategy. We have a healthy cash position and no debt, factors that will enable us to focus on the task at hand. We fully understand that crisp execution will lead to the success of this strategy.

Last, I want to thank the entire Overland team that has worked so hard over the last year to get us through a successful SOX404 audit. Our auditors have issued a clean opinion on both our 2005 financial statements and our system of internal controls. Although the cost of this achievement was extremely burdensome, we are pleased to now have a documented system of strong controls that reflect the historic culture of financial conservatism and high ethical values that is and always will be Overland Storage.

Sincerely,

VERN LOFORTI
Chief Financial Officer
Overland Storage, Inc.