UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2010

Commission file number 000-12230

BAKBONE SOFTWARE INCORPORATED

(Exact name of Registrant as specified in its charter)


Canada		Not applicable
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

9540 Towne Centre Drive, Suite 100 San Diego, California		92121
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (858) 450-9009

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 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 ¨

Indicate by a check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

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

Large accelerated filer ¨

Accelerated filer ¨

Non-accelerated filer ¨

Smaller reporting company x

(Do not check if a smaller

reporting company)

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

As of July 30, 2010 there were approximately 80,534,601 shares of the registrant’s common stock outstanding.

BAKBONE SOFTWARE INCORPORATED

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2010


PART I. FINANCIAL INFORMATION		3

Item 1.	Financial Statements	3

	Consolidated Balance Sheets as of June 30, 2010 (unaudited) and March 31, 2010	3

	Unaudited Consolidated Statements of Operations for the three months ended June 30, 2010 and 2009	4

	Unaudited Consolidated Statements of Cash Flows for the three months ended June 30, 2010 and 2009	5

	Notes to Consolidated Financial Statements (unaudited)	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	21

Item 4T.	Controls and Procedures	21

PART II. OTHER INFORMATION		21

Item 1.	Legal Proceedings	21

Item 1A.	Risk Factors	21

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	28

Item 3.	Defaults Upon Senior Securities	28

Item 4.	(Removed and Reserved)	28

Item 5.	Other Information	28

Item 6.	Exhibits	29

	Signatures	30

	Exhibit 10.1

	Exhibit 10.2

	Exhibit 10.3

	Exhibit 10.4

	Exhibit 10.5

	Exhibit 10.6

	Exhibit 31.1

	Exhibit 32.1

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

BAKBONE SOFTWARE INCORPORATED

CONSOLIDATED BALANCE SHEETS

(in thousands)


	June 30, 2010			March 31, 2010
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	4,883		$	4,903
Restricted cash		51			51
Accounts receivable, less allowances for doubtful accounts and sales returns of $87 at June 30, 2010 and $78 at March 31, 2010		8,619			10,582
Prepaid expenses		483			490
Other assets		923			249

Total current assets		14,959			16,275
Property and equipment, at cost		7,699			7,676
Less accumulated depreciation		(5,980	)		(5,656	)

Property and equipment, net		1,719			2,020
Intangible assets, net		1,642			1,814
Goodwill		7,615			7,615
Other assets		440			946

Total assets	$	26,375		$	28,670

LIABILITIES AND SHAREHOLDERS’ DEFICIT
Current liabilities:
Accounts payable	$	2,250		$	1,841
Accrued liabilities		6,297			6,101
Current portion of acquisition consideration payable		2,369			809
Current portion of deferred revenue		44,641			44,337

Total current liabilities		55,557			53,088
Deferred revenue, excluding current portion		43,432			44,840
Acquisition consideration payable, excluding current portion		4,101			6,037
Other liabilities		599			697

Total liabilities		103,689			104,662

Commitments and contingencies (Note 5)
Shareholders’ deficit:
Series A convertible preferred stock, no par value, 22,000 shares authorized at June 30, 2010, and March 31, 2010, 18,000 shares issued and outstanding at June 30, 2010 and March 31, 2010, liquidation preference of $25,754 and $26,491, respectively		11,160			11,160
Share capital, no par value, unlimited shares authorized, 80,535 and 77,642 shares issued and outstanding at June 30, 2010 and March 31, 2010, respectively		160,148			159,940
Employee benefit trust		(5	)		(8	)
Accumulated deficit		(242,412	)		(242,409	)
Accumulated other comprehensive loss		(6,205	)		(4,675	)

Total shareholders’ deficit		(77,314	)		(75,992	)

Total liabilities and shareholders’ deficit	$	26,375		$	28,670

See accompanying notes to consolidated financial statements.

BAKBONE SOFTWARE INCORPORATED

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)


	Three months ended June 30,
	2010			2009
Revenues:
License and service	$	13,983		$	15,100
Other		—			1,500

		13,983			16,600
Cost of revenues		1,426			1,345

Gross profit		12,557			15,255

Operating expenses:
Sales and marketing		5,860			6,536
Research and development		2,343			2,828
General and administrative		3,330			4,215

Total operating expenses		11,533			13,579

Operating income from continuing operations		1,024			1,676
Interest income		3			4
Interest expense		(211	)		(141	)
Foreign exchange loss, net		(4	)		(246	)

Income before income taxes and discontinued operations		812			1,293
Provision for income taxes		9			25

Income from continuing operations		803			1,268
Loss from discontinued operations, net		(806	)		(577	)

Net (loss) income	$	(3	)	$	691

Basic net (loss) income per common share:
Income from continuing operations	$	0.01		$	0.02

Loss from discontinued operations	$	(0.01	)	$	(0.01	)

Net (loss) income	$	(0.00	)	$	0.01

Diluted net (loss) income per common share:
Income from continuing operations	$	0.01		$	0.01

Loss from discontinued operations	$	(0.01	)	$	(0.00	)

Net (loss) income	$	(0.00	)	$	0.01

Weighted-average common shares outstanding:
Basic		86,328			76,747

Diluted		86,328			94,819

See accompanying notes to consolidated financial statements.

BAKBONE SOFTWARE INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)


	Three months ended June 30,
	2010			2009
Cash flows from operating activities:
Net (loss) income	$	(3	)	$	691
Adjustments to reconcile net (loss) income to net cash provided by operating activities from continuing operations:
Loss from discontinued operations		806			577
Depreciation and amortization		465			447
Non-cash interest expense		185			125
Stock-based compensation		134			12
Operating expenses funded by financing arrangement		55			103
Bad debt expense		26			—
Loss on disposal of capital assets		6			6
Changes in assets and liabilities, net of effects from acquisition of ColdSpark, Inc:
Accounts receivable		1,733			1,344
Prepaid expenses and other assets		(171	)		(68	)
Accounts payable		444			(125	)
Accrued and other liabilities		102			329
Deferred revenue		(2,510	)		(3,257	)

Net cash provided by operating activities of continuing operations		1,272			184

Cash flows from investing activities:
Cash paid for acquisitions, net of cash acquired		—			(1,014	)
Capital expenditures		(89	)		(67	)
Payments to ColdSpark shareholders		(476	)		—

Net cash used in investing activities of continuing operations		(565	)		(1,081	)

Cash flows from financing activities:
Payments on capital lease obligations		(8	)		(74	)
Payments on long term debt obligations		(69	)		(224	)

Net cash used in financing activities of continuing operations		(77	)		(298	)

Cash flows from discontinued operations
Net cash used in operating activities of discontinued operations		(752	)		(274	)
Net cash used in financing activities of discontinued operations		(21	)		(2	)

Net cash used in discontinued operations		(773	)		(276	)
Effect of exchange rate changes on cash and cash equivalents		123			500

Net decrease in cash and cash equivalents		(20	)		(971	)
Cash and cash equivalents, beginning of period		4,903			8,398

Cash and cash equivalents, end of period	$	4,883		$	7,427

Cash paid during the period for:
Interest	$	2		$	13
Income taxes	$	48		$	42
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Equipment acquired under capital leases	$	—		$	12
Capital expenditures included in accounts payable at end of period	$	6		$	74

See accompanying notes to consolidated financial statements.

BAKBONE SOFTWARE INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1.	The Company

BakBone Software Incorporated (“BakBone” or the “Company”), a Canadian federal company, is a leading provider of data protection, retention and availability technologies that reduce storage management complexity. In May 2010, the Company decided to close its Message Management division.

Effective with the closing of the Company’s Message Management division, BakBone operates in one reporting segment: Storage Management, which sells the NetVault products and solutions. During fiscal 2010, the Company operated two reporting segments: (i) Storage Management, which sells the NetVault products and solutions and (ii) Message Management, which sells ColdSpark’s SparkEngine, MailFusion and Compliance Catalyst families of products and solutions. The Company has operations in three primary geographic regions: North America, Asia-Pacific, and Europe, Middle East and Africa, or EMEA, and conducts commercial operations primarily through three of its respective wholly-owned subsidiaries: BakBone Software, Inc., BakBone Software KK, and BakBone Software Ltd.

2.	Basis of Presentation

The accompanying consolidated balance sheet at June 30, 2010, the consolidated statements of operations and cash flows for the three months ended June 2010 and 2009, have been prepared by the Company and have not been audited. These financial statements should be read in conjunction with the financial statements and notes thereto for the fiscal year ended March 31, 2010 included in the Company’s Annual Report on Form 10-K.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information, in accordance with the instructions to Form 10-Q and the guidance in Article 10 of Regulation S-X. Accordingly, since they are interim financial statements, the accompanying unaudited consolidated financial statements do not include all of the information and disclosures required by U.S. GAAP for complete financial statements. The accompanying unaudited consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, that are, in the opinion of management, necessary for a fair statement of the results of operations for the interim periods presented. Interim operating results are not necessarily indicative of operating results for the full year.

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. The Company operates and reports using a fiscal year end of March 31.

Significant Customers

As of and during the three months ended June 30, 2010, the Company had no customers with accounts receivable or revenue balances that comprised more than 10% of the Company’s consolidated accounts receivable or revenue balances. As of June 30, 2009, the Company had accounts receivable balances from one customer representing 17% of consolidated accounts receivable. During the three months ended June 30, 2009, the Company had one customer that comprised 11% of consolidated revenues.

Subsequent Events

The Company evaluated all events or transactions that occurred after the balance sheet date of June 30, 2010 through the date it issued these financial statements. No subsequent events were identified requiring additional disclosure in the notes to these financial statements.

3.	Significant Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions made by management include the allowance for doubtful accounts, the accounting for income taxes including the future realizability of our deferred tax assets, the accounting for business combinations, and the determination of the estimated useful life of our software for purposes of revenue recognition amortization. Estimates have been prepared on the basis of the most current and best available information and actual results could differ from those estimates.

Revenue Recognition

The Company derives revenues from software licenses, maintenance services, and professional services from three distinct groups of customers: resellers, OEMs, and direct end users.

The Company commences recognizing revenue under these arrangements when all of the following are met:

•

Persuasive Evidence of an Arrangement Exists. It is the Company’s practice to require a contract signed by both the partner and the Company and/or a customer-issued purchase order depending on the underlying facts and circumstances of the business relationship.

•

Delivery Has Occurred. The Company delivers software by both physical and electronic means. Both means of delivery transfer title and risk to the customer. Physical delivery terms are generally FOB shipping point. For electronic delivery of the software, delivery is complete when the customer has been provided electronic access to the software. Certain of the Company’s arrangements contain customer acceptance provisions. Under these arrangements, revenue recognition commences once the acceptance provisions have been satisfied.

•

The Vendor’s Fee is Fixed or Determinable. Fees are generally considered fixed and determinable when payment terms are within the Company’s standard credit terms.

•

Collectability is Probable. Customers must meet collectability requirements pursuant to the Company’s credit policy. For contracts that do not meet the Company’s collectability criteria, fees earned are deferred initially and recognized in accordance with its revenue policy once payment is received from the customer.

The Company’s customers are not contractually permitted to return products, but the Company accepts returns under certain circumstances. The Company accounts for potential returns from its reseller and OEM customers using historical returns experience with these customers to determine potential returns and to establish the appropriate sales returns allowance.

Sales incentives or other consideration given by the Company to its customers that are considered adjustments of the selling price of the Company’s products, such as rebates, are generally reflected as reductions to revenue.

Sales tax collected by the Company from its customers is not reported in revenue.

Storage Management Division

The Company licenses its software to its reseller customers under multiple-element arrangements involving a combination of software, post-contract support and/or professional services. Post-contract support includes rights to unspecified upgrades and enhancements and telephone support. Professional services include services related to implementation of the Company’s software as well as training. Software license arrangements with resellers include implicit platform transfer rights, which allow end users to exchange an original product for a different product or to exchange an original product on one platform for the same product operating on a different platform. The new product and/or different platform is not specified in the arrangement nor is the period of time in which the customer has to exercise this right. We have also historically provided our customers with a range of product concessions and other services which are not explicitly provided for in our sales arrangements. As no contract period exists under these arrangements, software-related revenue is recognized ratably over the estimated economic useful life of the software product of four years.

The economic useful life of the software product is estimated to be four years based upon the Company’s version release and end of life data, as well as Company practice with respect to supporting the product. The Company weighted the product useful life and its years of sustaining support following the end of life to determine the estimated economic useful life of the software product.

Maintenance renewal fees are recognized ratably over the arrangement period, which is typically one year. Professional services may also be sold separately and all fees generated from stand-alone sales of professional services are recognized when the service is complete.

The Company has multiple-element arrangements with OEM customers and one large direct customer under which, in addition to providing software licenses and maintenance services, the Company has a commitment to provide unspecified future software products. As vendor specific objective evidence of fair value cannot be determined for the unspecified future software products, all sales amounts procured under these arrangements are deferred and recognized ratably over the arrangement period.

Business Combinations

The Company accounts for business combinations by recognizing the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. The purchase price allocation process requires management to make significant estimates and assumptions, especially at acquisition date with respect to intangible assets, estimated contingent consideration payments and pre-acquisition contingencies. Examples of critical estimates in valuing certain of the intangible assets we have acquired or may acquire in the future include but are not limited to:

•

future expected cash flows from product sales, support agreements, consulting contracts, other customer contracts, acquired developed technologies and patents; and

•

discount rates.

Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results. Additionally, any change in the fair value of the acquisition-related contingent consideration subsequent to the acquisition date, including changes from events after the acquisition date, such as changes in our estimate of the bookings targets, will be recognized in earnings in the period of the estimated fair value change. A change in fair value of the acquisition-related contingent consideration could have a material effect on the statement of operations, financial position and cash flows in the period of the change in estimate.

Deferred Revenue

Deferred revenue represents software license, maintenance contract and professional services bookings, net of recognized revenue amounts. A majority of the Company’s sales transactions are deferred and recognized over the applicable period, generally three to five years.

Comprehensive Loss

Comprehensive loss is the total of net (loss) income and all other non-owner changes in shareholders’ deficit. The Company’s comprehensive loss combines net (loss) income and foreign currency translation adjustment. Comprehensive loss for the three months ended June 30, 2010 and 2009 is as follows:


	Three months ended June 30,
	2010			2009
Net (loss) income	$	(3	)	$	691
Foreign currency translation adjustment		(1,530	)		(3,075	)

Total comprehensive loss	$	(1,533	)	$	(2,384	)

The foreign currency translation adjustment each period represents the effect of the translation of assets and liabilities that are denominated in the functional currencies of foreign subsidiaries to the Company’s reporting currency. During the three months ended June 30, 2010, the foreign currency translation decrease of $1.5 million was related primarily to the translation of the Company’s assets and liabilities in its Asia-Pacific subsidiary as the U.S. dollar weakened against the Japanese yen during the period. During the three months ended June 30, 2009, the foreign currency translation decrease of $3.1 million was related primarily to the translation of the Company’s assets and liabilities in its EMEA subsidiary as the U.S. dollar weakened against the British pound during the period.

Net Income (Loss) Per Share

Basic net income (loss) per common share is computed by dividing the net income (loss) attributable to common shareholders for the period by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is computed by dividing the net income (loss) attributable to common shareholders for the period by the weighted average number of common shares and potential common shares outstanding during the period, except where the effect of including potential common shares would be antidilutive.

The following table summarizes potential common shares that are not included in the denominator used in the diluted net income (loss) per share calculation because to do so would be anti-dilutive (in thousands):


	Three months ended June 30,
	2010	2009
Stock options	8,478	5,474
Restricted stock units	18	—
Warrants	885	2,145
Unallocated shares held in EBT	23	23
Series A convertible preferred stock	18,000	—

Total anti-dilutive instruments	27,404	7,642

4.	Discontinued Operations

In May 2010, the Company decided to close its Message Management division and cease operations. As a result, the results of

operations and cash flows related to the division have been classified as discontinued operations in the consolidated financial statements for all periods presented and the prior period comparative financial statements have been reclassified to conform to the current period presentation.

The following represents the results of the Company’s discontinued operations:


	Three months ended June 30,
(in thousands)	2010			2009
Revenues	$	162		$	90
Expenses		(968	)		(667	)

Loss from discontinued operations	$	(806	)	$	(577	)

At June 30, 2010, the assets and liabilities of discontinued operations primarily represent residual amounts of receivables, property and equipment, liabilities and deferred revenue related to the division which was closed. The assets and liabilities of discontinued operations are included in the balances on the face of the Company’s consolidated balance sheets. Additional detail related to the assets and liabilities of the Company’s discontinued operations is as follows:


(in thousands)	June 30, 2010		March 31, 2010
Assets of Discontinued Operations
Accounts receivable	$	66	$	148
Other current assets		39		63

Total current assets		105		211
Property and equipment, net		28		54
Other non-current assets		—		12

Total assets	$	133	$	277


Liabilities of Discontinued Operations
Accounts payable and accrued liabilities	$	584	$	613
Deferred revenue, current		515		513

Total current liabilities		1,099		1,126
Deferred revenue, non-current		—		77
Other non-current liabilities		2		8

Total liabilities	$	1,101	$	1,211

5.	Commitments and Contingencies

In the normal course of business, the Company may be involved in various claims, negotiations and legal actions; however, as of June 30, 2010, the Company is not party to any litigation that is expected to have a material effect on the Company’s financial position, results of operations or cash flows.

6.	Shareholders’ Deficit

During the three months ended June 30, 2010, the remaining 75,000 restricted stock units vested pursuant to the vesting conditions of an outstanding restricted stock unit award. In connection with the vesting of the restricted stock units, the Company issued 45,000 shares. The remaining 30,000 restricted stock units were settled in cash pursuant to the contingent cash-settlement conditions of the amended award. A summary of the change in restricted stock unit awards during the three months ended June 30, 2010 is as follows:


	Number of shares
Unvested at March 31, 2010	75,000
Awarded	—
Vested	(75,000	)
Forfeited	—

Unvested at June 30, 2010	—

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Special Note About Forward-Looking Statements

This Quarterly Report, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 and the Securities Exchange Act of 1934. These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. We use words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “goal,” “intend,” “may,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would,” variations of such words, and similar expressions to identify forward-looking statements. In addition, statements that refer to projections of earnings, revenue, costs or other financial items; anticipated growth and trends in our business or key markets; future growth and revenues from our products; anticipated performance of products or services; plans, objectives and strategies for future operations; and other characterizations of future events or circumstances, are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements.

The following discussion should be read in conjunction with our consolidated financial statements and related notes and other financial information appearing elsewhere in this Form 10-Q. Readers are also urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business, including, without limitation, the disclosures, made under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors,” and the audited consolidated financial statements and related notes included in our Form 10-K for the fiscal year ended March 31, 2010 and other reports and filings made with the Securities and Exchange Commission. Risks that could cause actual results to differ from those contained in the forward-looking statements include, but are not limited to risks related to: weak economic and market conditions that could result in further reductions in spending on information technology products; costs and distractions associated with our exiting of the ColdSpark Message Management business; effects of the transition of our senior management team; competition in our target markets; potential capital needs; management of future growth and expansion; the development, implementation and execution of our Integrated Data Protection strategic vision; customer acceptance of our existing and newly introduced products and fee structures; the success of our brand development efforts; and other risks identified elsewhere in this Quarterly Report and in our most recent reports on Forms 10-K and 8-K. We assume no obligation to update any forward-looking statement to reflect events or circumstances arising after the date on which it was made, other than as required under applicable securities laws.

Overview

We are a leading provider of data protection, retention and availability technologies that reduce storage management complexity. We develop, market, sell and support a portfolio of products sold globally under the NetVault brand name. Our products include award-winning Linux solutions, application-focused solutions to protect the Windows environment, and unique solutions to leverage emerging disk-based and virtual environments. Our products provide protection for the applications that drive the business computing environments such as Microsoft SQL Server, Oracle, Microsoft Exchange, MySQL, Lotus Notes and others. The object-oriented design of our products allows them to be flexibly installed in complex, multi-platform environments, providing users with a consistent look-and-feel across all platforms. The current NetVault portfolio of products provides customers with:

•

Enterprise data protection, including backup and recovery;

•

Long-term data retention capabilities;

•

Disaster recovery of data and systems as well as application failover;

•

Global replication of data;

•

Storage resource management and reporting; and

•

Application resource reporting and discovery.

In May 2010, we closed our Message Management division. The division is reported in discontinued operations in the accompanying consolidated financial statements. As a result of closing our Message Management division, we operate one reporting segment: Storage Management, which sells the NetVault products and solutions. We have operations in three primary geographic regions: North America, Asia-Pacific, and Europe, Middle East and Africa, or EMEA, and conduct commercial operations primarily through three of our respective wholly-owned subsidiaries: BakBone Software, Inc., and BakBone Software KK, BakBone Software Ltd.

The following table summarizes consolidated revenues from continuing operations and revenues of each region on an absolute dollar basis and as a percentage of total consolidated revenues (in thousands):


	Three months ended June 30,
	2010			2009
Consolidated revenues, net	$	13,983		$	16,600
North America	$	4,415		$	7,085
As a percentage of consolidated revenues		31	%		43	%
Asia-Pacific	$	5,551		$	5,559
As a percentage of consolidated revenues		40	%		33	%
EMEA	$	4,017		$	3,956
As a percentage of consolidated revenues		29	%		24	%

In addition, we had consolidated deferred revenue balances, attributable to our continuing operations, as follows (in thousands):


	As of June 30, 2010		As of March 31, 2010
Consolidated deferred revenue	$	87,558	$	88,587

The following table summarizes the change in our consolidated deferred revenue balance attributable to our continuing operations, for the three months ended June 30, 2010:


Deferred revenue balance at March 31, 2010	$	88,587
Consolidated bookings for the three months		11,473
Consolidated revenue for the three months		(13,983	)
Foreign exchange impact		1,481

Deferred revenue balance at June 30, 2010	$	87,558

Revenues for the three months ended June 30, 2010 were $14.0 million, approximately $2.6 million, or 16%, lower than the $16.6 million in revenues during the three months ended June 30, 2009. Bookings for the three months ended June 30, 2010 were $11.5 million, approximately $2.1 million, or 15%, lower than the $13.6 million in bookings during the three months ended June 30, 2009. Our bookings for the three months ended June 30, 2009 included a $1.5 million contribution from the sale of non-core intellectual property rights to an OEM customer. Excluding this item, bookings during the three months ended June 30, 2010 decreased 4% as compared to bookings during the three months ended June 30, 2009.

Operating income from continuing operations totaled $1.0 million during the three months ended June 30, 2010 as compared to $1.7 million during the three months ended June 30, 2009. Excluding the non-recurring contribution from the sale of non-core IP in the three months ended June 30, 2009, our operating income from continuing operations increased by $0.9 million. Our operating expenses from continuing operations decreased $2.1 million, or 15%, to $11.5 million during the three months ended June 30, 2010 as compared to $13.6 million during the three months ended June 30, 2009. The decrease in operating expenses from continuing operations was the result of lower accounting and professional fees as well as strategic cost reductions across most operating functions. We reported a net loss of $3,000, or $0.00 per share, compared with net income of $691,000, or $0.01 per share, in the first quarter of the prior fiscal year.

While we expect the near term market conditions to be challenging, we believe the need for organizations to protect, recover, maintain and manage their data will require our current customers, as well as new customers, to invest in their infrastructure. As a result, we intend to continue to prudently invest in our business, through continued product development and sales and marketing efforts. The predictability of bookings for existing products remains uncertain due to the economic environment.

Portions of our Asia-Pacific revenues are currently denominated in U.S. dollars. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our product more expensive and, therefore, potentially less competitive in those markets. A majority of our international business is presently conducted in currencies other than the U.S. dollar. Foreign currency transaction gains and losses arising from normal business operations are credited to or charged against earnings in the period incurred. As a result, fluctuations in the value of the currencies in which we conduct our business relative to the U.S. dollar will cause currency transaction gains and losses. Due to the volatility of currency exchange rates, among other factors, we cannot predict the effect of exchange rate fluctuations upon future operating results and we could experience currency losses in the future. We have not previously undertaken hedging transactions to cover currency exposure, and we do not currently intend to engage in hedging activities.

Cost of revenues consists of the direct cost of providing customer support, including payroll and other benefits of staff working in our customer support departments, as well as associated costs of computer equipment, telephone and other general costs necessary to maintain support for our end users. Also included in cost of revenues are third party software license royalties, third party professional service costs and the direct costs of products delivered to customers.

Sales and marketing expenses consist primarily of employee payroll and other benefits, commissions, trade show costs, web advertising and travel costs for our worldwide sales and marketing staff. Commissions are part of our sales personnel compensation package, which is based on the procurement of sales orders and subsequent collection of customer receivables. As we expand our sales and marketing force, we expect sales and marketing expenses to increase.

Research and development expenses consist primarily of salary and related costs for our worldwide engineering staff. We have engineering personnel in our Poole, United Kingdom, San Diego, California, Santa Clara, California, and Novosibirsk, Russia offices that are responsible for the development effort of our NetVault products and our application plug-in modules.

General and administrative expenses include salaries and benefits for our corporate personnel and other expenses, such as facilities costs and professional services.

As part of the process of preparing our consolidated financial statements, we are required to estimate our provision for income taxes in each of the tax jurisdictions in which we do business. This process involves estimating our actual current tax expense in conjunction with the evaluation and measurement of temporary differences resulting from differing treatment of certain items for tax and financial accounting purposes. These temporary differences result in the establishment of deferred tax assets and liabilities, which are presented on a net basis. We assess on a periodic basis the probability that our net deferred tax assets will be recovered. In performing this assessment, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which the temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income, our ability to deduct tax loss carryforwards against future taxable income, and tax planning strategies among the various tax jurisdictions that we do business in when making this assessment. As of June 30, 2010 we have determined that it is not more likely than not that our deferred tax assets will be realized. Accordingly, we have recorded a valuation allowance for our net deferred tax assets and have not recorded a benefit for income taxes.

Our provision for income taxes is comprised of federal, state, and foreign income taxes. Our federal, state and foreign income taxes relate to income generated in the various tax jurisdictions in which we do business. We also recognize estimated tax liabilities for any tax positions we have taken which are not more likely than not to be sustained upon examination by the applicable taxing authority. The final payment of the amounts related to these uncertainties may ultimately prove to be less than or greater than our estimate. If this occurs we would record either a benefit or a charge to our income tax provision.

Application of Critical Accounting Policies

The preparation of our financial statements in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, valuation allowance for deferred tax assets, valuation of goodwill and stock-based compensation expense. 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.

We believe there are several accounting policies that are critical to understanding our historical and future performance. These policies affect the reported amounts of revenue and other significant areas that involve management’s judgments and estimates. These significant accounting policies are:

•

revenue recognition;

•

valuation allowance for deferred tax assets;

•

valuation of goodwill; and

•

stock-based compensation expense.

These policies, and our procedures related to these policies, are described below.

Revenue Recognition

We derive revenues from software licenses, maintenance services, and professional services from three distinct groups of customers: resellers, OEMs, and direct end users.

We commence recognizing revenue under these arrangements when all of the following are met:

•

Persuasive Evidence of an Arrangement Exists. It is our practice to require a contract signed by both the partner and BakBone and/or a customer-issued purchase order depending on the underlying facts and circumstances of the business relationship.

•

Delivery Has Occurred. We deliver software by both physical and electronic means. Both means of delivery transfer title and risk to the customer. Physical delivery terms are generally FOB shipping point. For electronic delivery of the software, delivery is complete when the customer has been provided electronic access to the software. Certain of our arrangements contain customer acceptance provisions. Under these arrangements, revenue recognition commences once the acceptance provisions have been satisfied.

•

The Vendor’s Fee is Fixed or Determinable. Fees are generally considered fixed and determinable when payment terms are within our standard credit terms.

•

Collectability is Probable. Customers must meet collectability requirements pursuant to our credit policy. For contracts that do not meet our collectability criteria, fees earned are deferred initially and recognized in accordance with its revenue policy once payment is received from the customer.

Our customers are not contractually permitted to return products, but we accept returns under certain circumstances. We account for potential returns from our customers using historical returns experience with these customers to determine potential returns and to establish the appropriate sales returns allowance.

Sales incentives or other consideration given by BakBone to our customers are considered adjustments of the selling price of our products, such as rebates, and are generally reflected as reductions to revenue.

Storage Management Division

We license our software to our reseller customers under multiple-element arrangements involving a combination of software, post-contract support and/or professional services. Post-contract support includes rights to unspecified upgrades and enhancements and telephone support. Professional services include services related to implementation of our software as well as training. Software license arrangements with resellers include implicit platform transfer rights, which allow end users to exchange an original product for a different product or to exchange an original product on one platform for the same product operating on a different platform. The new product and/or different platform is not specified in the arrangement nor is the period of time in which the customer has to exercise this right. We have also historically provided our customers with a range of product concessions and other services which are not explicitly provided for in our sales arrangements. As no contract period exists under these arrangements, software-related revenue is recognized ratably over the estimated economic useful life of the software product of four years.

The economic useful life of the software product is estimated to be four years based upon our version release and end of life data as well as our practice with respect to supporting the product. We weighted the product useful life and its years of sustaining support following the end of life to determine the estimated economic useful life of the software product.

We have multiple-element arrangements with OEM customers and one large direct customer under which, in addition to providing software licenses and maintenance services, we have a commitment to provide unspecified future software products. As vendor specific objective evidence of fair value cannot be determined for the unspecified future software products, all sales amounts procured under these arrangements are deferred and recognized ratably over the arrangement period.

Valuation Allowance for Deferred Tax Assets

In preparing our consolidated financial statements, we estimate our income tax liability in each of the jurisdictions in which we operate by estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and financial statement purposes. These differences result in deferred tax assets and liabilities. Significant management judgment is required in assessing the realizability of our deferred tax assets. In performing this assessment, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income in each tax jurisdiction during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. In the event that actual results differ from our estimates or we adjust our estimates in future periods, we may need to reduce our valuation allowance, which could materially impact our financial position and results of operations.

Valuation of Goodwill and Long-Lived Assets

We have recorded goodwill and indefinite-lived intangible assets in connection with the acquisitions we have completed in prior periods. We review our goodwill and indefinite-lived intangible assets for impairment as of April 1^st of each fiscal year or when an event or a change in facts and circumstances indicates the fair value of a reporting unit may be below its carrying amount. Significant management judgment is required in assessing the impairment of our goodwill.

A reporting unit is an operating segment, or one unit below. Effective with the acquisition of ColdSpark in May 2009, we operated in two reporting segments: (i) Storage Management, which sells the NetVault products and solutions; and (ii) Message Management, which sells the ColdSpark SparkEngine, MailFusion and Compliance Catalyst families of products and solutions. Effective with the closing of our Message Management segment in May 2010, we operate in one reporting segment, Storage Management.

Events or changes in facts and circumstances that we consider as impairment indicators include but are not limited to the following:

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significant underperformance of our business relative to expected operating results;

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significant adverse economic and industry trends;

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significant decline in our market capitalization for an extended period of time relative to net book value; and

•

expectations that a reporting unit will be sold or otherwise disposed.

The annual goodwill impairment test consists of a two-step process as follows:

Step 1. We compare the fair value of each reporting unit to its carrying amount, including the existing goodwill. The fair value of each reporting unit is determined using a discounted cash flow valuation analysis. The carrying value of each reporting unit is determined by specifically identifying and allocating the assets and liabilities of BakBone to each reporting unit based on headcount, relative revenues, or other methods as deemed appropriate by management. If the carrying amount of a reporting unit exceeds its fair value, an indication exists that the reporting unit’s goodwill may be impaired and we then perform the second step of the impairment test. If the fair value of a reporting unit exceeds its carrying amount, no further analysis is required.

Step 2. If further analysis is required, we compare the implied fair value of the reporting unit’s goodwill, determined by allocating the reporting unit’s fair value to all of its assets and its liabilities in a manner similar to a purchase price allocation, to its carrying amount. If the carrying amount of the reporting unit’s goodwill exceeds its fair value, an impairment loss will be recognized in an amount equal to that excess.

Long-lived assets, such as property, plant, and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposal group classified as held-for-sale would be presented separately in the appropriate asset and liability sections of the balance sheet, if material.

Stock-Based Compensation Expense

Stock-based compensation expense is estimated at the grant date based upon the fair-value of the award and is recognized as expense using the straight-line amortization method over the requisite service period of the award, which is normally the vesting period. We estimate the fair value of stock options using the Black-Scholes option pricing model, which requires the input of certain highly subjective assumptions, including expected stock price volatility, expected term and expected forfeiture rates. A small change in the estimates used can result in a relatively large change in the estimated fair-value. We established the assumption for expected stock price volatility based on our historical stock price volatility. We estimated the expected term assumption for stock options using the Simplified Method. We estimate forward-looking forfeiture rates based upon our historical employee termination experience.

Results of Operations

Comparison of Results for the Three Months Ended June 30, 2010 and 2009

The following summarizes consolidated revenues from continuing operations and their percentage changes over the same period of the prior year (dollars in thousands):


	Three months ended June 30,
	2010		2009
Consolidated revenues, net	13,983		16,600
(Decrease) over same period of prior year	(16	)%
License and service revenues	13,983		15,100
(Decrease) over same period of prior year	(7	)%
Other revenues	—		1,500

REVENUES—LICENSE AND SERVICE

We define bookings as the gross dollars invoiced through the sale of software licenses, maintenance contracts and professional services. We utilize bookings information as an operations measure, but it is not intended to replace U.S. GAAP accounting. Under the ratable revenue recognition method, license bookings are recognized as revenue over the appropriate period (generally three to five years). In general, variations in revenues period-over-period are affected by the amortization of current and prior period license bookings. Accordingly, we believe that trends in current and historical bookings are key factors in analyzing our operating results.

On a worldwide basis, we sell our storage management products through two different sales channels: value-added resellers (“VAR”) and original equipment manufacturers and direct customers (“OEM”). VAR revenues are sourced from the sale of software licenses, related maintenance contracts and professional services through the reseller channel. Software licenses sold through the reseller channel do not generally involve customer-specific customization. OEM revenues are sourced from the sale of software licenses, related maintenance contracts and professional services sold through our OEM partners and to direct customers. Software licenses sold through the OEM channel generally involve customer-specific customization and are governed by specifically-negotiated contracts. OEM bookings and revenues are billed and collected centrally in North America in U.S. dollars and presented for each of our three regions based upon the region in which the direct customer is located. As such, OEM bookings and revenues are not impacted by foreign exchange movements to the degree that our VAR bookings and revenues are impacted.

VAR revenues. The following table summarizes VAR revenues by geographic region and their percentage changes over the same period of the prior year (dollars in thousands):


	Three months ended June 30,
	2010			2009
North America	$	3,377		$	3,933
(Decrease) over same period of prior year		(14	)%
Asia-Pacific	$	5,177		$	5,114
Increase over same period of prior year		1	%
EMEA	$	3,636		$	3,522
Increase over same period of prior year		3	%
Consolidated	$	12,190		$	12,569
(Decrease) over same period of prior year		(3	)%

VAR revenues in North America decreased by $0.6 million, or 14%, to $3.4 million for the three months ended June 30, 2010 compared to $3.9 million for the three months ended June 30, 2009. The decrease in revenues during the three months ended June 30, 2010 was primarily due to decreased license bookings in both the current and most recent prior periods.

VAR revenues in the Asia-Pacific region increased $63,000, or 1%, to $5.2 million for the three months ended June 30, 2010 compared to $5.1 million for the three months ended June 30, 2009. The increase in revenues during the three months ended June 30, 2010 was due to a 6% increase in the average Japanese yen to U.S. dollar exchange rate as compared to the three months ended June 30, 2009, which caused an approximate increase of $0.3 million in our Asia-Pacific revenues as reported in U.S. dollars. During the three months ended June 30, 2010, our functional currency revenues in Asia-Pacific decreased approximately $0.2 million primarily due to a single large transaction that was recognized as revenue entirely in fiscal 2010.

VAR revenues in EMEA increased $0.1 million, or 3%, to $3.6 million for the three months ended June 30, 2010 compared to $3.5 million for the three months ended June 30, 2009. During the three months ended June 30, 2010, EMEA’s functional currency revenues increased approximately $0.2 million, or 7%, due to increased license and maintenance and maintenance renewal bookings in prior periods. However, this increase was partially off-set by a weakening of the British pound during the three months ended June 30, 2010 as compared to the three months ended June 30, 2009. During the three months ended June 30, 2010, the average British pound to U.S. dollar exchange rate decreased 3% as compared to the three months ended June 30, 2009, causing an approximate decrease of $0.1 million in our EMEA revenues as reported in U.S. dollars.

VAR bookings. As discussed above, revenues are impacted by both current and prior period bookings. The information below summarizes VAR bookings by geographic region and their percentage changes over the same period in the prior year (dollars in thousands):


	Three months ended June 30,
	2010			2009
North America	$	2,190		$	2,773
(Decrease) over same period of prior year		(21	%)
Asia-Pacific	$	5,644		$	4,241
Increase over same period of prior year		33	%		—
EMEA	$	2,877		$	3,654
(Decrease) over same period of prior year		(21	%)
Consolidated	$	10,711		$	10,668
Increase over same period of prior year		—	%

VAR bookings in North America decreased $0.6 million, or 21%, to $2.2 million for the three months ended June 30, 2010 from $2.8 million for the three months ended June 30, 2009, primarily due to a decrease in the volume of new license bookings sold through our existing distribution channels.

VAR bookings in Asia-Pacific increased $1.4 million, or 33%, to $5.6 million for the three months ended June 30, 2010 from $4.2 million for the three months ended June 30, 2009. During the three months ended June 30, 2010, our functional currency license and maintenance bookings increased approximately $1.2 million, or 27%, primarily due to market growth in Japan. Additionally, during the three months ended June 30, 2010, the average Japanese yen to U.S. dollar exchange rate increased 6% as compared to the three months ended June 30, 2009 causing an approximate increase of $0.2 million in our Asia-Pacific bookings as reported in U.S. dollars.

VAR bookings in EMEA decreased $0.8 million, or 21%, to $2.9 million for the three months ended June 30, 2010 from $3.7 million for the three months ended June 30, 2009. During the three months ended June 30, 2010, our functional currency license and maintenance and maintenance renewal bookings decreased approximately $0.7 million, or 19%, primarily due to lower bookings in the United Kingdom and Germany, as a result of significant turnover of our sales representatives and the timing of certain significant maintenance renewal contracts. Additionally, during the three months ended June 30, 2010, the average British pound to U.S. dollar exchange rate decreased 3% as compared to the three months ended June 30, 2009, causing an approximate decrease of $0.1 million in our EMEA bookings as reported in U.S. dollars.

OEM revenues. The following table summarizes OEM revenues by geographic region and their percentage changes over the same period of the prior year (dollars in thousands):


	Three months ended June 30,
	2010			2009
North America	$	1,038		$	1,652
(Decrease) over same period of prior year		(37	%)
Asia-Pacific	$	375		$	445
(Decrease) over same period of prior year		(16	%)
EMEA	$	380		$	434
(Decrease) over same period of prior year		(12	%)
Consolidated	$	1,793		$	2,531
(Decrease) over same period of prior year		(29	%)

North America OEM revenues decreased $0.6 million, or 37%, to $1.0 million for the three months ended June 30, 2010 from $1.7 million for the three months ended June 30, 2009. The decrease in revenues is primarily the result of a decrease in current period and prior period bookings from three of our OEM partners.

Asia-Pacific OEM revenues decreased $70,000, or 16%, to $375,000 for the three months ended June 30, 2010 from $445,000 for the three months ended June 30, 2009. The decrease in revenues is primarily the result of a decrease in current period and prior period bookings from two of our OEM partners.

EMEA OEM revenues decreased $54,000, or 12%, to $380,000 for the three months ended June 30, 2010 from $434,000 for the three months ended June 30, 2009. The decrease in revenues is primarily the result of a decrease in current period and prior period bookings from three of our OEM partners.

OEM bookings. As discussed above, revenues are impacted by both current and prior period bookings. Included below is a summary of OEM bookings by geographic region and their percentage changes over the same period of the prior year (dollars in thousands):


	Three months ended June 30,
	2010			2009
North America	$	223		$	620
(Decrease) over same period of prior year		(64	%)
Asia-Pacific	$	339		$	333
Increase over same period of prior year		2	%
EMEA	$	200		$	357
(Decrease) over same period of prior year		(44	%)
Consolidated	$	762		$	1,310
(Decrease) over same period of prior year		(42	%)

North America OEM bookings decreased $0.4 million, or 64%, to $0.2 million for the three months ended June 30, 2010 from $0.6 million for the three months ended June 30, 2009. During the first quarter of fiscal 2010, we sold certain non-core intellectual property rights to one of our OEM partners. As a result, the bookings from this customer have significantly decreased as compared to the prior year. Additionally, we experienced a decrease in bookings from four of our other existing OEM partners.

Asia-Pacific OEM bookings remained consistent at $0.3 million during the three months ended June 30, 2010 and 2009. During the three months ended June 30, 2010, we experienced a decrease in bookings from one of our OEM partners which was off-set by an increase in bookings from another one of our OEM partners.

EMEA OEM bookings decreased $0.2 million, or 44%, to $0.2 million for the three months ended June 30, 2010 from $0.4 million for the three months ended June 30, 2009. During the three months ended June 30, 2010, we experienced a decrease in bookings related to three of our existing OEM partners.

Included below is a reconciliation of our VAR and OEM bookings to the total revenues recognized for the three months ended June 30, 2010 and 2009 (in thousands):


For the three months ended June 30, 2010	VAR			OEM			Total
Revenues sourced from current period bookings:
Total bookings for the three months ended June 30, 2010	$	10,711		$	762		$	11,473
Bookings deferred into subsequent periods		(10,019	)		(734	)		(10,753	)

Revenues from fiscal 2011 bookings		692			28			720
Revenues sourced from prior period bookings:		11,498			1,765			13,263

Total revenues recognized in the three months ended June 30, 2010	$	12,190		$	1,793		$	13,983


For the three months ended June 30, 2009	VAR			OEM			Total
Revenues sourced from current period bookings:
Total bookings for the three months ended June 30, 2009	$	10,668		$	1,310		$	11,978
Bookings deferred into subsequent periods		(9,794	)		(892	)		(10,686	)

Revenues from fiscal 2010 bookings		874			418			1,292
Revenues sourced from prior period bookings:		11,695			2,113			13,808

Total revenues recognized in the three months ended June 30, 2009	$	12,569		$	2,531		$	15,100

REVENUES—OTHER

During the three months ended June 30, 2009, we entered into an intellectual property transfer and license agreement with one of our OEM partners. Under the terms of this agreement we sold certain non-core intellectual property rights to this partner for $1.5 million. As our support commitment, as specified by the arrangement, was insignificant and no other obligation exists, the full contract amount was recognized as revenue during the three months ended June 30, 2009.

COST OF REVENUES

Cost of revenues for the three months ended June 30, 2010 totaled $1.4 million compared with cost of revenues of $1.3 million for the three months ended June 30, 2009. During the three months ended June 30, 2010, our gross margin decreased to 89.8% from 91.9 % for the three months ended June 30, 2009. The decrease in gross margin is primarily attributable to the decrease in revenues as a result of the intellectual property transfer and license agreement with one of our OEM partners, which was recognized during the three months ended June 30, 2009.

SALES AND MARKETING EXPENSES

Sales and marketing expenses decreased by $0.7 million, or 10%, to $5.9 million for the three months ended June 30, 2010, from $6.5 million for the year ended June 30, 2009. During the three months ended June 30, 2010, we experienced a $0.4 million decrease in payroll-related expenses due primarily to a reduction in sales and marketing personnel between June 2009 to June 2010. Additionally, we experienced a $0.3 million decrease in marketing- related expenses due primarily to fewer marketing-related programs during the three months ended June 30, 2010 as compared to the three months ended June 30, 2009.

RESEARCH AND DEVELOPMENT EXPENSES

Research and development expenses decreased $0.5 million, or 17%, to $2.3 million for the three months ended June 30, 2010 from $2.8 million for the three months ended June 30, 2009. During the three months ended June 30, 2010, we experienced a decrease in payroll-related expenses of approximately $0.3 million, due primarily to a decrease in research and development related personnel between June 2009 to June 2010. Additionally we experienced a decrease in professional service and consulting expenses of approximately $0.1 million.

GENERAL AND ADMINISTRATIVE EXPENSES

General and administrative expenses decreased by $0.9 million, or 21%, to $3.3 million for the three months ended June 30, 2010, from $4.2 million for the three months ended June 30, 2009. The decrease was primarily attributable to a $0.7 million decrease in acquisition-related costs which were incurred during the three months ended June 30, 2009, related to the acquisition of ColdSpark and certain assets of Asempra. Additionally, we experienced a decrease in audit related costs of approximately $0.2 million for the audits of our fiscal 2010 financial statements as compared to our fiscal 2009 financial statements. Our payroll related costs increased approximately $0.1 million during the three months ended June 30, 2010, due primarily to severance costs related to the termination of two of our executive officers during the quarter, which were off-set partially by a decrease in core payroll related costs as a result of a decrease in administrative personnel between June 2009 and June 2010.

INTEREST EXPENSE

During the three months ended June 30, 2010 and 2009, we incurred interest expense of $0.2 million and $0.1 million, respectively. Our interest expense primarily relates to interest expense associated with our ColdSpark acquisition. As the consideration given to the ColdSpark shareholders will be paid over three years, we calculated the present value of the consideration payable to the ColdSpark shareholders as of the acquisition date, for both the cash payments and common shares to be issued, and recorded the applicable interest expense using the effective interest method. We anticipate the following amounts of non-cash interest expense will be charged to earnings in each of the fiscal years related to the ColdSpark acquisition, until the acquisition consideration is paid in full in fiscal 2013:


Year ended March 31,		Non-cash Interest Expense (in Thousands)
2011		681
2012		380
2013		64

FOREIGN EXCHANGE GAIN (LOSS), NET

During the three months ended June 30, 2010 and 2009, we recorded net foreign exchange losses of $4,000 and $0.2 million, respectively, related to foreign exchange rate changes that impacted or are expected to impact cash flows. During the three months ended June 30, 2010, our net foreign exchange losses consisted of $0.3 million of foreign exchange gains related to the strengthening of the Japanese yen against the U.S. dollar and the British pound on intercompany balances, offset by $0.3 million of foreign exchange losses related to Euro currency holdings in our EMEA region and to U.S. dollar currency holdings in our Asia-Pacific region. During the three months ended June 30, 2009, our net foreign exchange losses consisted of $0.1 million of foreign exchange gains related to the strengthening of the British pound against the U.S. dollar on intercompany balances, offset by $0.3 million of foreign exchange losses related to U.S. dollar and Euro currency holdings in our EMEA region.

PROVISION FOR INCOME TAXES

During the three months ended June 30, 2010 and 2009, we recorded provisions for income taxes of $9,000 and $25,000, respectively. During the three months ended June 30, 2010, our provision for income taxes consisted of approximately $65,000 of charges related to taxes on income generated in certain foreign jurisdictions, which were off-set by the reversal of approximately $56,000 of tax accruals as a result of the expiration of the related statute of limitations. During the three months ended June 30, 2009, our provision for income taxes consisted of charges related primarily to taxes on income generated in certain foreign jurisdictions.

Although we have generated consolidated pre-tax income during the three months ended June 30, 2010, we have incurred operating losses in all years prior to the first quarter of fiscal 2011. Management has determined that it is more likely than not that a tax benefit from such losses will not be realized. Accordingly, we did not record a benefit for income taxes for these periods.

DISCONTINUED OPERATIONS

On May 21, 2010, we decided to close our Message Management division. This business had been classified as discontinued operations in the accompanying consolidated financial statements. During the three months ended June 30, 2010 and 2009, we incurred losses from discontinued operations of $0.8 million and $0.6 million, respectively. During the three months ended June 30, 2010, our loss from discontinued operations was due primarily to payroll, severance and lease termination costs associated with closing the operations. During the three months ended June 30, 2009, the loss was due primarily due to a loss from our Message Management operations.

Liquidity and Capital Resources

As of June 30, 2010, we had $4.9 million of cash and cash equivalents and $40.6 million in negative working capital, or $4.0 million in positive working capital after excluding the current portion of deferred revenue, as compared to $4.9 million of cash and cash equivalents and $36.8 million in negative working capital, or $7.5 million in positive working capital after excluding the current portion of deferred revenue, as of March 31, 2010. Working capital, defined as current assets minus current liabilities, is intended to measure our short-term liquidity, or our ability to pay off short-term liabilities with current assets. Because short-term deferred revenue does not require the future use of current assets, management has excluded the current portion of deferred revenue from the calculation of working capital as an indicator of short-term liquidity. Our cash, combined with our cash flow from operating activities, have been our principal sources of liquidity.

Operating Activities of Continuing Operations

We generate cash from operations primarily from cash collected on software license and software maintenance contract sales. Net cash provided by operating activities of continuing operations was $1.3 million and $0.2 million during the three months ended June 30, 2010 and 2009, respectively. Net cash provided by operating activities during the three months ended June 30, 2010 and 2009 was primarily the result of an increase in cash collections during the period. During the three months ended June 30, 2009, we used significant cash resources for the acquisition transaction costs related to our acquisition of ColdSpark and certain assets of Asempra which caused our cash provided by operating activities to be lower.

Investing Activities of Continuing Operations

Net cash used in investing activities was $0.6 million and $1.1 million for the three months ended June 30, 2010 and 2009, respectively. During the three months ended June 30, 2010, we made cash payments to the former shareholders of ColdSpark totaling $0.5 million pursuant to the terms of the merger agreement. During the three months ended June 30, 2009, we paid $1.0 million to acquire ColdSpark and certain assets of Asempra, net of cash acquired. Capital expenditures were $0.1 million during both the three months ended June 30, 2010 and 2009.

Financing Activities of Continuing Operations

During the three months ended June 30, 2010 and 2009, net cash used in financing activities of $0.1 million and $0.3 million, respectively, consisted of payments on capital lease and long term debt obligations.

Cash Flows of Discontinued Operations

Net cash used in discontinued operations was $0.8 million and $0.3 million for the three months ended June 30, 2010 and 2009, respectively, and primarily related to the cash outflows for payroll and other operating expenses. Additionally, during the three months ended June 30, 2010, we incurred significant cash resources in connection with closing our Message Management division.

During the three months ended June 30, 2010 and 2009, net cash used in financing activities of discontinued operations of $21,000 and $2,000, consisted of payments on capital lease and debt obligations.

Factors That May Affect Future Financial Condition and Liquidity

Currently our cash commitments include normal recurring trade payables, expense accruals, minimum royalty obligations, debt, and operating and capital leases, all of which are currently expected to be funded through existing working capital. We expect to incur approximately $0.4 million in capital expenditures during the remainder of fiscal 2011.

Pursuant to the terms of the merger agreement for our acquisition of ColdSpark in May 2009, we are required to pay aggregate consideration of $8.1 million and issue up to 18.2 million common shares, less up to $1.625 million in cash and shares to cover indemnification obligations under the merger agreement, if any. The merger agreement provides for payment of the merger consideration in four tranches as follows: (i) $1.5 million and 9,117,877 common shares at the closing of the transaction, which occurred on May 13, 2009, provided that $750,000 of the cash amount payable at closing may be paid 13 months after the closing date along with interest at the rate equal to the greater of (A) the applicable prime rate as reported in the Wall Street Journal on the closing

date plus 3.5% or (B) 8%; (ii) $1.5 million and 3,488,383 common shares thirteen months after the closing date, or June 13, 2010; (iii) $1.5 million and 3,488,383 common shares twenty-five months after the closing date; and (iv) $3,625,000 and 2,075,137 common shares thirty-seven months after the closing date. We may defer all or a portion of the cash amounts payable in (ii) and (iii) above by issuing common shares equal to the deferred amount and paying interest on any deferred cash payment. We are entitled to satisfy any indemnification claims by reducing subsequent payments of merger consideration by a pro rata amount of the indemnification claims, 50% in common shares and 50% in cash.

In June, 2010 we paid cash of $437,945 related to the deferred portion of the initial payment plus interest of $37,955, for a total cash payment of $475,900. Also in June 2010, we notified the Coldspark shareholder’s representative that we were withholding payment of $812,500 and 1,889,535 common shares that would otherwise be due in June 2010 in order to satisfy certain indemnification claims pursuant to the terms of the merger agreement. We issued the remaining 1,423,894 common shares and elected to defer the remaining $687,500 cash payment due in June 2010. We issued an additional 1,423,884 common shares in connection with this deferral. As a result of the deferral election, we are required to accrue and pay interest at a rate of 8% per year. If it were determined that we are not entitled to indemnification for our claims, we could become obligated to pay some or all of the withheld cash and issue some or all of the withheld shares. In addition, upon resolution of an unrelated matter, we expect to pay another $339,100 of the deferred portion of the initial payment plus interest through the payment date, and issue an additional 349,908 common shares related to our June 2010 payment.

As of June 30, 2010, our expected future obligations under the Coldspark merger agreement (assuming we are not required to pay the cash and issue the shares previously withheld in June 2010 related to our indemnification claims and the other unrelated matter) are as follows:


(in thousands) Payment Type	Due Date	Cash		Common Shares
Third payment(1)	June 2011	$	1,295	3,965
Interest on deferred payment(1)	June 2011		55	—
Fourth payment(2)	June 2012		4,517	—
Interest on deferred payment(2)	June 2012		71	—

Total		$	5,938	3,965

(1)

Our expected June 2011 payment consists of (i) $607,686 of the $1.5 million cash payment due pursuant to the merger agreement; (ii) the $687,500 cash payment deferred in June 2010; and (iii) the remaining 4.0 million common shares due pursuant to the merger agreement. Additionally, we expect to pay approximately $55,000 of interest related to the $687,500 deferred cash payment

(2)	Our expected June 2012 payment consists of the remaining $4.5 million of cash due pursuant to the merger agreement. Additionally, we expect to pay approximately $71,000 of interest related to the deferred portion of the June 2011 cash payment.

During the three months ended June 30, 2010, we experienced a decrease in bookings as a result of weak economic and industry conditions as well as other financial and business factors, many of which are beyond our control. In May 2010, we decided to realign our corporate strategy and focus on our core storage and data protection business. As part of this strategy we closed our Message Management operations. By closing our Message Management operations and focusing on our Storage Management business we will eliminate the operating losses incurred by our Message Management division, which we believe will result in a more profitable business, as our core Storage Management division generated approximately $1.0 million of operating income during the three months ended June 30, 2010 and $7.6 million of operating income during the year ended March 31, 2010. We believe that our current cash and cash equivalents will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months from the date of the filing of this Quarterly Report and that we will have sufficient liquidity to fund our business and meet our contractual obligations over a period beyond the next 12 months. However, we may be required to obtain additional financing in order to fund our continued operations or make required payments pursuant to the merger agreement with ColdSpark. Due to the tightening that has occurred in the credit markets, general economic conditions, our previous SEC filing delinquencies, our previous material weaknesses in our internal controls over financial reporting and other economic and business factors, this financing may not be available to us on acceptable terms or at all. Although we cannot accurately anticipate the effect of inflation or foreign exchange markets on our operations, we do not believe these external economic forces have had, or are likely in the foreseeable future to have, a material impact on our financial position, results of operations and cash flows.

Off-Balance Sheet Arrangements

At June 30, 2010, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, special purpose or variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we did not engage in trading activities involving non-exchange traded contracts. As a result, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. We do not have relationships and transactions with persons or entities that derive benefits from their non-independent relationship with us or our related parties except as disclosed elsewhere in this Quarterly Report and in our most recent Annual Report on Form 10-K.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Market risk represents the risk of loss that may impact our consolidated financial statements through adverse changes in financial market prices and rates. Our market risk exposure results primarily from fluctuations in foreign exchange rates. We do not have a significant market risk exposure to fluctuations in interest rates. International revenues represented 69% and 57% of our total revenue for each of the three months ended June 30, 2010 and 2009, respectively. Portions of our Asia-Pacific revenues are currently denominated in U.S. dollars. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and, therefore, potentially less competitive in those markets. A majority of our international business is presently conducted in currencies other than the U.S. dollar. Foreign currency transaction gains and losses arising from normal business operations are credited to or charged against earnings in the period incurred. As a result, fluctuations in the value of the currencies in which we conduct our business relative to the U.S. dollar will cause currency transaction gains and losses, which we have experienced in the past and continue to experience. Due to the substantial volatility of currency exchange rates, among other factors, we cannot predict the effect of exchange rate fluctuations upon future operating results. We could experience currency losses in the future. We have not previously undertaken hedging transactions to cover currency exposure.

Item 4T.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our principal executive and financial officer, has evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as of June 30, 2010. Based on that evaluation, our principal executive officer and principal financial officer concluded that, as of June 30, 2010, our disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during the first quarter of fiscal year 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Because of its inherent limitations, internal control over financial reporting can provide only reasonable assurance of achieving the desired control objectives. As a result, any controls and procedures, no matter how well designed and operated, may not prevent or detect misstatements. Internal control over financial reporting also can be circumvented by collusion or improper management override of controls. Projections of any evaluation of control effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

We are involved in litigation and claims which arise from time to time in the normal course of business. In the opinion of management, any liability that may arise from such contingencies would not have a significant adverse effect on our consolidated financial position, results of operations or cash flows.

Item 1A.

Risk Factors

Our business could continue to be harmed by the weak general economic and market conditions that lead to reduced spending on information technology products.

As our business has expanded globally, we have become increasingly subject to the risks arising from adverse changes in domestic and global economic and political conditions. General economic conditions during the calendar years 2008 and 2009 caused our customers to delay or reduce information technology purchases. If economic activity in the United States and other countries remains slow, customers may continue to delay or further reduce information technology purchases. This could result in additional reductions in sales of our products, longer sales cycles, slower adoption of new technologies and increased price competition. In addition, weakness in the end user market could negatively affect the cash flow of our resellers and customers who could, in turn, delay paying their obligations to us, which would increase our credit risk exposure and cause a decrease in operating cash flows. Also, if our resellers experience excessive financial difficulties and/or insolvency, and we are unable to successfully transition end users to purchase our product from other resellers or directly from us, our sales could decline significantly. Any of these events would likely harm our business, results of operations and financial condition.

We have incurred substantial net losses since inception, and we may not be able to achieve or maintain profitability or positive cash flow.

We have incurred operating and net losses since the inception of our operations in March 2000. During the three months ended June 30, 2010, we generated a net loss of $3,000, and our net losses were $9.8 million and $5.5 million for the years ended March 31, 2010 and 2009, respectively. As of June 30, 2010, our accumulated deficit was $242.4 million. We may not be able to achieve positive cash flow from operations in future periods. If we cannot achieve and sustain operating profitability, we may not be able to meet our working capital requirements, which would have a material adverse effect on our business, results of operations, financial condition and cash flows.

Our future capital needs are uncertain and our ability to access additional financing may be negatively impacted by the volatility and disruption of the capital and credit markets and adverse changes in the global economy.

Our capital requirements in the future will depend on many factors, including:

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acceptance of and demand for our software products;

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the costs associated with integrating and developing acquired products and businesses;

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the extent to which we invest in new technology and product development;

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the costs of developing new products, services or technologies; and

•

the costs associated with the growth of our business, if any.

We intend to finance our operations and any growth of our business with existing cash and any cash flow from operations. We expect our cash balance to vary based on our bookings, disposal costs related to our Message Management business, core operating costs and the timing of any payments related to the ColdSpark acquisition. We believe that our existing cash and anticipated net cash flows from operations will be sufficient to meet our operating and capital requirements through at least the next 12 months from the date of the filing of this Quarterly Report. However, if the costs associated with closing our Message Management operations exceed our current projections, we are faced with unexpected legal costs associated with exiting the Message Management business or adverse global economic conditions persist or worsen, we could experience an additional decrease in cash from operations and we may be required to obtain additional financing in order to fund our continued operations. Due to the existing uncertainty in the equity markets including debt, private equity and venture capital and traditional bank lending markets, access to additional debt or equity may not be available to us on acceptable terms or at all. If we cannot raise funds on acceptable terms when necessary, we may not be able to develop or enhance our products and services, take advantage of future opportunities, or respond to competitive pressures or unanticipated customer requirements. Furthermore, if we issue equity or convertible debt securities to raise additional funds, our existing shareholders may experience dilution, and the new equity or debt securities may have rights, preferences, and privileges senior to those of our existing shareholders. If we incur additional debt, it would increase our leverage relative to our results of operations or to our equity capitalization.

Our acquisition of ColdSpark and subsequent exiting of the ColdSpark Message Management business have had and could continue to have an adverse affect on our financial condition.

In May 2010, we announced that we intended to exit our ColdSpark Message Management business, which we acquired in connection with our acquisition of ColdSpark, Inc. in May 2009. We have incurred significant costs in connection with acquiring, integrating and further developing the ColdSpark Message Management business, which, among other things, has resulted in a decrease in our cash balance since the completion of the acquisition. We recorded an impairment charge in the fourth quarter of fiscal 2010 of approximately $12.6 million, which reduces the current carrying value of the business to its estimated fair value as of March 31, 2010. We have made or expect to make cash payments of approximately $0.5 million in connection with the closing of the Message Management business. However, these costs could be higher than estimated if we were to incur unexpected costs related to the transition of our existing Message Management customers or legal or other costs. In addition, the closing of our Message Management business has required, and may continue to require, significant attention from senior management.

We will also continue to incur significant costs related to our acquisition of ColdSpark. Pursuant to the terms of the merger agreement for our acquisition of ColdSpark in May 2009, we are required to pay aggregate consideration of $8.1 million and issue up to 18.2 million common shares in four tranches over a four year period, less up to $1.625 million in cash and shares to cover indemnification obligations under the merger agreement, if any. In June 2010, we notified the Coldspark shareholder’s representative that we were withholding payment of $812,500 and 1,889,535 common shares that would have otherwise been due in June 2010 in order to satisfy certain indemnification claims pursuant to the terms of the merger agreement. However, we could be required to make these payments to the former ColdSpark shareholders if it were determined that we are not entitled to indemnification for our claims.

Although we have closed our Message Management business, we are still required to make future payments of cash and common shares to the former ColdSpark stockholders. Payments of a portion of the cash consideration may be deferred by issuing common shares equal to the deferred amount plus interest on any deferred payment. In June 2010, we opted to defer the portion of the cash payment due in June 2010 and not held back for indemnification purposes. We expect to make the following cash payments to former ColdSpark stockholders: (i) $1.35 million in June 2011, which includes $687,500 of the June 2010 payment we elected to defer and $55,000 of related interest and (ii) $4,588,000 in June 2012, which includes $892,314 of the June 2011 payment we expect to defer, approximately $71,000 of related interest,

and the remaining cash amounts due pursuant to the merger agreement. See our discussion under “Liquidity and Capital Resources” in Part I, Item 2 of this Quarterly Report. In addition, we expect to issue approximately 4.0 million common shares to the former ColdSpark stockholders in June 2011 as payment of the remaining stock consideration under the merger agreement. Making the above cash payments will have a significant impact on our cash balances and working capital. We may not have sufficient cash available to make the cash payments and additional financing may not be available to us on favorable terms or at all. In addition, the above share issuances will result in significant dilution to our shareholders. Our dispute with the former ColdSpark stockholders could also result in significant legal and other expenses and cause diversion of management attention and resources from the operation of our business.

If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud.

Effective internal controls are necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, our operating results could be misstated, our reputation may be harmed and the trading price of our common shares could be negatively affected. In connection with the audits of our financial statements for the fiscal years ended March 31, 2006, 2007, 2008 and 2009, we identified material weaknesses in our internal controls as further described in our Annual Reports on Form 10-K for those fiscal years. We have implemented actions to address these weaknesses and to enhance the reliability and effectiveness of our internal controls and operations, and our management concluded that there are no material weaknesses in our internal control over financial reporting as of June 30, 2010 and March 31, 2010. However, our internal control over financial reporting is not required to be and has not been audited by our independent registered public accounting firm. In addition, our controls over financial processes and reporting may not be effective in the future and additional material weaknesses or significant deficiencies in our internal controls may not be discovered or remediated in the future. Any failure to remediate any future material weaknesses or implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results, cause us to fail to meet our reporting obligations or result in material misstatements in our financial statements or other public disclosures. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock.

Competition in our target markets could reduce our sales.

We operate in a segment of the intensely competitive storage management software market. This market is characterized by rapidly changing technology and evolving standards. We have a number of competitors that vary in size and scope and breadth of products offered. Many of our competitors have greater financial resources than we do in the areas of sales, marketing, branding and product development, and we expect to face additional competition from these competitors in the future. Our current competitors include, among others, Symantec Corporation, EMC Corporation, IBM’s Tivoli division, CA Inc. and CommVault Systems, Inc. Some of these companies compete against us by offering a full suite of storage management tools, including software that addresses data protection. We also face competition from a number of smaller companies who, like us, focus solely or primarily on the data protection software market. Furthermore, our OEM partners, who do not currently compete with us, could decide to compete with us by offering their own data protection solutions that exclude our software, and other storage equipment vendors may enter our market either through acquisition of competing technologies or products, or through development of their own data protection software solutions.

Our existing and future competitors could introduce products with superior features, scalability and functionality at lower prices than our product. Most of our competitors provide broad suites of storage management software solutions and thus could gain market share by bundling existing or new data protection products with other more established storage products or by acquiring or forming strategic alliances with our other competitors. If our competitors are successful in gaining market share, our business, results of operations, financial condition and cash flows could be adversely affected.

Our future revenues depend upon continued market acceptance of our NetVault product portfolio.

Currently we derive substantially all of our revenues from our NetVault product portfolio, and we expect this will continue for the foreseeable future. If the market does not continue to accept these products, our revenues will decline significantly, and this would negatively affect our results of operations, financial condition and cash flows. Factors that may affect the market acceptance of our NetVault products include the performance, price and total cost of ownership of our products, and the availability, functionality and price of competing products and technologies. Many of these factors are beyond our control.

Our bookings, revenues and operating results may fluctuate significantly, which could cause the market price of our stock to fall.

Our operating results have fluctuated in the past and can be expected to fluctuate from time to time in the future. We may experience a shortfall in bookings or revenues in any given quarter in relation to our plans or investor expectations. In addition, if we have a shortfall in bookings or revenues, our efforts to reduce operating expenses in response will likely lag behind such shortfall. Our revenues and bookings, and our licensing revenues and bookings in particular, are difficult to forecast and are likely to fluctuate significantly from quarter-to-quarter due to a number of factors, many of which are outside of our control. Factors that may cause fluctuations in our revenues and bookings include the following:

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timing and magnitude of sales;

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historical sales patterns in the IT industry which often involve customer purchase decisions being made at or near the end of each calendar quarter;

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timing of large enterprise transactions which are typified by long solicitation and decision periods and often remain highly uncertain until the sale is actually completed;

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introduction, timing and market acceptance of new products by us and our competitors;

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rate of growth of Network Attached Storage and Storage Area Network technology deployment;

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rate of adoption and associated growth of the Linux operating system;

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changes in our pricing policies and distribution terms;

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possibility that our customers may defer purchases in anticipation of new products or product updates by us or by our competitors; and

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changes in market demand for IT products in general.

Any deterioration in our operating results, including fluctuations based on any shortfalls in bookings or revenues, could cause the market price of our stock to fall substantially. If our operating results are below the expectations of securities analysts or investors, the market price of our common stock may fall abruptly and significantly.

We are dependent on certain key customers.

During the three months ended June 30, 2010, we had no customers that comprised 10% or more of our consolidated revenues. However, we have derived, and may continue to derive, a significant portion of our revenues from a limited number of OEM customers. If any of our largest OEM customers were to reduce purchases from us or we are unable to attract new OEM customers, our business would be adversely affected. For example, during fiscal 2009, several of our OEM arrangements terminated, resulting in a significant decline in OEM bookings for fiscal 2010. In addition, we do not have contracts with our key customers that require such customers to make any minimum purchases from us. Therefore, we cannot be sure that these customers will continue to purchase our product at current levels, or at all. As a result, a significant customer in one period may decide not to purchase our product in a subsequent period, which would have an adverse impact on our revenues, results of operations, financial condition and cash flows.

We rely on indirect sales channels such as value-added resellers, distributors and OEMs, and this makes it difficult for us to predict our revenues.

We rely, and will continue to rely, on our indirect sales channel for the marketing and distribution of our products. Our agreements with value-added resellers and distributors do not contain exclusivity provisions and in most cases may be terminated by either party without cause and with limited or no notice. Many of our resellers also carry other product lines that are competitive with ours. These resellers may not give a high priority to the marketing of our products. They may give a higher priority to other products, including the products of competitors, or may decide not to continue to carry our products. In addition, we may not be able to retain our current resellers or successfully recruit new resellers. Any such changes in our distribution channels could seriously harm our business, operating results and financial condition.

Our strategy also involves developing significant partnerships with key hardware and software providers to integrate NetVault products into their offerings to support more robust data protection solutions. We may fail to implement this strategy successfully. We are currently investing, and will continue to invest, resources to develop this channel. Such investments, if not successful, could seriously harm our operating margins. Before we can sell our products to an OEM, generally we must engage in a lengthy sales cycle and develop a version of our software customized for and integrated with the hardware or software product of the OEM. This process, which can take up to 12 months or more, requires the commitment of OEM personnel and resources, and we compete with other suppliers for these resources. Any delays in completing this process or any failure to timely develop a customized and integrated version of our software for an OEM would adversely affect our ability to sell our products.

Sales of our products through our OEMs depend on the success of our OEMs in developing and effectively marketing new products, applications and product enhancements on a timely and cost-effective basis that meet changing customer needs and respond to emerging industry standards and other technological changes. Our reliance on OEMs exposes us to additional risks. If our OEMs do not meet these challenges our revenues may suffer. The OEMs we partner with may incorporate the technologies of other companies in addition to, or to the exclusion of, our technologies, and are not obligated to purchase our product from us, and they may not continue to include our products with their products. In addition, we have no control over the shipping dates or volumes of products the OEMs ship. Our OEM customers may compete with one another. If one of our OEM customers views the products we have developed for another OEM as competing with its products, it might decide to stop doing business with us, which could adversely affect our business, results of operations, financial condition and cash flows. The inability to recruit, or the loss of, important OEMs could seriously harm our business, operating results and financial condition. Finally, should one of our OEM partners create or acquire competitive products to ours, our OEM revenues would likely decline.

Because our intellectual property is critical to the success of our business, our results of operations may suffer if we are unable to adequately protect or enforce our intellectual property rights.

Our proprietary technologies are crucial to our success and ability to compete. We rely primarily on a combination of patents, copyrights, trade secret laws, contractual provisions and trademarks to establish and protect our intellectual property rights in our proprietary technologies. Sometimes our products are licensed under “shrink wrap” license agreements that do not require a physical signature by the end user licensee and therefore may be unenforceable under the laws of some jurisdictions. We presently have five patents issued and we continually invest resources to gain additional patent protection for our proprietary technology. We may not be issued additional patents in the future, and the benefit we may derive from any patents, if and when issued, may equal or exceed the costs of obtaining such patents.

Our general practice is to enter into confidentiality or license agreements with employees, consultants and customers and seek to control access to and distribution of our source code, documentation and other proprietary information. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our product or to obtain and use information that we regard as proprietary. Policing unauthorized use of our proprietary information is difficult. Other parties also may independently develop or otherwise acquire equivalent or superior technology. In addition, the laws in some countries in which our product is or may be developed, manufactured or sold may not protect our intellectual property rights to the same extent as the laws of the United States, or at all. Our failure to protect our intellectual property rights could result in increased competition and therefore reduce our market share, which would have a material adverse effect on our business, results of operations, financial condition and cash flows.

We may become involved in costly and lengthy patent infringement or intellectual property litigation which could seriously harm our business.

In recent years, there has been significant litigation in the United States and in foreign countries involving patents and other intellectual property rights. We may become party to litigation in the future as a result of an alleged infringement of others’ intellectual property. From time to time, we receive inquiries from other companies concerning whether we used their proprietary information or technology. It also is possible that patent holders will assert patent rights which apply broadly to our industry, and that such patent rights, if valid, may apply to our product or technology. Any claims that we improperly use another party’s proprietary information or technology or that we infringe another party’s intellectual property, with or without merit, could adversely affect or delay sales of our product, result in costly and time-consuming litigation, divert our technical and management personnel, or require us to develop non-infringing technology or enter into royalty or licensing arrangements, any of which could adversely affect our business. We cannot be certain that the necessary licenses will be available or that they can be obtained on commercially reasonable terms. If we were to fail to obtain such royalty or licensing agreements in a timely manner or on reasonable terms, our business, results of operations, financial condition and cash flows could be materially adversely affected.

Our foreign operations create special challenges that could adversely affect our results of operations.

We have significant operations outside of the United States, including a significant portion of our engineering and sales operations, and we generate a significant portion of our revenues from sales outside the United States. It is our intention to expand our international operations in order to increase our revenues from sales outside the United States and to continue to take advantage of lower costs associated with software development outside the United States. As of July 30, 2010, we had 80 employees in Europe, the Middle East and Africa (“EMEA”) and 68 employees in the Asia-Pacific region out of 238 total employees. Our foreign operations and revenues are subject to a number of risks, including:

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potential loss of proprietary information due to piracy, misappropriation, or weaker intellectual property protection laws or weaker enforcement of such laws;

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imposition of foreign laws and other governmental controls, including trade restrictions, as well as the burdens of complying with a wide variety of multiple local, country and regional laws;

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unexpected domestic and international political or regulatory changes;

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fluctuations in currency exchange rates and general economic instability;

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lack of acceptance of localized products, if any, in foreign countries;

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longer negotiation and accounts receivable payment cycles;

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potentially adverse tax consequences;

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difficulties in coordinating the activities of our geographically dispersed and culturally diverse operations; and

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difficulties in ensuring that our subsidiaries maintain sufficient internal control over financial reporting in order to produce financial statements in compliance with accounting principles generally accepted in the United States (“U.S. GAAP”).

Our continued growth will require further expansion of our international operations. To expand international operations successfully, we must establish additional foreign operations, hire and retain additional personnel and recruit additional international resellers, all of which will require significant management attention and financial resources. If we fail to further expand our international operations and revenues, we may not achieve our anticipated growth.

A majority of our international business is presently conducted in currencies other than the U.S. dollar. Foreign currency transaction gains and losses arising from normal business operations are credited to or charged against earnings in the period incurred. As a result, fluctuations in the value of the currencies in which we conduct our business relative to the U.S. dollar will cause currency transaction gains and losses, which we have experienced in the past and continue to experience. Due to the substantial volatility of currency exchange rates, among other factors, we cannot predict the effect of exchange rate fluctuations upon future operating results and we may experience currency losses. Portions of our Asia-Pacific revenues are currently denominated in U.S. dollars. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and, therefore, potentially less competitive in those markets. We have not previously undertaken hedging transactions to cover currency exposure, and we do not currently intend to engage in hedging activities. As a result, our results of operations, financial condition and cash flows could be adversely affected by such exchange rate fluctuations.

Our success depends on our ability to keep pace with rapid technological developments in the storage industry.

Our future success depends, in part, on our ability to address the rapidly changing needs of organizations by developing and introducing new product updates and features on a timely basis. To achieve this objective we must extend the operation of our products to new platforms and keep pace with technological developments and emerging industry standards. To achieve broad acceptance of our software, we must obtain certifications from hardware vendors approving our software for use as a data protection solution on their platforms. This process requires continual testing and development, and we must invest significant technical resources in adapting our products to the changing hardware specifications. If we are unsuccessful in obtaining new certifications, the market for our software may be limited. Moreover, software products typically have a limited life cycle, and it is difficult to estimate when they will become obsolete. We must therefore continually develop and introduce innovative products and/or upgraded versions of our existing products before the current software has completed its life cycle. Our failure to do so may result in our inability to achieve and maintain profitability.

Our products may contain significant defects, which may result in liability and/or decreased sales.

Software products frequently contain errors or failures, especially when first introduced or when new versions are released. Despite our efforts to test our products, we may experience significant errors or failures in our products, or software may not work with other hardware or software as expected, which could delay the development or release of new products or new versions of our products and adversely affect market acceptance of our products. End user customers use our products for applications that are critical to their businesses, and they have a greater sensitivity to product defects than the market for other software products generally. Our end users and distribution partners may claim that we are responsible for damages to the extent they are harmed by any failure of our products.

If we were to experience significant delays in the release of new products or new versions of our products, or if customers were dissatisfied with product functionality or performance, we could lose revenue or be subject to liability for service or warranty costs, and our business, results of operations, financial condition and cash flows could be adversely affected.

Our success depends on hiring and retaining key personnel, including our executive officers and other qualified employees.

We have experienced significant changes in our senior management team within the past few months. James Johnson, our former Chief Executive Officer, and Ken Horner, our former Senior Vice President, Corporate Development and Strategy, are no longer employed by us, and our Chief Financial Officer, Steve Martin, is currently operating as our Interim Chief Executive Officer. These management transitions and uncertainties have resulted, and could continue to result, in further disruption of our business.

Our future growth and success depends on the continued contributions of our senior management, as well as our ability to hire and retain key management, engineering, sales and marketing and operations personnel as needed. If we are unable to hire and retain qualified employees, our business and operating results may be adversely affected. We need to hire and retain qualified personnel to meet customer demand for our products and services and develop new products and services, and we may not be able to do so. All of our employees are free to terminate their employment with us at any time. Competition for people with the skills we require is intense, particularly in the San Diego area where our headquarters are located, and the high cost of living in this area makes our recruiting and compensation costs higher. As a result, we expect to continue to experience increases in compensation costs.

We rely upon software licensed from third parties, and if it became unavailable to us, we could be required to modify our software or to acquire a license or right to use alternative technology.

We license and use software owned by third parties in our business, some of which is incorporated into our products. These third party software licenses may not continue to be available to us on acceptable terms. Also, these third parties may from time to time receive claims that they have infringed the intellectual property rights of others, including patent and copyright infringement claims, which may affect our ability to continue licensing this software. Our inability to use any of this third party software could result in shipment delays or other disruptions in our business, which could adversely affect our business, results of operations, financial condition and cash flows.

Potential future acquisitions could adversely affect our ongoing operations.

Although we do not have any current plans to make material acquisitions, we may in the future make further acquisitions or investments in companies, products or technologies that we believe complement or expand our existing business and assist us in quickly bringing new products to market. However, we have limited experience in making acquisitions and investments. As a result, our ability to identify and evaluate prospects, complete acquisitions and properly manage the integration of businesses is relatively unproven. Failure to properly evaluate and execute acquisitions or investments or to integrate completed acquisitions may have a material adverse effect on our business, results of operations, financial condition and cash flows.

In making or attempting to make acquisitions or investments, we face a number of risks, including risks related to:

•

identifying suitable candidates, performing appropriate due diligence, identifying potential liabilities and negotiating acceptable terms;

•

reducing our working capital and hindering our ability to expand or maintain our business, if we make acquisitions using cash;

•

the potential distraction of our management, diversion of our resources and disruption of our business;

•

retaining and motivating key employees of the acquired companies;

•

managing operations that are distant from our current headquarters and operation locations;

•

competing for acquisition opportunities with competitors that are larger than we are or have greater financial and other resources than we have;

•

accurately forecasting the financial impact of a transaction;

•

assuming liabilities of acquired companies, including existing or potential litigation related to the operation of the business prior to the acquisition;

•

maintaining good relations with the customers and suppliers of the acquired company;

•

effectively integrating acquired companies and assets and achieving expected synergies; and

•

maintaining sufficient cash to build the acquired business operations until they generate positive cash flow.

Any acquired businesses, products or technologies may not generate sufficient revenue and cash flows to offset the associated costs of such acquisitions. In addition, such acquisitions could result in other adverse effects. For example, if the acquisition resulted in goodwill, the company is subject to annual review for goodwill impairment. If impairment testing indicates that the carrying value of a reporting unit exceeds its fair value, the goodwill of the reporting unit is deemed impaired. Accordingly, an impairment charge would be recognized for that reporting unit in the period identified, which could have a material adverse effect on our operating results. Moreover, from time to time, we may enter into negotiations for the acquisition of businesses, products or technologies but be unable or unwilling to consummate the acquisitions under consideration. This could cause significant diversion of managerial attention and resources.

Because we are a Canadian corporation, certain civil liabilities and judgments against us or our directors by U.S. investors may be unenforceable.

We are incorporated under the laws of Canada and some of our directors are residents of Canada. As a result, it may be difficult for our U.S.-based shareholders to initiate a lawsuit within the United States. It may also be difficult for shareholders to enforce a U.S. judgment in Canada or elsewhere or to succeed in a lawsuit in Canada or elsewhere based only on violations of U.S. securities laws.

Litigation may harm our business or otherwise distract our management.

Substantial, complex or extended litigation could cause us to incur large expenditures and distract our management. For example, we may in the future be subject to class actions, other securities litigation or other proceedings or actions arising in relation to the restatement of our prior period financial statements or related to our past or future acquisition activities. Litigation and any potential regulatory proceeding or action may be time consuming, expensive and distracting from the conduct of our business, and the outcome of litigation and any potential regulatory proceeding or action is difficult to predict. The adverse resolution of any specific lawsuit or any potential regulatory proceeding or action could have a material adverse effect on our business, results of operations and financial condition. To the extent expenses incurred in connection with litigation or any potential regulatory proceeding or action (which may include substantial fees of attorneys and other professional advisers and potential obligations to indemnify officers and directors who may be parties to such actions) are not covered by available insurance, such expenses could adversely affect our business, results of operations, financial condition and cash flows.

There is a limited market for our common shares and selling our shares may be difficult.

Our common shares have been quoted on the OTCBB since May 2009. From February 2005 until May 27, 2009, trading of our common shares was conducted on the “Pink Sheets” due to our failure to keep current in filing our periodic reports with the SEC. In addition, our common shares have not traded on the TSX since December 2004, when the Canadian jurisdictions of Ontario, Alberta and British Columbia issued cease trade orders due to delays in the filing of our financial statements. Our common shares were subsequently de-listed from the TSX in May 2006. In April 2009, the cease trade orders in all of the Canadian jurisdictions were lifted. The trading market for our common shares is limited and an active trading market may not develop. Selling our common shares may be difficult because the limited trading market for our shares on the OTCBB could result in lower prices and larger spreads in the bid and ask prices of our shares, as well as lower trading volume.

In addition, our stock may be defined as a “penny stock” under Rule 3a51-1 under the Exchange Act. “Penny stocks” are subject to Rule 15g-9, which imposes additional sales practice requirements on broker-dealers that sell low-priced securities to persons other than established customers and institutional accredited investors. For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to sale. Consequently, the rule may affect the ability of broker-dealers to sell our common stock and affect the ability of holders to sell their shares of our common stock in the secondary market. To the extent our common stock is subject to the penny stock regulations, the market liquidity for the shares will be adversely affected.

Our share price is volatile and your investment could decline in value.

Our stock price has fluctuated significantly in the past and is likely to continue to fluctuate significantly, making it difficult to resell shares when investors want to at prices they find attractive. General economic, political and stock market conditions may affect the market price of our common shares, and may cause our share price to fluctuate in ways unrelated or disproportionate to our operating performance. Factors affecting the trading price of our common shares could include:

•

variations in our financial results;

•

our restatement of previously reported financial information and delayed filings for subsequent years;

•

announcements of innovations, new solutions, strategic alliances or significant agreements by us or by our competitors;

•

recruitment or departure of key personnel;

•

changes in estimates of our financial results;

•

changes in the recommendations of any securities analysts that elect to follow our common stock;

•

market reaction to any acquisitions, joint ventures or strategic investments announced by us or our competitors;

•

any significant litigation brought against us;

•

market conditions in our industry, the industries of our customers and the economy as a whole; and

•

sales of substantial amounts of our common shares, or the perception that substantial amounts of our common shares will be sold, by our existing stockholders in the public.

The stock market is subject to price and volume fluctuations that affect the market prices for companies in general, and small-capitalization, high technology companies in particular, which are often unrelated to the operating performance of these companies. In addition, in the past, securities class action litigation has been instituted against companies following periods of volatility in the market price of their securities, and we may be subject to a heightened risk of securities class action litigation and due to our restatement of previously published financial information.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.

Defaults Upon Senior Securities

None.

Item 4.

(Removed and Reserved)

Item 5.

Other Information

None.

Item 6.

Exhibits


Exhibit Number		Description of Document

10.1(1)		Retention Letter Agreement, dated May 19, 2010, by and between the Company and Steve Martin

10.2(1)		Retention Letter Agreement, dated May 19, 2010, by and between the Company and Dan Woodward

10.3(2)		Retention Letter Agreement, dated May 19, 2010, by and between the Company and Roy Hogsed

10.4(2)		Retention Letter Agreement, dated May 19, 2010, by and between the Company and Robert Wright

10.5(1)		Separation Agreement and Release, dated May 19, 2010, by and between the Company and James R. Johnson

10.6(1)		Separation Agreement and Release, dated May 20, 2010, by and between the Company and Kenneth Horner

31.1		Certification of Principal Executive and Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification of Principal Executive and Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(1)	Previously filed with the SEC as an exhibit to and incorporated herein by reference from our Current Report on form 8-K filed on May 21, 2010.

(2)	Previously filed with the SEC as an exhibit to and incorporated herein by reference from our Annual Report on form 10-K filed on June 24, 2010.

SIGNATURE

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


		BAKBONE SOFTWARE INCORPORATED

DATE: August 5, 2010		/S/ STEVE R. MARTIN
		Steve R. Martin
		Senior Vice President, Chief Financial Officer and Interim Chief Executive Officer *(Principal Executive, Financial and Accounting Officer)*

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BAKBONE SOFTWARE INC 10-Q