SEC Info℠

Home

Search

My Interests

Help

Sign In

Please Sign In

Crossroads Systems Inc – ‘10-Q’ for 7/31/14

On:  Wednesday, 9/10/14, at 5:27pm ET   ·   For:  7/31/14   ·   Accession #:  1144204-14-55253   ·   File #:  1-15331

Previous ‘10-Q’:  ‘10-Q’ on 6/9/14 for 4/30/14   ·   Next:  ‘10-Q’ on 3/11/15 for 1/31/15   ·   Latest:  ‘10-Q’ on 5/25/17 for 4/30/17

in

this entire Filing. an “Entity” Search.

Show

Documents searched

and

each “hit”. the 1st “hit”.

↓↑Hints

 Text Wildcards:  ? (any letter/digit),  * (many).  Search Logic:  for Documents:  & (and),  | (or);  for Text:  | (anywhere),  "(&)" (near).  Details... 

  As Of               Filer                 Filing    For·On·As Docs:Size             Issuer                      Filing Agent

 9/10/14  Crossroads Systems Inc            10-Q        7/31/14   64:5.9M                                   Toppan Merrill/FA

Document/Exhibit                   Description                      Pages   Size 

 1: 10-Q        Quarterly Report                                    HTML    299K 
 2: EX-31.1     Certification -- §302 - SOA'02                      HTML     23K 
 3: EX-31.2     Certification -- §302 - SOA'02                      HTML     23K 
 4: EX-32.1     Certification -- §906 - SOA'02                      HTML     19K 
 5: EX-32.2     Certification -- §906 - SOA'02                      HTML     19K 
43: R1          Document And Entity Information                     HTML     40K 
33: R2          Condensed Consolidated Balance Sheets               HTML    111K 
41: R3          Condensed Consolidated Balance Sheets               HTML     56K 
                [Parenthetical]                                                  
45: R4          Condensed Consolidated Statements of Operations     HTML     84K 
59: R5          Condensed Consolidated Statements of Cash Flows     HTML    123K 
35: R6          Organization and Basis of Presentation              HTML     41K 
40: R7          Fair Value Measurements                             HTML     39K 
30: R8          Inventory                                           HTML     34K 
22: R9          Property and Equipment                              HTML     43K 
60: R10         Accrued Expenses and Deferred Revenue               HTML     70K 
47: R11         Line of Credit and Long Term Liabilities            HTML     40K 
46: R12         Commitments and Contingencies                       HTML     37K 
51: R13         Stockholders' Equity                                HTML    134K 
52: R14         Stock Options and Stock Based Compensation          HTML    141K 
50: R15         Employee Benefits                                   HTML     24K 
53: R16         Related Party Transactions                          HTML     27K 
42: R17         Preferred Stock Rights                              HTML     25K 
44: R18         Organization and Basis of Presentation (Policies)   HTML     50K 
49: R19         Fair Value Measurements (Tables)                    HTML     31K 
64: R20         Inventory (Tables)                                  HTML     33K 
55: R21         Property and Equipment (Tables)                     HTML     41K 
37: R22         Accrued Expenses and Deferred Revenue (Tables)      HTML     73K 
48: R23         Line of Credit and Long Term Liabilities (Tables)   HTML     34K 
39: R24         Stockholders' Equity (Tables)                       HTML    100K 
17: R25         Stock Options and Stock Based Compensation          HTML    137K 
                (Tables)                                                         
56: R26         Organization and Basis of Presentation (Details     HTML     29K 
                Textual)                                                         
61: R27         Fair Value Measurements (Details)                   HTML     29K 
26: R28         Fair Value Measurements (Details Textual)           HTML     26K 
25: R29         Inventory (Details)                                 HTML     26K 
28: R30         Property and Equipment (Details)                    HTML     40K 
29: R31         Property and Equipment (Details Textual)            HTML     21K 
31: R32         Accrued Expenses and Deferred Revenue (Details)     HTML     36K 
16: R33         Accrued Expenses and Deferred Revenue (Details 1)   HTML     27K 
54: R34         Accrued Expenses and Deferred Revenue (Details 2)   HTML     23K 
36: R35         Accrued Expenses and Deferred Revenue (Details      HTML     33K 
                Textual)                                                         
38: R36         Line of Credit and Long Term Liabilities (Details)  HTML     36K 
20: R37         Line of Credit and Long Term Liabilities (Details   HTML     51K 
                Textual)                                                         
63: R38         Commitments and Contingencies (Details Textual)     HTML     26K 
12: R39         Stockholders' Equity (Details)                      HTML     27K 
32: R40         Stockholders' Equity (Details 1)                    HTML     74K 
58: R41         Stockholders' Equity (Details Textual)              HTML    157K 
19: R42         Stock Options and Stock Based Compensation          HTML     26K 
                (Details)                                                        
24: R43         Stock Options and Stock Based Compensation          HTML     36K 
                (Details 1)                                                      
27: R44         Stock Options and Stock Based Compensation          HTML     57K 
                (Details 2)                                                      
34: R45         Stock Options and Stock Based Compensation          HTML     67K 
                (Details 3)                                                      
15: R46         Stock Options and Stock Based Compensation          HTML     83K 
                (Details Textual)                                                
21: R47         Employee Benefits (Details Textual)                 HTML     20K 
13: R48         Related Party Transactions (Details Textual)        HTML     38K 
57: R49         Preferred Stock Rights (Details Textual)            HTML     30K 
62: XML         IDEA XML File -- Filing Summary                      XML     92K 
14: EXCEL       IDEA Workbook of Financial Reports                  XLSX    124K 
23: EXCEL       IDEA Workbook of Financial Reports (.xls)            XLS    964K 
 6: EX-101.INS  XBRL Instance -- crds-20140731                       XML   1.34M 
 8: EX-101.CAL  XBRL Calculations -- crds-20140731_cal               XML    117K 
 9: EX-101.DEF  XBRL Definitions -- crds-20140731_def                XML    673K 
10: EX-101.LAB  XBRL Labels -- crds-20140731_lab                     XML    907K 
11: EX-101.PRE  XBRL Presentations -- crds-20140731_pre              XML    764K 
 7: EX-101.SCH  XBRL Schema -- crds-20140731                         XSD    139K 
18: ZIP         XBRL Zipped Folder -- 0001144204-14-055253-xbrl      Zip    128K 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

FOR THE QUARTERLY PERIOD ENDED July 31, 2014

OR

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER: 001-15331

CROSSROADS SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

(512) 349-0300

(Registrant's telephone number, including area code)

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

Indicate by 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). x Yes ¨ No

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

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

As of September 10, 2014 Registrant had outstanding 15,428,731 shares of common stock, par value $0.001 per share.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

FORM 10-Q

QUARTER ENDED July 31, 2014

TABLE OF CONTENTS

PART I -      FINANCIAL INFORMATION

ITEM 1.         FINANCIAL STATEMENTS –

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

See accompanying notes to the condensed consolidated financial statements.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(In thousands, except share and per share data)

See accompanying notes to the condensed consolidated financial statements.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(In thousands)

See accompanying notes to the consolidated financial statements.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements include the accounts of Crossroads Systems, Inc. and its wholly-owned subsidiaries (“Crossroads” or the “Company”).   Headquartered in Austin, Texas, Crossroads Systems, a Delaware corporation, is a global provider of data archive solutions.   Through the innovative use of new technologies, Crossroads delivers customer-driven solutions that enable proactive data security, advanced data archiving, optimized performance and significant cost-savings.

The accompanying unaudited condensed consolidated financial statements of Crossroads Systems, Inc. have been prepared in accordance with the instructions to Form 10-Q; and therefore, do not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with United States generally accepted accounting principles (“GAAP”). The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes; thereto, together with management’s discussion and analysis of financial condition and results of operations contained in the Company’s 2013 Annual Report on Form 10-K filed on January 23, 2014 (“2013 Form 10-K”). In the opinion of management, the accompanying condensed consolidated financial statements reflect all adjustments of a normal recurring nature considered necessary to fairly state the financial position of the Company at October 31, 2013 and July 31, 2014, the results of its operations for the three and nine months ended July 31, 2014 and 2013, and its cash flows for the nine months ended July 31, 2014 and 2013. The results of operations for the periods presented are not necessarily indicative of results that may be expected for the year ending October 31, 2014.

Principles of Consolidation and Presentation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Crossroads GmbH. All significant intercompany transactions have been eliminated in consolidation.

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has accumulated significant losses as it has been developing its current and next generation products. The Company believes that cash flow from operations, customer reimbursed expenses, and proceeds from the issuance of equity will be sufficient to fund the anticipated operations for the subsequent four quarters through the quarter ended July 31, 2015.  These financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern for a reasonable period of time.

The investment in KIP CR P1 LP (the “Partnership” (see Note 6)), is a partnership in which the Company is a limited partner and an affiliate of Fortress Investment Group, LLC is the general partner. This investment is accounted for using the equity method and the value is nominal at July 31, 2014.

Use of Estimates

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates, and such differences may be material to the consolidated financial statements.

Computation of Loss Per Share

Basic loss per share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted loss per share is computed by giving effect to all dilutive potential common shares that were outstanding during the period. Basic loss per share excludes the dilutive effect of common stock equivalents such as stock options and warrants. Future weighted-average shares outstanding calculations will be impacted by the following factors, among others: (i) the ongoing issuance of common stock associated with stock option and warrant exercises; (ii) fluctuations in the Company’s stock price, which could cause changes in the number of common stock equivalents included in the loss per share computation; and (iii) the issuance of common stock to effect business combinations should the Company enter into such transactions.

The Company has excluded all outstanding common stock equivalents from the calculation of diluted loss per share because all such common stock equivalents are antidilutive for all periods presented. The total number of common stock equivalents excluded from the diluted net loss per common share calculation was 12,266,695 and 10,569,405 for the three and nine months ended July 31, 2014 and 2013, respectively. The dilutive common stock equivalents for the nine months ended July 31, 2014 and 2013 include warrants to purchase 5,426,664 and 3,280,849 shares of common stock, 3,747,447 and 4,231,154 shares of preferred stock, which are excluded until converted to common shares (Note 8), and stock options to purchase 3,092,584 and 3,057,402 shares of common stock, respectively.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Net loss available to common stockholders is calculated by deducting from net loss the preferred dividends paid and accrued of $0.2 and $0.4 million for the three and nine months ended July 31, 2014, respectively. Net loss available to common stockholders was calculated by deducting from net loss, the preferred dividends paid and accrued and beneficial conversion features attributable to warrants, totaling $1.1 and $2.0 million for the three and nine months ended July 31, 2013, respectively.

Contracts to Modify or Customize Products

The Company periodically enters into contracts with certain customers to significantly modify or customize products. In accounting for such arrangements, the Company first looks to the guidance in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Subtopic 985-605, Software - Revenue Recognition (“ASC 985-605”), and then ASC Subtopic 605-25, Revenue Recognition – Multiple-Element Arrangements, to determine the appropriate accounting elements in the arrangement.  The Company then considers the appropriate recognition model for each accounting element based on the nature of the element and applies the guidance in ASC Subtopic 605-35, Revenue Recognition – Construction-Type and Production-Type Contracts, ASC Subtopic 985-60, ASC Subtopic 605-15, Revenue Recognition – Products, or ASC Subtopic 605-20, Revenue Recognition – Services, as applicable.  Amounts allocated to the modification/customization service element are evaluated for classification in the consolidated statement of operations as either revenue or reduction of research and development expense based on the following considerations: whether and in what circumstances the consideration received is refundable, ownership of the final product and intellectual property rights to develop the product, and exclusivity of the final product. 

Recently Issued Accounting Pronouncements

In July 2013, the FASB issued new accounting guidance on the presentation of unrecognized tax benefits. This new guidance requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists, with limited exceptions. The prospective adoption of this new accounting guidance in the first quarter of 2014 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In March 2013, the FASB issued guidance that requires a parent company to release any related cumulative translation adjustment into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. The adoption of this new accounting guidance in the first quarter of 2014 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In May 2014, the FASB issued new accounting guidance on Revenue from Contracts with Customers, and supersede the revenue recognition requirements in Topic 605, Revenue Recognition, including most industry-specific revenue recognition guidance throughout the Industry Topics of the Codification. In addition, the amendments supersede the cost guidance in Subtopic 605-35, Revenue Recognition—Construction-Type and Production-Type Contracts, and create new Subtopic 340-40, Other Assets and Deferred Costs—Contracts with Customers. In summary, the core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amendments in this update are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. The Company has not evaluated the potential impact on the Company’s consolidated financial statements from the adoption of this update.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. To increase the comparability of fair value measurements, a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies, is applied as follows:

Level 1 – Valuations based on quoted prices for identical assets and liabilities in active markets.

Level 2 –  Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Level 3 – Valuations based on unobservable inputs reflecting management’s assumptions, consistent with reasonably available assumptions made by other market participants. These valuations require significant judgment.

As of July 31, 2014, the fair value of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, approximates book value due to the short maturity of these instruments. Based upon borrowing rates currently available to the Company for loans with similar terms, the carrying value of its debt obligations approximates fair value. As of July 31, 2014 and October 31, 2013, the Company held no investments.

In accordance with ASC 815-40-25 and ASC 815-10-15 Derivatives and Hedging and ASC 480-10-25 Liabilities-Distinguishing Liabilities from Equity as approved by shareholders, the 5.0% Series F Convertible Preferred Stock was accounted for outside of stockholders’ equity totaling $6.4 million and the warrants issued in connection with the convertible preferred stock accounted for as liabilities at their fair value totaling $0.8 million. The value of the derivative warrant liability was re-measured at each reporting period with changes in fair value recorded as change in value of derivative liability in the accompanying consolidated statements of operations. To derive an estimate of the fair value of these warrants, the Company utilized a dynamic Black Scholes Merton formula that computes the impact of share dilution upon the exercise of the warrant shares. This process relied upon inputs such as shares outstanding, estimated stock price, strike price and volatility assumptions to dynamically adjust the payoff of the warrants in the presence of the dilution effect. In the event the convertible preferred shares were redeemed, any redemption price in excess of the carrying amount of the convertible preferred stock would have been treated as a dividend. The change in the derivative liabilities measured using significant unobservable inputs for the nine months ended July 31, 2014 were as follows (in thousands). See Note 8 explaining the revaluation of Series-F Preferred Stock and Warrants:

3. INVENTORY

Inventory, net consists of the following (in thousands):

4. PROPERTY AND EQUIPMENT

Property and equipment, net consist of the following (in thousands, except number of years):

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Depreciation expense was approximately $137,000 and $208,000 for three months ended, and $517,000 and $617,000 for nine months ended July 31, 2014 and 2013, respectively.

5. ACCRUED EXPENSES AND DEFERRED REVENUE

Accrued expenses consist of the following (in thousands):

Included in payroll related accrued expenses as of October 31, 2013 was $202,000 related to bonus compensation, $135,000 of which was settled in January 2014 with 66,081 shares of common stock.   Also included in payroll related accrued expenses as of October 31, 2013 was $326,000 of unpaid severance, relating to the reduction in force which occurred October 24, 2013, and $142,000 of unpaid severance, relating to the termination of the Company’s previous CEO on May 8, 2013.

Warranty reserve activity, included in accrued expenses, during the year ended October 31, 2013 and nine months ended July 31, 2014 was as follows (in thousands):

Deferred revenue, current portion, consists of the following (in thousands):

Effective July 22, 2013, the Company entered into a credit agreement (the “Credit Agreement”) with Fortress Credit Co. LLC, an affiliate of Fortress Investment Group LLC (collectively referred to as “Fortress”) that provided for aggregate term loan commitments of up to $10.0 million. The Credit Agreement consisted of: Term Loan A in the principal amount of $5.0 million, maturing on July 22, 2016 and bearing no interest for the first 12 months and Term Loan B in the principal amount of $5.0 million, maturing on February 1, 2016 and bearing no interest for the first six months. The Company drew down the full $10.0 on Term Loan A and Term Loan B (collectively referred to as “Fortress Term Loans”) on July 24, 2013. The Fortress Term Loans accrue interest at 10% annually after the interest free period and interest is due monthly in arrears. The Company began making principal payments on Term Loan A in July 2014. The proceeds from the Fortress Term Loans were used to pay off the Company’s outstanding revolving credit and term loan with Silicon Valley Bank. During the nine months ended July 31, 2014, the Company made principal payments of approximately $2.0 million in excess of the contractual principal payment amounts.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Credit Agreement requires the Company to maintain a minimum of $1.5 million of unrestricted cash at each month end and restricts the Company from making certain cash distributions to equity security holders or from incurring additional indebtedness without prior written consent from Fortress. The Company is also required to supply monthly financial statements to Fortress within 30 days of the end of each month.

Debt issuance costs associated with the Fortress Term Loans totaling $2.3 million were recorded as a deferred charge and are being amortized over the term of the debt using the effective interest rate method with an effective interest rate of 17.48% at July 31, 2014. The effective interest rate is based on the Company’s monthly expense, which includes debt discount and loan origination fee amortization.

In connection with the Credit Agreement, the Company issued warrants to Fortress to purchase 1,454,545 shares of the Company’s common stock at an exercise price of $2.0625 per share (the “Fortress Warrants”). See Note 8 for discussion of the Fortress Warrants.

In addition, the Company also transferred substantially all of its patents, other than its’972 patent family, to the Partnership, which now controls 121 pending or granted non-’972 patents. There was no licensing activity during fiscal year 2013 or to date during fiscal year 2014 associated with these patents. The general partner cannot be removed without the consent of Fortress. The Company accounts for the investment in the partnership on a consolidated basis using the equity method of accounting.

These warrants also previously contained what is commonly known as a “full-ratchet” anti-dilution provision, which provided that if the Company issued or were deemed to have issued additional shares of common stock without consideration or for a consideration per share less than the applicable exercise price of the Fortress Warrants, which is initially $2.0625 per share, then the exercise price of the warrants will be reduced on a “full ratchet” basis, concurrently with the new issue, to the consideration per share the Company received for the new issue or deemed issue of the additional shares of common stock. In January 2014, the Company and the holders agreed to amend the warrant to remove this full-ratchet anti-dilution provision.

The principal balance due to Fortress is as follows (in thousands):

7. COMMITMENTS AND CONTINGENCIES

Leases

The Company leases office space and equipment under long-term operating lease agreements that expire on various dates through March 31, 2020. Rental expense under these agreements was approximately$81,000 and $116,000 for the three months ended July 31, 2014 and 2013, and $327,000 for both the nine months ended July 31, 2014 and 2013, respectively. Crossroads leases its headquarters, approximately 37,800 square feet of general office, laboratory, data center and administrative space in Austin, Texas. The original lease was effective October 31, 2005 and extended in accordance with an extension agreement through February 28, 2015. On May 2, 2014, the lease was amended, extending the lease through March 31, 2020, and reducing the space leased to 16,200 square feet. The extended term of the lease represents a lease commitment of approximately $258,000 per year through the lease term.  

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Legal Proceedings

Intellectual Property Litigation

The Company filed a lawsuit on September 11, 2013 against Dot Hill Systems Corp. ("Dot Hill") styled Crossroads Systems, Inc. v. Dot Hill Systems Corp., Civil Action No. 1:13-CV-800-SS alleging patent infringement of U.S. Patent No. 6,425,035and breach of the Amended Settlement and License Agreement dated June 27, 2006 between Crossroads and Dot Hill. Dot Hill has filed a motion to dismiss and Crossroads has filed its response; the Court denied Dot Hill’s motion. Dot Hill recently filed a partial motion for summary judgment regarding whether certain products Dot Hill sells are subject to royalties under the Amended Settlement and License Agreement. Crossroads has prepared and filed its response requesting summary judgment in its favor on this issue. The Markman hearing is scheduled for October 6-7, 2014.

The Company filed a lawsuit on October 7, 2013 against Oracle Corporation alleging infringement by Oracle Corporation of U.S. Patent Nos. 6,425,035, 7,051,147 and 7,934,041 (the case is styled Crossroads Systems, Inc., v. Oracle Corporation; Civil Action No. 1:13-CV-895-SS (W.D. Tex., Austin Division)). Oracle has answered the complaint and the action is pending. The Markman hearing is scheduled for October 6-7, 2014. Oracle is also a party to four petitions for Inter Partes Review filed at the United States Patent and Trademark Office, which collectively challenge the validity of each asserted patent. Crossroads is preparing its responses to these petitions.

The Company filed a lawsuit on November 26, 2013 against Tandberg Data Corporation alleging infringement by Tandberg Data Corporation of U.S. Patent Nos. 6,425,035 and 7,934,041 (the case is styled Crossroads Systems, Inc. v. Tandberg Data Corporation; Civil Action No. 1:13-cv-01026-SS (W.D. Tex., Austin Division)). This case was settled in May 2014, and subsequently dismissed.

The Company filed a lawsuit on November 26, 2013 against Huawei Technologies Co. Ltd., Huawei Enterprise USA, Inc. & Huawei Technologies USA, Inc. alleging infringement of U.S. Patent Nos. 6,425,035, 7,051,147 and 7,934,041 (the case is styled Crossroads Systems, Inc. v. Huawei Technologies Co., Ltd. et al; Civil Action No. 1:13-cv-01025-SS (W.D. Tex., Austin Division)). Huawei has answered the complaint and the action is pending. The Markman hearing is scheduled for October 6-7, 2014. Huawei is also a party to four petitions for Inter Partes Review filed at the United States Patent and Trademark Office, which collectively challenge the validity of each asserted patent. Crossroads is preparing its responses to these petitions.

The Company filed a lawsuit on November 26, 2013 against Dell Inc. alleging infringement of U.S. Patent Nos. 6,425,035 and 7,934,041 (the case is styled Crossroads Systems, Inc. v. Dell Inc.; Civil Action No. 1:13-cv-01023-SS (W.D. Tex., Austin Division)). This case was dismissed without prejudice in June 2014.

The Company filed a lawsuit on February 18, 2014 against Cisco Systems, Inc. alleging infringement of U.S. Patent Nos. 6,425,035 and 7,934,041 (the case is styled Crossroads Systems, Inc. v. Dell Inc.; Civil Action No. 1:14-cv-00148-SS (W.D. Tex., Austin Division)). Cisco has answered the complaint and the action is pending. The Markman hearing is scheduled for October 6-7, 2014. Cisco is also a party to two petitions for Inter Partes Review filed at the United States Patent and Trademark Office, which challenges the validity of U.S. Patent No. 6,425,035. Crossroads is preparing its responses to this petition.

The Company filed a lawsuit on February 18, 2014 against NetApp, Inc. alleging infringement of U.S. Patent Nos. 6,425,035, 7,934,041, 7,987,311 and 7,051,147 (the case is styled Crossroads Systems, Inc. v. Dell Inc.; Civil Action No. 1:14-cv-00149-SS (W.D. Tex., Austin Division)). NetApp has answered and the action is pending. The Markman hearing is scheduled for October 6-7, 2014. NetApp is also a party to five petitions for Inter Partes Review filed at the United States Patent and Trademark Office, which collectively challenge the validity of each asserted patent. Crossroads is preparing its responses to these petitions.

The Company filed a lawsuit on February 18, 2014 against Quantum Corporation alleging infringement of U.S. Patent Nos. 6,425,035 and 7,934,041 (the case is styled Crossroads Systems, Inc. v. Dell Inc.; Civil Action No. 1:14-cv-00150-SS (W.D. Tex., Austin Division)). Quantum has answered the complaint and the action is pending. The Markman hearing is scheduled for October 6-7, 2014. Quantum is also a party to two petitions for Inter Partes Review filed at the United States Patent and Trademark Office, which challenges the validity of U.S. Patent No. 6,425,035. Crossroads is preparing its responses to this petition.

On April 15, 2014, NetApp, Inc. filed an action for declaratory judgment of non-infringement of U.S. Patent Nos. 7,987,311 and 7,051,147 (the case is styled NetApp, Inc. v. Crossroads Systems, Inc.; Civil Action No. 4:14-CV-01727-JSW (N.D. Cal., Oakland Division). This action has been dismissed based on a joint request by the parties.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

8. STOCKHOLDERS’ EQUITY

2010 Private Placement

On October 23, 2010 the Company sold 3,125,000 shares of its common stock at $3.20 per share for gross proceeds to the Company of $ 10.0 million.  In conjunction with this private placement, the Company also issued warrants to purchase an additional 1,074,212 shares of common stock with an exercise price of $3.20 per share.   Fees in the amount of $0.8 million relating to the stock placement were netted against proceeds.  The warrants were valued at $1.3 million using the Black-Scholes model.  The Black-Scholes inputs used were:  expected dividend rate of 0%, expected volatility of 63%, risk free interest rate of 1.47%, and expected term of 5 years.  The warrants were exercisable immediately upon issue, and expire October 22, 2015. As of July 31, 2014, there were 949,034 warrants outstanding.

Iron Mountain Private Placement

On July 31, 2012, the Company issued and sold to Iron Mountain Incorporated (“IRM”) 582,524 shares of its common stock at $5.15 per share, for an aggregate purchase price of $3 million. The Company also entered in a registration rights agreement with IRM, pursuant to which the Company agreed to prepare and file a registration statement with the Securities and Exchange Commission (“SEC”) at IRM’s request, no later than sixty days following such request, and to keep it continuously effective until the shares covered by the registration statement have been sold or become eligible for sale pursuant to SEC Rule 144 without restriction on the volume of securities that may be sold in any single transaction, assuming for this purpose that the security holders are not affiliates of the Company.  The shares were registered with the SEC in fiscal year 2013.

2013 Private Placement

On March 22, 2013, the Company entered into a securities purchase agreement with certain accredited investors for the issuance and sale in a private placement of 4,231,154 units at a purchase price of $2.0625 per unit, valued at $8.6 million, for net proceeds of approximately $7.9 million after related expenses. Each unit consists of one share of cumulative 5.0% Series F convertible preferred stock, par value $0.001 per share and a warrant to purchase one-half of a share of common stock equal per share of convertible preferred stock purchased, at an exercise price of $2.00 per whole share, subject to certain adjustments, resulting in the issuance of warrants to purchase an additional 2,282,754 shares of common stock with an exercise price of $2.00 per share. The convertible preferred stock ranks senior to the common stock and each other class or series of the Company’s capital stock, whether common, preferred or otherwise, with respect to distributions of dividends and distributions upon liquidation, dissolution or winding up of the Company.

The warrants were initially valued using the Black-Scholes pricing model at approximately $2,284,000.  The relative fair value of these warrants totaling $1,543,000 was initially allocated to additional paid in capital.  The Black-Scholes inputs used were:  expected dividend rate of 0%, expected volatility of 63%, risk free interest rate of 0.82 %, and expected term of 5 years.  This valuation resulted in a beneficial conversion feature on the convertible preferred stock of approximately $1,090,000. This amount was recorded, upon issuance, as a deemed dividend.   Fees in the amount of $0.7 million relating to the stock placement were netted against proceeds.   The warrants were exercisable immediately upon issue, and expire March 22, 2018.   During the three months ended July 31, 2014, the Company issued 73,396 dividend common shares valued at approximately $246,000. During the three months ended January 31, 2014, the Company issued 150,703 dividend common shares valued at approximately $366,000. The next dividend is due December 31, 2014. The Company filed a registration statement to register these securities on Form S-1 on May 10, 2013 with the Securities and Exchange Commission (“SEC”).

The warrants related to the Series F Preferred Shares were revalued at October 31, 2013 using the Black-Scholes pricing model at approximately $772,000.  The dynamic Black-Scholes inputs used were:  expected dividend rate of 0%, expected volatility of 65%, risk free interest rate of 1.10%, and expected term of 4.4 years. Upon the expiration of the ratchet, the warrant liability was $0.

The convertible preferred stock has the rights, qualifications, limitations and restrictions set forth in the Certificate of Designation (the “Certificate of Designation”) filed with the Secretary of State of the State of Delaware on March 28, 2013. The Certificate of Designation authorizes issuance of up to 4,500,000 shares of convertible preferred stock, with 3,750,000 shares designated as “Sub-Series F-1” and 750,000 shares designated as “Sub-Series F-2.” The right of holders of convertible preferred stock to convert the convertible preferred stock is subject to a 9.99% beneficial ownership limitation for holders of Sub-Series F-1 and a 4.99% beneficial ownership limitation for holders of Sub-Series F-2. Such beneficial ownership limitations may be increased or decreased by a holder of Sub-Series F-1 to any percentage not in excess of 19.99% after providing notice of such increase or decrease to the Company. For as long as at least 90% of the aggregate number of shares of Sub-Series F-1 issued on the Original Issue Date are outstanding, the holders of such Sub-Series F-1, voting as a single class, will be entitled to elect two directors of the Company. If less than 90%, but at least 20%, of such shares of Sub-Series F-1 are outstanding, such holders, voting as a single class, will be entitled to elect one director of the Company. As of the date hereof, less than 90% of the aggregate number of shares of Sub-Series F-1 are outstanding, as the remainder have been voluntarily converted into common stock at the option of the holders. Therefore, the holders of the Sub-Series F-1 shares are entitled to elect one director to the board of directors. The holders of Sub-Series F-2 will not be entitled to vote on the directors elected by the holders of Sub-Series F-1. The holders of shares of the convertible preferred stock are entitled to a liquidation preference equal to the original issuance price plus any unpaid dividends.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Certificate of Designation contains customary anti-dilution protection for proportional adjustments (e.g. stock splits). The Series F convertible preferred stock previously included an anti-dilution provision that would adjust the conversion price of the Series F convertible preferred stock to the issue price of any equity securities the Company issued at a price less than $2.0625 per share, subject to certain exceptions. This type of provision is commonly referred to as a “full-ratchet” anti-dilution provision. This “full-ratchet” provision is no longer in effect as it was removed from the Certificate of Designation on March 14, 2014 by the requisite approval of the holders of shares of the Company’s common stock and Series F convertible preferred stock.  

The full ratchet anti-dilution provisions in the Company’s convertible preferred stock and warrants issued in its March 2013 private placement (discussed above) were not in effect until those provisions were approved by a vote of the Company’s stockholders at its 2013 annual meeting held on June 21, 2013. Upon approval of these provisions the warrants were reclassified as a derivative liability and recorded at fair value. Also upon approval of the full ratchet anti-dilution provision the Series F convertible preferred stock were potentially convertible into more shares of common stock than currently authorized, therefore those shares were classified in temporary equity. Upon the expiration of the full ratchet anti-dilution provisions in March 2014, the Company reclassified the preferred stock and warrants to permanent stockholders' equity following the stockholders vote described in the preceding paragraph.

In accordance with ASC 815-40-25 and ASC 815-10-15 Derivatives and Hedging and ASC 480-10-25 Liabilities-Distinguishing Liabilities from Equity as approved by shareholders, the convertible preferred shares were accounted for net outside of stockholders’ equity at $6.4 million with the warrants accounted for as liabilities at their fair value of $0.8 million as of October 31, 2013. The ratchet included with the warrants expired during the second quarter of 2014 and as a result the value of the derivative warrant liability was $0 as of July 31, 2014.

In the event the convertible preferred shares are redeemed, any redemption price in excess of the carrying amount of the convertible preferred stock would be treated as a dividend. During the nine months ended July 31, 2014, there were 483,707 shares of Series F Preferred shares converted to common shares.

Dividends on the Series F convertible preferred stock will accrue at an annual rate of 5.0% of the original issue price and will be payable on a semi-annual basis. The convertible preferred ranks senior to the common stock and each other class or series of the Company’s capital stock, whether common, preferred or otherwise, with respect to distributions of dividends and distributions upon liquidation, dissolution or winding up of the Company. Pursuant to a registration rights agreement entered into with the purchasers of the Series F convertible preferred stock, in the event that a registration statement for the resale of the common stock underlying the convertible preferred stock and March 2013 warrants was not declared effective prior to July 26, 2013 (120 days from the closing of the March 2013 private placement), then the rate at which dividends accrued on the convertible preferred stock would be increased to an annual rate of 12.0% from that date until such time as a registration statement is declared effective, at which time the dividend rate reverts to an annual rate of 5.0%. The registration statement was not declared effective by July 26, 2013, and as a result the dividend rate on the convertible preferred stock increased to an annual rate of 12.0%, until September 19, 2013 when it was declared effective. The Company may elect to satisfy the obligation to pay semi-annual dividends in cash, by distribution of common stock or a combination thereof, in the Company’s discretion.

On February 28, 2013, in connection with the 2013 Private Placement, the Company issued convertible promissory notes to two investors, in the aggregate principal amount of $550,000. Pursuant to the terms of the notes, both note holders had the right to convert the outstanding amounts under their notes into Series F convertible preferred stock shares at a discount of 15% to the issue price of the Series F convertible preferred stock. This resulted in a beneficial conversion feature of $107,000. Each note holder exercised this right and received 188,235 Series F convertible preferred stock shares, in the case of the note holder converting $330,000 of promissory notes and interest, and 156,863 Series F convertible preferred stock shares, in the case of note holder converting $275,000 of promissory notes and interest.

2013 Fortress Credit Agreement

As discussed in Note 6, on July 22, 2013 the Company issued warrants to purchase 1,454,545 shares of its common stock to Fortress at $2.0625 per share. To derive an estimate of the fair value of these warrants, the Company utilized a dynamic Black Scholes Merton formula that computes the impact of share dilution upon the exercise of the warrant shares. This process relies upon inputs such as shares outstanding, estimated stock prices, strike price and volatility assumptions to dynamically adjust the payoff of the warrants in the presence of the dilution effect.   The Fortress Warrant was recorded at a fair value of $1,374,000 or $1.0625 per underlying warrant share.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Fortress Warrant is exercisable on or after October 22, 2013 and will expire on the seventh anniversary of the effective date of the Fortress Transactions. If the Fortress Warrant is exercisable and there is no effective Registration Statement registering, or no current prospectus available for, the resale of the shares of common stock issuable upon exercise of the Fortress Warrant, then the Fortress Warrant may also be exercised at such time by means of a “cashless exercise,” determined according to the terms of the Fortress Warrant.

The Fortress Warrants included what is commonly referred to as “full-ratchet” anti-dilution protection, which provision would only have gone into effect if approved by the Company’s stockholders at its 2014 annual meeting of stockholders. Subject to stockholder approval, if, prior to the earlier to occur of (A) twelve months following the warrant, issuance date of July 22, 2013 and (B) the date on which the Company indicates a positive earnings per share in its public disclosure, the Company issued or was deemed to have issued additional shares of Common Stock without consideration or for a consideration per share less than the applicable exercise price, which is initially $2.0625 per share, then the exercise price of the Fortress Warrant would have been reduced, concurrently with such issue, to the consideration per share received by the Company for such issue or deemed issue of the additional shares of common stock.

On January 23, 2014, Crossroads Systems, Inc. entered into an Amendment to the Fortress Warrants with CF DB EZ LLC, which is an affiliate of Fortress. The sole purpose of this amendment was to remove the “full-ratchet” anti-dilution provision of the warrant that Crossroads issued to Fortress.

2014 Private Placement

On March 31, 2014 the Company sold 1,986,622 units at $2.2565 per unit for gross proceeds to the Company of $4.5 million. Each unit consists of one share of common stock and a warrant to purchase one-half of a share of common stock.  The warrants to purchase 993,311 shares of common stock have a weighted average exercise price of $2.45 per share.   Fees in the amount of $0.2 million relating to the stock placement were netted against proceeds.  The warrants were valued at $1.1 million using the Black-Scholes model.  The Black-Scholes inputs used were:  expected dividend rate of 0%, expected volatility of 74%, risk free interest rate of 1.64%, and expected term of 2.5 years.  The warrants were exercisable upon the six-month anniversary of issue, and expire March 31, 2019. As of July 31, 2014, there were 993,311 warrants outstanding.

As a result of credit, common stock and preferred stock transactions, the Company has the following common stock warrants outstanding at July 31, 2014:

Warrants Outstanding

A rollforward of activity in stockholders equity is presented in the following table as of July 31, 2014 (in thousands, unaudited):

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Company has a stock-based compensation plan available to grant incentive stock options, non-qualified stock options and restricted stock to employees and non-employee members of the board of directors and advisors.

The Company’s 2010 Stock Incentive Plan (the “2010 Plan”) succeeded the 1999 Stock Option/Stock Issuance Plan (the “1999 Plan.  As of July 31, 2014, options to purchase 488,021 shares of common stock were outstanding under the 1999 Plan, and no further grants can be made under the 1999 Plan.

The 2010 Plan was approved by the board of directors on May 26, 2010 and became effective on August 13, 2010, upon approval by shareholders.  A maximum of 3,500,000 shares of Crossroads common stock may be awarded, plus the automatic increase as detailed below. The total number of shares that will be reserved, and that may be issued, under the 2010 Plan will automatically increase on the first trading day of each calendar year, by a number of shares equal to four percent (4%) of the total outstanding shares on the last day of the prior calendar year, subject to a maximum annual increase of 250,000.   As of July 31, 2014, options to purchase 3,684,576 shares of common stock were granted from the 2010 Plan, of which 2,604,563 were outstanding. During the nine months ended July 31, 2014 and 2013, common stock share grants of 66,081 and 146,555, respectively, were granted from the 2010 Plan.

As of July 31, 2014, options to purchase an aggregate of 3,092,584 shares of common stock were outstanding under the 1999 Plan and the 2010 Plan, of which 1,985,652 were vested. Under the 2010 Plan, 306,955 shares of common stock were available for future grants as of July 31, 2014.  The shares of common stock reserved for future grant are reduced by 291,887 options previously exercised under the 2010 Plan, and 296,595 shares of stock granted under the 2010 Plan.  The Compensation Committee of the board of directors determines the exercise price, term and other conditions applicable to each stock option granted under the 2010 Plan. The exercise price of stock options is set on the grant date and may not be less than the fair market value per share of the Company’s stock on that date (at market close). The 2010 Plan options generally become exercisable over a four-year period (vesting 25% after one year, the remaining 75% vesting quarterly thereafter) and expire after ten years. During the nine months ended July 31, 2014, the majority of the employee incentive stock option grants vest on a schedule of 25% at the end of six months and 12.5% thereafter. Stock option exercises are fulfilled with new shares of common stock.

The Company realized stock-based compensation expense for all awards issued under the Company’s stock plans in the following line items in the consolidated statements of operations:

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of October 31, 2013, approximately $147,000 of stock-based compensation was accrued for 67% of the total estimated management bonus for the fiscal year ended October 31, 2013. Accordingly, 66,081 shares of common stock were granted in January 2014 to satisfy this liability.

The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model. Expected volatility is based on historical volatility of the Company’s stock. The expected term represents an estimate of the time options are expected to remain outstanding based upon historical analysis. The risk-free rate for periods within the contractual life of the option is based on the U.S. treasury yield curve in effect at the time of grant. The variables used in the Black-Scholes calculation are listed below for the respective periods:

The following table summarizes information about stock option activity for the nine months ended July 31, 2014 (unaudited):

The weighted average fair value per option granted during the nine months ended July 31, 2014 and 2013 was $1.18 and $1.42 respectively. The total intrinsic value of options (which is the amount by which the stock price exceeded the exercise price of the options on the date of exercise) exercised during the nine months ended July 31, 2014 and 2013 was $310,000 and $32,700 respectively. During the nine months ended July 31, 2014 and 2013, the amount of cash received from the exercise of stock options was $515,000 and $59,000, respectively.

The Company granted 10,000 and 83,883 options to non-employees during the nine months ended July 31, 2014 and 2013, with a fair value of approximately $14,000 and $120,000, respectively.

At July 31, 2014, there was approximately $608,000 of total unrecognized compensation cost related to non-vested stock option awards which is expected to be recognized over a weighted-average period of 0.9 year. There were 1,016,820 and 405,127 options that became vested during the nine months ended July 31, 2014 and 2013, respectively, with the total fair value of these awards of approximately $1,268,000 and $896,000 respectively.

The following table shows information about outstanding stock options at July 31, 2014:

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In 1996, the Company established the Crossroads Systems, Inc. 401(k) Savings Plan (the “Savings Plan”), which is a qualified plan under section 401(k) of the Internal Revenue Code.   All employees who have attained 18 years of age are eligible to enroll in the Savings Plan.   The Company may make matching contributions to those employees participating in the Savings Plan based upon Company productivity and profitability. Company contributions vest over a period of six years.   In October 2000, the Company adopted a new 401(k) Savings Plan that meets all of the criteria set forth above in the Savings Plan.   The Company made matching contributions $136,000 and $215,000 during the nine months ended July 31, 2014 and 2013, respectively.

11. RELATED PARTY TRANSACTIONS

Iron Mountain

On December 19, 2013, the Company and IRM mutually agreed to end their contract involving the development of a co-branded product.  The Company received $1.6 million in connection with the terminated contract in the first quarter of fiscal year 2014.  The Company bifurcated the payment between amounts received for work performed on the development of the product of $550,000, and a gain from settlement of $1,050,000. The Company recorded the amounts attributable to development as services revenue, and the gain on settlement was reflected as a reduction in operating expenses. IRM also agreed that it would not transfer the shares without the Company's prior written consent until the two-year anniversary date of the settlement, and that it would vote the shares consistent with the recommendation of Crossroads’ board of directors.

2014 Private Placement 

The lead investor in the 2014 Private Placement (see Note 8) was Lone Star Value Investors, LP (“LSVI”). LSVI is controlled by the Company’s Chairman of the board of directors, Jeffrey E. Eberwein. LSVI acquired 1,288,352 shares of common stock in the placement, which included warrants to purchase 644,176 shares of common stock at an exercise price of $2.46 per share, for approximately $2.9 million.

12. PREFERRED STOCK RIGHTS

On May 23, 2014, the Company's board of directors adopted a tax benefit preservation plan (the “Plan”). The Plan is intended to diminish the risk that the Company’s ability to use net operating loss carryforwards to reduce future federal income tax obligations may become substantially limited due to an “ownership change,” as defined in Section 382 of the Internal Revenue Code. The board of directors authorized and declared a dividend distribution of one right for each outstanding share of common stock, par value $0.001 per share, and 5.0% Series F Convertible Preferred Stock, par value $0.001 per share, of the Company to stockholders of record as of the close of business on June 4, 2014. Each right entitles the registered holder to purchase from the Company one one-thousandth of a share of Series G Participating Preferred Stock, par value $0.001 per share, of the Company at an exercise price of $14.00 per one one-thousandth of a share of Series G Participating Preferred Stock, subject to adjustment.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The rights will become exercisable following (i) the 10th business day (or such later date as may be determined by the board of directors) after the public announcement that an acquiring person has acquired beneficial ownership of 4.99% or more of the common stock (calculated pursuant to the plan) or (ii) the 10th business day (or such later date as may be determined by the board) after a person or group announces a tender or exchange offer that would result in ownership by a person or group of 4.99% or more of the common stock (calculated pursuant to the Plan).

In addition, upon the occurrence of certain events, the exercise price of the rights would be adjusted and holders of the rights (other than rights owned by an acquiring person or group) would be entitled to purchase common stock at approximately half of market value. Given the potential adjustment of the exercise price of the rights, the rights could cause substantial dilution to a person or group that acquires 4.99% or more of the Company's common stock on terms not approved by the Company's board of directors.

No rights were exercisable at July 31, 2014. There is no impact to the Company's financial results as a result of the adoption of the rights plan for the nine month period ended July 31, 2014.

The following discussion and analysis of the financial condition and results of our operations should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended October 31, 2013. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section entitled “Risk Factors” included elsewhere in our filings with the Securities and Exchange Commission.

Forward-Looking Statements

Various statements contained in or incorporated by reference into this quarterly report that express a belief, expectation, or intention, or that are not statements of historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements may include projections and estimates concerning capital expenditures, our liquidity and capital resources, the timing and success of specific projects, outcomes and effects of litigation, claims and disputes, elements of our business strategy and other statements concerning our operations, economic performance and financial condition. When used in this quarterly report, the words “could,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “may,” “continue,” “predict,” “potential,” “project” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. In particular, the factors discussed below and detailed in our Form 10-K for the year ended October 31, 2013, as well as those discussed in the section entitled “Risk Factors” included elsewhere in our filings with the Securities and Exchange Commission, could affect our actual results and cause our actual results to differ materially from expectations, estimates, or assumptions expressed in, forecasted in, or implied in such forward-looking statements.

Forward-looking statements may include statements about our:

All forward-looking statements involve risks, assumptions and uncertainties. The occurrence of the events described, and the achievement of the expected results depends on many events, some or all of which are not predictable or within our control. Actual results may differ materially from expected results. These risks, assumptions and uncertainties are not necessarily all of the important factors that could cause actual results to differ materially from those expressed in any of our forward-looking statements. Other unknown or unpredictable factors also could harm our results. In light of these risks, uncertainties and assumptions, the forward-looking events might not occur.

Readers are cautioned not to place undue reliance on forward-looking statements, as there can be no assurance that the plans, intentions or expectations upon which they are based will occur. By their nature, forward-looking statements involve numerous assumptions, known and unknown risks and uncertainties, both general and specific, that contribute to the possibility that the predictions, forecasts, projections and other things contemplated by the forward-looking statements will not occur. Forward-looking statements in this quarterly report are based on management’s beliefs and opinions at the time the statements are made. The forward-looking statements contained in this quarterly report are expressly qualified in their entirety by this cautionary statement. The forward-looking statements included in this quarterly report are made as of the date of this quarterly report and we undertake no obligation to publicly update or revise any forward-looking statements to reflect new information, future events or otherwise, except as required by applicable securities laws.

Overview

The following discussion and analysis of the financial condition and results of our operations should be read in conjunction with consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q.

Crossroads Systems, Inc. (“Crossroads” “the Company,” “we” or “us”) is a global provider of data protection solutions. A 17-year old company based in Austin, Texas, Crossroads develops products that address specific IT challenges, such as cost-effectively storing and protecting business-critical data. Crossroads’ commitment to innovation is evident through our 100+ patent awards and numerous industry recognitions for excellence in data storage and protection. Our products are sold worldwide to Fortune 2000 companies. Additionally, technology leaders such as IBM, Hewlett Packard (HP), Hitachi Data Systems (HDS) and Fujifilm are among our original equipment manufacturer (OEM) and strategic partners.

Our strategic focus is on long-term data preservation in markets experiencing high data growth. We currently ship the following products: StrongBox®, Read Verify Appliance® (“RVA”), SPHiNX™, and storage routers. All of our solutions solve data management problems involving storage, protection, and archiving. Our approach emphasizes long-term investment protection for our customers by reducing the complexities and ongoing costs associated with data protection and storage management. Moreover, our products are designed with a scalable architecture, which enables companies to purchase additional storage as needed and make it available instantly without operation-halting downtime. We sell these products through a network of OEM and strategic partners for our United States and European operations.

IP Licensing Campaign Focus

We continue to realize revenue from existing intellectual property, or IP, licensees with go-forward royalties derived from the ‘972 patent family. We maintain an active licensing program related to the ‘972 family, which has been licensed to over 40 of the leading storage industry providers. We pursue licensing fees for past shipments and recurring licensing fees related to ongoing shipments. In some cases we are required to litigate where we believe other companies are infringing our patents. Historically, these cases have generally been settled quickly as we engage in business discussions with the opposing parties; however, one or more of the litigants may pursue their defense to greater lengths, which would require higher expenses to continue the lawsuit.

In July 2013, we entered into a loan transaction with Fortress Credit Co LLC, an affiliate of Fortress Investment Group LLC (we refer to those affiliates collectively as “Fortress”), which included the formation of a partnership controlled by Fortress (the “Partnership”) to which we assigned all of our existing and issued patents and applications other than our patents in the ’972 family. We refer to this group of patents as the non-‘972 patents. The Partnership may seek to generate revenues through patent licensing and enforcement activity with respect to these patents. The non ‘972 patent portfolio has never been the focus of a licensing campaign. However, we expect to begin a formal licensing campaign in the next 12 months, but we are unable to predict if this campaign will be profitable. We also have the right, in connection with the repayment of the amounts due under the credit agreement and upon the payment of a pre-determined premium of $2.0 million (20% of the amount Fortress loaned to the Company), to buy out Fortress’s interest in the Partnership and return all of the rights to the assigned non-’972 patent rights to ourselves. We intend to periodically monitor and assess the viability and the value of such a buyout.

We continue to look for different ways to extract value from our non-‘972 patents, which may include commercial, financial and strategic initiatives. We believe our IP has value beyond its quantifiable monetary value. For example, we believe that the proprietary nature of our products is appealing to both end-users and strategic partners who view our products as not being easily replaceable. Additionally, IP may be a significant barrier to entry for potential competitors. Therefore, we will continue to assess the value of our current portfolio and attempt to expand and take advantage of our IP portfolio potential.

Key Financial Definitions

Revenue . Revenue consists of sales of hardware, software and services, as well as royalties we earn for products and the license of certain intellectual property. Our “product revenue” is composed of sales of our hardware products and software products sold to our network of strategic partners, including value added resellers, and original equipment manufacturers, as well as directly to end users. Our “IP license, royalty and other revenue” is derived from the licensing of intellectual property, royalty payments, and sales of service contracts.

Cost of Revenue. Cost of revenue is composed of cost of product revenue and IP license, royalty and other revenue. “Cost of product revenue” consists primarily of the cost charged by our previous contract manufacturer to manufacture our products, shipping charges and warranty obligations. “Cost of IP license, royalty and other revenue” consists of professional fees and services, overhead allocations, and obsolete inventory adjustments.

Operating Expenses. Operating expenses consist of sales and marketing, research and development, general and administrative expenses and amortization of intangible assets. Personnel-related costs, which include stock-based compensation expense, are the most significant component of each of these expense categories. We had 99 employees as of July 31, 2013 and 47 employees as of July 31, 2014. In any particular period, the timing of additional hires could materially affect our operating expenses, both in absolute dollars and as a percentage of revenue.

Sales and Marketing Expenses. Sales and marketing expenses include personnel costs, employee sales commissions and marketing programs. We have sales and marketing personnel throughout the United States and in our sales office in Germany.

Research and Development Expenses. Research and development expenses primarily include personnel costs, depreciation on lab equipment, costs of prototype equipment, other related costs of quality assurance and overhead allocations. We expense research and development costs as incurred. Though we incur software development costs, the costs of software development that we incur after a product has reached marketability are considered immaterial, and to date, we have not capitalized any such costs.

General and Administrative Expenses. General and administrative expenses consist primarily of compensation and related costs for personnel and facilities related to our executive, finance, human resource, information technology and legal organizations, and fees for professional services. Professional services, excluding those for IP (which are included in cost of revenue), consists of outside legal, tax and audit costs.

Interest Expense. Interest expense consists of amounts charged by lenders related to interest on our line of credit and term loans, both paid and accrued.

Amortization of Debt Discount and Issuance Costs Expense. Amortization of debt discount and issuance costs expense consists of the effective interest amortization of debt, which includes the amortization of financing costs, and the fair value of the Fortress warrants. It is separated from interest paid due to the material nature of both.

Critical Accounting Policies and Estimates

Contracts to Modify or Customize Products

We have entered into contracts with certain customers to significantly modify or customize products. In accounting for such arrangements, we first determine the accounting elements in the arrangement and then consider the appropriate recognition model for each accounting element based on the nature.  Amounts allocated to the modification/customization service element are evaluated for classification in the consolidated statement of operations as either revenue or reduction of research and development expense based on the following considerations: whether and in what circumstances the consideration received is refundable, ownership of the final product and intellectual property rights to develop the product, and exclusivity of the final product.

On March 4, 2013, FASB issued ASU 2013-05, Foreign Currency Matters (Topic 830) Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity (“ASU 2013-05”). ASU 2013-05 updates accounting guidance related to the application of consolidation guidance and foreign currency matters. This guidance resolves the diversity in practice about what guidance applies to the release of the cumulative translation adjustment into net income. This guidance is effective for interim and annual periods beginning after December 15, 2013. We anticipate adopting ASU 2013-05 beginning November 1, 2014. We do not anticipate that these changes will have a material impact on our consolidated financial statements or disclosures.

There have been no other material updates to our critical accounting policies and estimates set forth in “Part II—Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates” in our 2013 Form 10-K.

Results of Operations

Three and Nine Months Ended July 31, 2014 Compared to the Three and Nine Months Ended July 31, 2013

Revenue.   Total revenue decreased $0.7 million, or 25.3%, to $2.1 million for the three months ended July 31, 2014 from $2.8 million for the three months ended July 31, 2013. Total revenue decreased $0.6 million, or 6.3%, to $8.5 million for the nine months ended July 31, 2014 from $9.1 million for the nine months ended July 31, 2013.

Product revenues for the three months ended July 31, 2014 decreased $0.6 million, or 51.6%, to $0.6 million compared with $1.2 million for the three months ended July 31, 2013 due primarily to a decrease in revenue from StrongBox of $0.4 million from reduced product volume. The three months ending July 31, 2013 also included a final payment on an OEM rebranding contract for Strongbox. In addition, revenue from our SPHiNX product decreased $0.2 million due to lower licensing revenue from HP in the current fiscal quarter.

Product revenues for the nine months ended July 31, 2014 decreased $1.3 million, or 30.4%, to $2.9 million compared with $4.2 million for the nine months ended July 31, 2013 primarily due to a decrease of $0.8 million of SPHiNX licensing revenue from HP, as well as a decrease in Strongbox revenue of $0.5 million, due to the recognition of the final payment on an OEM rebranding contract in 2013, as well as revenue recognized on the Iron Mountain research and development services agreement.

IP license, royalty and other revenue consists of the following for the three and nine months ended July 31, 2014 and 2013:

IP license, royalty and other revenues for the three months ended July 31, 2014 decreased $0.1 million, or 4.4%, to $1.5 million compared with $1.6 million for the three months ended July 31, 2013.

IP license revenue increased $0.1 million as a result of increased ongoing royalties from certain licensees for the three months ended July 31, 2014. HP royalty and post contract support (PCS) service revenue decreased $0.1 million for the three months ended July 31, 2014, due to decreasing royalties for legacy router shipments, and reduced support for our SPHiNX product which HP is actively moving to their new platform. PCS and other service revenue (non-HP) decreased $0.1 million primarily due to revenue recognized from the Iron Mountain research and development services agreement during the fiscal third quarter of 2013.

IP license, royalty and other revenues for the nine months ended July 31, 2014 increased $0.7 million, or 14.4%, to $5.6 million compared with $4.9 million for the nine months ended July 31, 2013.

IP license revenue increased $0.9 million in 2014 as a result of the one-time increase in royalties received from a certain licensee. HP royalty and PCS service revenue decreased $0.1 million for the nine months ended July 31, 2014, compared to the nine months ended July 31, 2013, as a result of decreasing royalties for legacy router shipments, and reduced service revenue from our HP SPHiNX product which HP is actively moving to their new platform. PCS and other service revenue (non-HP) decreased $0.1 million primarily due to revenue recognized from the Iron Mountain research and development services agreement during the fiscal third quarter of 2013.

Cost of Revenue.   Cost of revenue decreased $0.3 million, or 38.0%, to $0.4 million for the three months ended July 31, 2014 from $0.7 million for the three months ended July 31, 2013. Product costs for the three months ended July 30, 2014 decreased $0.1 million, or 27.0%, to $0.1 million from $0.2 million for the three months ended July 31, 2013. IP license, royalty and other costs decreased $0.2 million, or 42.1%, for the three months ended July 31, 2014 to $0.3 million from $0.5 million for the three months ended July 31, 2013, due to reduced product volume.

Cost of revenue decreased $1.0 million, or 38.4%, to $1.5 million, for the nine months ended July 31, 2014 from $2.5 million for the nine months ended July 31, 2013. Product costs for the nine months ended July 31, 2014 remained consistent at $0.6 million. IP license, royalty and other costs decreased $1.0 million, or 50.5%, for the nine months ended July 31, 2014 to $0.9 million from $1.9 million for the nine months ended July 31, 2013, primarily due to $0.8 million of costs related to the Iron Mountain research and development services agreement during fiscal year 2013.

Sales and Marketing.   Sales and marketing expenses decreased $0.9 million, or 50.8%, to $0.9 million for the three months ended July 31, 2014 from $1.8 million for the three months ended July 31, 2013. This decrease was primarily due to decreased payroll and benefits expenses of approximately $0.7 million from a reduction-in-force in October 2013, reduced travel, entertainment and tradeshow related expenses of approximately $0.1 million, and contract labor and outside services of approximately $0.1 million. Headcount for our Sales and Marketing departments decreased from 36 from the fiscal quarter ended July 31, 2013 to 13 in the fiscal quarter ended July 31, 2014, a decrease of 63.8% and include business development, sales engineers and employees in our sales office in Germany.

Sales and marketing expenses decreased $2.8 million, or 49.6%, to $2.8 million for the nine months ended July 31, 2014 from $5.6 million for the nine months ended July 31, 2013. This decrease was primarily due to decreased payroll and benefits of approximately $1.8 million from a reduction-in-force in October 2013, travel, entertainment and tradeshow related expenses of $0.3 million, reduction in evaluation units, equipment and freight of $0.2 million, office related expenses in our German subsidiary of approximately $0.2 million, allocated overhead expenses of $0.1 million, contract labor and outside services of approximately $0.1 million, and other general departmental expenses of $0.1 million.

Research and Development.    Research and development expenses decreased $0.9 million, or 38.7%, to $1.4 million for the three months ended July 31, 2014 from $2.2 million for the three months ended July 31, 2013. This decrease was due to decreased payroll and benefits expense of approximately $0.8 million from a reduction-in-force in October 2013, and decreased contract labor and outside services of $0.1 million. Headcount for our research and development departments decreased from 47 from the fiscal quarter ended July 31, 2013 to 23 in the fiscal quarter ended July 31, 2014, a decrease of 51.1%. We anticipate research and development expenses will be consistent going forward.

Research and development expenses decreased $3.7 million, or 45.4%, to $4.4 million for the nine months ended July 31, 2014 from $8.1 million for the nine months ended July 31, 2013. This decrease was due to decreases in payroll and benefits of approximately $3.2 million from a reduction-in-force in October 2013, decreased consulting and outside services of $0.4 million, decreased equipment depreciation by $0.1 million, allocated overhead expense decreased by $0.1 million, and a decrease in other expenses of $0.1 million, offset by an increase in stock based compensation of $0.2 million.

General and Administrative.  General and administrative expenses decreased $0.6 million, or 33.8%, to $1.1 million for the three months ended July 31, 2014 from $1.7 million for the three months ended July 31, 2013. This decrease was due to decreased professional fees of approximately $0.3 million, payroll and benefits expense of approximately $0.2 million, and consulting and outside services of approximately $0.1 million. Headcount for our general and administrative departments decreased from 13 from the fiscal quarter ended July 31, 2013 to 10 in the fiscal quarter ended July 31, 2014, a decrease of 23.1%.

General and administrative expenses increased $0.2 million for the nine months ended July 31, 2014, or 4.3%, to $3.7 million, from $3.5 million for the nine months ended July 31, 2013. The increase was due to increases in professional fees by approximately $0.1 million, an increase in insurance expense of $0.1 million, and an increase in contract labor and outside services by $0.1 million, offset by decreased payroll, benefits, and stock based compensation of $0.1 million. We expect the absolute amount of general and administrative expenses going forward to be consistent with prior periods.

Gain on settlement.  Gain on settlement increased $1.1 million, or 100.0%, for the nine months ended July 31, 2014 from $0.0 million for the nine months ended July 31, 2013. The increase was due to the bifurcation of the payment received from IRM, between amounts received for work performed on the development of the product, and a gain from settlement. We recorded the amounts attributable to development as services revenue, and the gain on settlement was reflected as a reduction in operating expenses.

Interest expense.  Interest expense increased $131,000, or 247.2%, to $184,000 for the three months ended July 31, 2014 from $53,000 for the three months ended July 31, 2013. The increase was due to increased average outstanding debt for the three months ended July 31, 2014, at higher interest rates on the outstanding debt.

Interest expense increased $0.5 million, or 254.0%, to $0.7 million for the nine months ended July 31, 2014 from $0.2 million for the nine months ended July 31, 2013. The increase was due to increased average outstanding debt for the nine months ended July 31, 2014, at higher interest rates on the outstanding debt.

Amortization of debt discount and issuance costs.  Amortization of debt discount and issuance costs expense increased $0.3 million, or 1,781.3%, to $0.3 million for the three months ended July 31, 2014 from $16,000 for the three months ended July 31, 2013. The amortization relates to the additional borrowings drawn from Fortress during 2013.

Amortization of debt discount and issuance costs expense increased $1.0 million, or 5,943.8%, to $1.0 million for the nine months ended July 31, 2014 from $16,000 for the nine months ended July 31, 2013. The amortization relates to the additional borrowings drawn from Fortress during 2013.

Change in value of derivative liability.  The change in value of derivative liability was $0 for the three months ended July 31, 2014, and a benefit of $0.8 million, for the three months ended July 31, 2013. The change in value of derivative liability was an expense of $2.8 million, for the nine months ended July 31, 2014, and a benefit of $0.8 million, for the three months ended July 31, 2013. The change is the periodic revaluation of the warrants issued in connection with the Series F preferred shares sold during fiscal year 2013. In March 2014, upon the expiration of the full ratchet anti-dilution provisions, the Series F preferred stock and related warrants were reclassified as permanent stockholders' equity and the derivative liability associated with the warrants has been removed and recorded as a positive change in derivative liability in the statement of operations.

Liquidity and Capital Resources

Cash Flows

Our principal liquidity requirements are to meet our lease obligations, our working capital needs as well as the repayment of our line of credit from Fortress. Subject to our operating performance, which, if significantly adversely affected, would adversely affect the availability of funds, we expect to finance our operations through cash and cash equivalents provided by operations (including IP licensing) and customer reimbursed expenses, proceeds from the sale of our common stock or preferred stock, and exercises of options or warrants. Expected revenue from our newly introduced StrongBox product has been slower to materialize than expected, as the selling cycle for StrongBox is longer than our other products. We may require additional capital from equity or debt financings to fund our operations or respond to strategic opportunities. We are currently evaluating various alternatives to monetize our intellectual property or other financing arrangements. We may not be able to secure timely additional financing on favorable terms, or at all.

The following table summarizes our primary sources and uses of cash in the periods presented (in thousands):

Net cash used in operating activities decreased $7.6 million from $10.0 million for the nine months ended July 31, 2013 to $2.5 million in the nine months ended July 31, 2014. Net loss for the nine months ended July 31, 2014 was $7.3 million, reflecting a decrease of approximately $2.8 million compared with the nine months ended July 2013. Included in 2014 net loss were non-cash adjustments for the loss on derivative liability of $2.8 million, stock based compensation of $1.3 million, amortization of debt discount of $1.0 million, and depreciation of $0.5 million, reducing cash used in operating activities. These non-cash adjustments were offset partially by a decrease in professional fees included in accrued expenses of approximately $1.0 million, and a decrease in prepaid amounts for consulting and trade-show expenses included in prepaid expenses and other assets of $0.1 million during the nine months ended July 31, 2014.

Cash flows from investing activities primarily relate to capital expenditures to support our employees and our capital needs in our research and development efforts. Net cash used by investing activities was approximately $53,000 in the nine months ended July 31, 2014 compared to $334,000 in cash used by investing activities during the nine months ended July 31, 2013. In the nine months ended July 31, 2014, and 2013, cash used was primarily related to the purchase of property and equipment, and cash received from surplus equipment liquidated.

Cash flows provided by financing activities in the nine months ended July 31, 2014 was $1.8 million. Proceeds from the sale of common stock, and exercise of options and warrants amounted to approximately $5.5 million, offset by the repayment of debt of $3.6 million. Cash provided by financing activities in the nine months ended July 31, 2013 was $13.3 million, primarily from the borrowing of debt in the amount of $9.7 million, and the issuance of preferred stock and a bridge loan of approximately $8.0 million, partially offset by the repayment of debt of $4.3 million.

Financing Arrangements

Fortress Loan Transaction and Related Warrants. Effective July 22, 2013, we entered into a Credit Agreement (the “Credit Agreement”) with Fortress Credit Co LLC, an affiliate of Fortress Investment Group LLC (such affiliates collectively, “Fortress”) that provides for aggregate term loan commitments of up to $10.0 million, consisting of a term loan A (“Term Loan A”) in the principal amount of $5.0 million and a term loan B (“Term Loan B” and, together with Term Loan A, the “Term Loans”) in the principal amount of $5.0 million. We drew down the full $10.0 million of both Term Loans on July 24, 2013. The obligations of the Company under the Credit Agreement are secured by, among other things, substantially all of the assets of the Company.   In connection with our entry into this loan transaction with Fortress, we transferred 121 pending or granted non-’972 patents, which constitute substantially all of our patents other than those relating to the Company’s ’972 patent family, to a limited partnership of which we are a limited partner and of which an affiliate of Fortress is the general partner. The limited partnership concurrently provided the Company a non-exclusive license to the assigned non-’972 patent rights for the life of such patents, subject to earlier termination if we undergo an insolvency event.

Term Loan A will mature on July 22, 2016 and Term Loan B will mature on February 1, 2016. The outstanding principal balance of the Term Loans will bear interest at 10.0% per annum. Term Loan A requires payments of interest only until August 1, 2014, with the principal to be repaid in 24 equal monthly payments beginning on that date together with accrued interest. Term Loan B requires payments of interest only for six months after it is initially drawn, with the principal to be repaid in 24 equal monthly payments beginning on the first day of the month that is seven months after the date Term Loan B is initially drawn, together with accrued interest. The Company may prepay all or any part of the Term Loans at any time but would need to pay 3.0% upon repayment in entirety of either Load A or Loan B.

Under the Credit Agreement, we are subject to certain customary affirmative covenants, including, but not limited to, the obligations of the Company to deliver financial statements to Fortress, provide certain information and notices to Fortress, discharge all taxes, maintain good standing and governmental authorizations, maintain its properties and maintain insurance. The Company, Crossroads Systems (Texas), Inc., a wholly owned subsidiary of the Company (“Crossroads Texas”), and the limited partnership described above are also subject to certain customary negative covenants, including, but not limited to, limitations on dispositions, changes in the nature of business, mergers or acquisitions, distributions, investments and transactions with affiliates.

The Credit Agreement also contains certain covenants that generally protect the collateral granted to Fortress and the patents and patent rights of the Company, Crossroads Texas and the limited partnership. The Company is also subject to certain financial covenants, including (i) a requirement to maintain a minimum of $1,500,000 of unrestricted cash at each month end; (ii) a prohibition on making any cash dividend payments or distributions to any of its equity security holders other than dividends payable with respect to the Company’s presently issued and outstanding 5% Series F Convertible Preferred Stock (described below) and any additional shares of preferred stock issued pursuant to the transaction documents currently in effect pursuant to which the presently issued and outstanding shares of 5% Series F Convertible Preferred Stock were issued; and (iii) a prohibition on incurring other indebtedness without Fortress’s prior written consent or as provided in the Credit Agreement.

Events of Default are defined under the Credit Agreement to include, but are not limited to, actions by any of the Company, Crossroads Texas or the limited partnership that result in a payment default, breach of representations and warranties, failure to comply with specific covenants, other defaults under or invalidity of any loan documents, insolvency proceedings, inability to pay debts, change of control and certain events relating to the intellectual property of the Company.

The Credit Agreement also contains customary representations and warranties by the Company to Fortress and customary indemnification provisions.

As a condition to and in connection with the Credit Agreement, the Company issued to Fortress the Fortress Warrant, pursuant to which Fortress is entitled to purchase 1,454,545 shares of our common stock for $2.0625 per share. The Fortress Warrant is exercisable on or after October 22, 2013 and will expire on the seventh anniversary of the effective date of the Fortress transactions. If the Fortress Warrant is exercisable and there is no effective Registration Statement registering, or no current prospectus available for, the resale of, the shares of common stock issuable upon exercise of the Fortress Warrant, then the Fortress Warrant may also be exercised at such time by means of a “cashless exercise,” determined according to the terms of the Fortress Warrant.

These warrants also previously contained what is commonly known as a “full-ratchet” anti-dilution provision, which provided that if we issued or were deemed to have issued additional shares of common stock without consideration or for a consideration per share less than the applicable exercise price of the Fortress Warrants, which is initially $2.0625 per share, then the exercise price of the warrants will be reduced on a “full ratchet” basis, concurrently with the new issue, to the consideration per share we received for the new issue or deemed issue of the additional shares of common stock.

On January 23, 2014, we entered into an Amendment to the Fortress Warrant to remove the “full-ratchet” anti-dilution provision of the Fortress Warrant. This “full-ratchet” anti-dilution provision would have expired no later than July 22, 2014 under the original terms of the Warrant. As a result, the remaining long-term derivative liability was transferred to additional paid-in capital in January 2014.

Private Placements.

On March 22, 2013, we entered into a Securities Purchase Agreement with certain accredited investors for the issuance and sale in a private placement of 4,231,154 units at a purchase price of $2.0625 per unit, valued at $8.6 million, for net proceeds of approximately $7.9 million after related expenses.

Each unit consists of one share of 5.0% Series F convertible preferred stock, par value $0.001 per share and a warrant to purchase one-half of a share of common stock per share of convertible preferred stock purchased, at an exercise price of $2.00 per whole share, subject to certain adjustments, resulting in the issuance of warrants to purchase an additional 2,282,754 shares of common stock with an exercise price of $2.00 per share. The warrants were valued using the Black-Scholes pricing model at approximately $2,284,000 which resulted in a beneficial conversion feature on the convertible preferred stock of approximately $1,090,000. This amount was recorded as a deemed dividend.

The convertible preferred stock has the rights, qualifications, limitations and restrictions set forth in the Certificate of Designation (the “Certificate of Designation”) filed with the Secretary of State of the State of Delaware on March 28, 2013. The Certificate of Designation authorizes for issuance up to 4,500,000 shares of convertible preferred stock, with 3,750,000 shares designated as “Sub-Series F-1” and 750,000 shares designated as “Sub-Series F-2.” The right of holders of convertible preferred stock to convert the convertible preferred stock is subject to a 9.99% beneficial ownership limitation for holders of Sub-Series F-1 and a 4.99% beneficial ownership limitation for holders of Sub-Series F-2. Such beneficial ownership limitations may be increased or decreased by a holder of Sub-Series F-1 to any percentage not in excess of 19.99% after providing notice of such increase or decrease to the Company. For as long as at least 90% of the aggregate number of shares of Sub-Series F-1 issued on the Original Issue Date are outstanding, the holders of such Sub-Series F-1, voting as a single class, will be entitled to elect two directors of the Company. If less than 90%, but at least 20%, of such shares of Sub-Series F-1 are outstanding, such holders, voting as a single class, will be entitled to elect one director of the Company. As of the date hereof, less than 90% of the aggregate number of shares of Sub-Series F-1 are outstanding, as a remainder have been voluntarily converted into common stock at the option of the holders. Therefore, the holders of Sub-Series F-1 shares are entitled to elect one director to our board of directors. The holders of Sub-Series F-2 will not be entitled to vote on the directors elected by the holders of Sub-Series F-1. The holders of shares of the convertible preferred stock are entitled to a liquidation preference equal to the original issuance price plus accrued and unpaid dividends.

The Certificate of Designation contains customary anti-dilution protection for proportional adjustments (e.g. stock splits). The Series F convertible preferred stock previously included an anti-dilution provision that would adjust the conversion price of the Series F convertible preferred stock to the issue price of any equity securities we issued at a price less than $2.0625 per share, subject to certain exceptions. This type of provision is commonly referred to as a “full-ratchet” anti-dilution provision. This “full-ratchet” provision is no longer in effect as it was removed from the Certificate of Designation on March 14, 2014 by the requisite approval of the holders of shares of our common stock and Series F convertible preferred stock. In accordance with ASC 815-40-25 and ASC 815-10-15 Derivatives and Hedging and ASC 480-10-25 Liabilities-Distinguishing Liabilities from Equity, the convertible preferred shares are accounted for net, outside of stockholder’s equity and warrants may be accounted for as liabilities at their fair value during periods where the full ratchet anti-dilution provision is in effect, which could have a significant impact on the Company’s financial statements. Upon the expiration of the full ratchet anti-dilution provisions in March 2014, the Company reclassified the preferred stock and warrants to permanent stockholders' equity.

The Series F warrants are accounted for as a liability at their fair value of $0.8 million as of October 31, 2013. The value of the derivative warrant liability was re-measured at each reporting period with changes in fair value recorded as earnings. Crossroads engaged an independent company to value its derivative liability and perform re-measurements. To derive an estimate of the fair value of these warrants, a dynamic Black Scholes Merton formula is utilized that computes the impact of share dilution upon the exercise of the warrant shares. This process relied upon inputs such as shares outstanding, estimated stock prices, strike price and volatility assumptions to dynamically adjust the payoff of the warrants in the presence of the dilution effect. In the event the convertible preferred shares were redeemed, any redemption price in excess of the carrying amount of the convertible preferred stock would be treated as a dividend.

The warrants became exercisable six months after the closing date of the issuance, and expire March 22, 2018.

Dividends on the Series F convertible preferred stock accrue at an annual rate of 5.0% of the original issue price and are payable on a semi-annual basis. The convertible preferred ranks senior to the common stock and each other class or series of the Company’s capital stock, whether common, preferred or otherwise, with respect to distributions of dividends and distributions upon liquidation, dissolution or winding up of the Company. Pursuant to a registration rights agreement entered into with the purchasers of the Series F convertible preferred stock, in the event that a registration statement for the resale of the common stock underlying the convertible preferred stock and March 2013 warrants was not declared effective prior to July 26, 2013 (120 days from the closing of the March 2013 private placement), then the rate at which dividends accrue on our convertible preferred stock will be increased to an annual rate of 12.0% from that date until such time as a registration statement is declared effective, at which time the dividend rate will revert to an annual rate of 5.0%. Our registration statement was not declared effective by July 26, 2013, and as a result the dividend rate on the convertible preferred stock at present increased to an annual rate of 12.0% until September 19, 2013, when that registration statement was declared effective. We may elect to satisfy our obligation to pay semi-annual dividends in cash, by distribution of common stock or a combination thereof, in our discretion.

On February 28, 2013, we issued promissory notes to two investors for an aggregate principal amount of $550,000. Pursuant to the terms of the notes, both note holders had the right to convert the outstanding amounts under their notes into units at a discount of 15% to the issue price of the units. Each note holder exercised this right and received 188,235 units resulting from converting $330,000 of promissory notes and interest, and 156,863 units resulting from converting $275,000 of promissory notes and interest.

On March 31, 2014, we entered into a Securities Purchase Agreement with certain accredited investors for the issuance and sale in a private placement of 1,986,622 units, at a purchase price of $2.2565 per unit for net proceeds of approximately $4.5 million before expenses. Affiliates of Lone Star Value Management, LLC, of which our Chairman serves as a managing member, purchased approximately $2.9 million of Units. Roth Capital Partners acted as financial advisor to the Company in the transaction, which was negotiated and approved by a special committee of the board of directors. We did not engage a placement agent in connection with the Private Placement, and therefore paid no commissions.

Each Unit consists of one share of our Common Stock, par value $0.001 per share, and warrants to purchase one-half of a share of Common Stock, at a weighted average exercise price of $2.45 per whole share.

Recent Accounting Pronouncements

In July 2013, the FASB issued new accounting guidance on the presentation of unrecognized tax benefits. This new guidance requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists, with limited exceptions. The prospective adoption of this new accounting guidance in the first quarter of 2014 did not have a material impact on our consolidated financial position, results of operations or cash flows.

In March 2013, the FASB issued guidance that requires a parent company to release any related cumulative translation adjustment into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. The adoption of this new accounting guidance in the first quarter of 2014 did not have a material impact on our consolidated financial position, results of operations or cash flows.

In May 2014, the FASB issued new accounting guidance on Revenue from Contracts with Customers, which supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, including most industry-specific revenue recognition guidance throughout the Industry Topics of the Codification. In addition, the amendments supersede the cost guidance in Subtopic 605-35, Revenue Recognition—Construction-Type and Production-Type Contracts, and create new Subtopic 340-40, Other Assets and Deferred Costs—Contracts with Customers. In summary, the core principle of the guidance is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. The Company has not evaluated the potential impact on the Company’s financial statements from the adoption of this update.

Not applicable.

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, our management has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective (i) to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms; and (ii) to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

Changes in Internal Controls

During the last fiscal quarter, there were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Intellectual Property Litigation

The Company filed a lawsuit on September 11, 2013 against Dot Hill Systems Corp. ("Dot Hill") styled Crossroads Systems, Inc. v. Dot Hill Systems Corp., Civil Action No. 1:13-CV-800-SS alleging patent infringement of U.S. Patent No. 6,425,035and breach of the Amended Settlement and License Agreement dated June 27, 2006 between Crossroads and Dot Hill. Dot Hill has filed a motion to dismiss and Crossroads has filed its response; the Court denied Dot Hill’s motion. Dot Hill recently filed a partial motion for summary judgment regarding whether certain products Dot Hill sells are subject to royalties under the Amended Settlement and License Agreement. Crossroads has prepared and filed its response requesting summary judgment in its favor on this issue. The Markman hearing is scheduled for October 6-7, 2014.

The Company filed a lawsuit on October 7, 2013 against Oracle Corporation alleging infringement by Oracle Corporation of U.S. Patent Nos. 6,425,035, 7,051,147 and 7,934,041 (the case is styled Crossroads Systems, Inc., v. Oracle Corporation; Civil Action No. 1:13-CV-895-SS (W.D. Tex., Austin Division)). Oracle has answered the complaint and the action is pending. The Markman hearing is scheduled for October 6-7, 2014. Oracle is also a party to four petitions for Inter Partes Review filed at the United States Patent and Trademark Office, which collectively challenge the validity of each asserted patent. Crossroads is preparing its responses to these petitions.

The Company filed a lawsuit on November 26, 2013 against Tandberg Data Corporation alleging infringement by Tandberg Data Corporation of U.S. Patent Nos. 6,425,035 and 7,934,041 (the case is styled Crossroads Systems, Inc. v. Tandberg Data Corporation; Civil Action No. 1:13-cv-01026-SS (W.D. Tex., Austin Division)). This case was settled in May 2014, and subsequently dismissed.

The Company filed a lawsuit on November 26, 2013 against Huawei Technologies Co. Ltd., Huawei Enterprise USA, Inc. & Huawei Technologies USA, Inc. alleging infringement of U.S. Patent Nos. 6,425,035, 7,051,147 and 7,934,041 (the case is styled Crossroads Systems, Inc. v. Huawei Technologies Co., Ltd. et al; Civil Action No. 1:13-cv-01025-SS (W.D. Tex., Austin Division)). Huawei has answered the complaint and the action is pending. The Markman hearing is scheduled for October 6-7, 2014. Huawei is also a party to four petitions for Inter Partes Review filed at the United States Patent and Trademark Office, which collectively challenge the validity of each asserted patent. Crossroads is preparing its responses to these petitions.

The Company filed a lawsuit on November 26, 2013 against Dell Inc. alleging infringement of U.S. Patent Nos. 6,425,035 and 7,934,041 (the case is styled Crossroads Systems, Inc. v. Dell Inc.; Civil Action No. 1:13-cv-01023-SS (W.D. Tex., Austin Division)). This case was dismissed without prejudice in June 2014..

The Company filed a lawsuit on February 18, 2014 against Cisco Systems, Inc. alleging infringement of U.S. Patent Nos. 6,425,035 and 7,934,041 (the case is styled Crossroads Systems, Inc. v. Dell Inc.; Civil Action No. 1:14-cv-00148-SS (W.D. Tex., Austin Division)). Cisco has answered the complaint and the action is pending. The Markman hearing is scheduled for October 6-7, 2014. Cisco is also a party to two petitions for Inter Partes Review filed at the United States Patent and Trademark Office, which challenges the validity of U.S. Patent No. 6,425,035. Crossroads is preparing its responses to this petition.

The Company filed a lawsuit on February 18, 2014 against NetApp, Inc. alleging infringement of U.S. Patent Nos. 6,425,035, 7,934,041, 7,987,311 and 7,051,147 (the case is styled Crossroads Systems, Inc. v. Dell Inc.; Civil Action No. 1:14-cv-00149-SS (W.D. Tex., Austin Division)). NetApp has answered and the action is pending. The Markman hearing is scheduled for October 6-7, 2014. NetApp is also a party to five petitions for Inter Partes Review filed at the United States Patent and Trademark Office, which collectively challenge the validity of each asserted patent. Crossroads is preparing its responses to these petitions.

The Company filed a lawsuit on February 18, 2014 against Quantum Corporation alleging infringement of U.S. Patent Nos. 6,425,035 and 7,934,041 (the case is styled Crossroads Systems, Inc. v. Dell Inc.; Civil Action No. 1:14-cv-00150-SS (W.D. Tex., Austin Division)). Quantum has answered the complaint and the action is pending. The Markman hearing is scheduled for October 6-7, 2014. Quantum is also a party to two petitions for Inter Partes Review filed at the United States Patent and Trademark Office, which challenges the validity of U.S. Patent No. 6,425,035. Crossroads is preparing its responses to this petition.

On April 15, 2014, NetApp, Inc. filed an action for declaratory judgment of non-infringement of U.S. Patent Nos. 7,987,311 and 7,051,147 (the case is styled NetApp, Inc. v. Crossroads Systems, Inc.; Civil Action No. 4:14-CV-01727-JSW (N.D. Cal., Oakland Division). This action has been dismissed based on a joint request by the parties.

The following risk factor is provided to supplement and update the risk factors contained in the reports we file with the SEC, including the risk factors contained in ITEM 1A of Part I of our Annual Report on Form 10-K for the year ended October 31, 2013.

We adopted a tax benefits preservation plan, designed to preserve the value of certain income tax assets, primarily tax net operating loss carryforwards (“NOLs”), which may discourage acquisition and sale of large blocks of our stock and may result in significant dilution for certain stockholders. On May 23, 2014, we adopted a tax benefits preservation plan in the form of a Section 382 Rights Agreement (the “382 Agreement”). The 382 Agreement is designed to preserve stockholder value and the value of certain income tax assets primarily associated with NOLs by acting as a deterrent to any person acquiring beneficial ownership of 4.99% or more of the Company’s outstanding common stock (including shares of Series F Preferred Stock) without the approval of the board of directors. The 382 Agreement may discourage existing 5% stockholders from selling their interest in a single block which may impact the liquidity of the Company's common stock, may deter institutional investors from investing in our stock, and may deter potential acquirers from making premium offers to acquire the Company, factors which may depress the market price of our stock.

In July 2014, the company issued an aggregate of 73,396 shares of common stock as a dividend to the holders of its Series F convertible preferred stock.

The issuance of these securities was exempt from the registration requirements of the Securities Act of 1933, as amended (the Securities Act), as under applicable Securities and Exchange Commission guidance, the issuance did not constitute a “sale” within the meaning of Section 2(a)(3) of the Securities Act.

None

Not applicable.

None.

SIGNATURES

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

---

Dates Referenced Herein   and   Documents Incorporated by Reference

This ‘10-Q’ Filing		Date		Other Filings
		3/31/20
		3/31/19
		3/22/18
		12/15/16
		7/22/16
		2/1/16
		10/22/15		4
		7/31/15		10-Q,  4
		2/28/15
		12/31/14		4,  SC 13D/A
		11/1/14
		10/31/14		10-K,  4
Filed on:		9/10/14		4
		8/1/14		4
For Period end:		7/31/14		4,  CORRESP,  UPLOAD
		7/30/14
		7/22/14
		6/4/14
		5/23/14		8-A12B,  8-K
		5/2/14		3
		4/30/14		10-Q,  4
		4/15/14
		3/31/14		3,  4,  8-K
		3/14/14		8-K,  8-K/A,  DEF 14A
		2/18/14		4,  8-K
		1/31/14		10-Q,  4
		1/23/14		10-K,  8-K
		12/19/13
		12/15/13
		11/26/13		4,  424B3,  8-K
		10/31/13		10-K,  4
		10/24/13		8-K
		10/22/13
		10/7/13		8-K
		9/19/13		EFFECT
		9/11/13
		7/31/13		10-Q,  4,  4/A
		7/26/13		S-1/A
		7/24/13		3,  424B3,  8-K
		7/22/13
		6/21/13		3,  8-K,  8-K/A
		5/10/13		S-1
		5/8/13		424B3,  8-K,  DEFA14A
		3/28/13
		3/22/13		10-Q/A,  4,  8-K,  8-K/A
		3/4/13
		2/28/13		8-K
		7/31/12		10-Q,  4,  8-K
		10/23/10
		8/13/10
		5/26/10
		6/27/06
		10/31/05
				List all Filings

↑Top

---

Filing Submission 0001144204-14-055253   –   Alternative Formats (Word / Rich Text, HTML, Plain Text, et al.)

---

---

Copyright © 2024 Fran Finnegan & Company LLC – All Rights Reserved.
About — Privacy — Redactions — Help — Fri., Apr. 19, 2:42:19.2pm ET