SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
---------
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
-------------------------------------------------
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NUMBER 1-13616
STORAGE COMPUTER CORPORATION
----------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 02-0450593
-------- ----------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
11 RIVERSIDE STREET NASHUA, NH 03062
------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(603) 880-3005
--------------
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Number of shares outstanding of the registrant's class of common stock, as of
the latest practicable date.
OUTSTANDING AT
CLASS NOVEMBER 2, 2001
----- ----------------
Common Stock 15,960,184
1
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited). Page
Consolidated Balance Sheets - September 30, 2001 3
and December 31, 2000.
Statements of Consolidated Operations - Three and nine months 4
ended September 30, 2001 and 2000.
Statements of Consolidated Cash Flows - Nine months 5
ended September 30, 2001 and 2000.
Notes to Consolidated Financial Statements - September 30, 2001. 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations. 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 13
PART II - OTHER INFORMATION
Item 1. Legal Proceedings. 14
Item 2. Changes in Securities and Use of Proceeds. 14
Item 3. Defaults Upon Senior Securities. 14
Item 4. Submission of Matters to a Vote of Security Holders. 14
Item 5. Other Information. 14
Item 6. Exhibits and Reports on Form 8-K. 14
2
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Storage Computer Corporation
Consolidated Balance Sheets
September 30, December 31,
2001 2000
---- ----
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 7,313,205 $ 14,852,259
Accounts receivable, net 1,294,475 847,829
Inventories 4,380,387 4,316,104
Due from officers and directors 1,584,360 -
Other current assets 279,425 399,302
------------ ------------
Total current assets 14,851,852 20,415,494
Property and equipment, net 954,473 1,141,299
Goodwill and other intangibles, net 20,954,751 23,317,443
Other assets 105,796 244,040
------------ ------------
Total assets $ 36,866,872 $ 45,118,276
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 884,649 $ 896,049
Accrued expenses 2,404,954 2,436,291
Deferred revenue and customer deposits 533,123 492,028
Current maturities of long-term debt 252,901 263,863
------------ ------------
Total current liabilities 4,075,627 4,088,231
------------ ------------
Long-term debt, less current maturities 1,239,937 1,489,299
------------ ------------
Commitments and contingencies - -
Redeemable convertible preferred stock 12,350,491 12,556,661
------------ ------------
Shareholders' equity:
Preferred stock 2,108,822 -
Common stock 15,791 15,042
Additional paid-in capital 64,079,406 57,792,635
Accumulated deficit (47,003,202) (30,823,592)
------------ ------------
Total shareholders' equity 19,200,817 26,984,085
------------ ------------
Total liabilities and shareholders' equity $ 36,866,872 $ 45,118,276
============ ============
See Notes to Consolidated Financial Statements.
3
Storage Computer Corporation
Statements of Consolidated Operations (Unaudited)
Three Months Ended Nine Months Ended
------------------ -----------------
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
---- ---- ---- ----
Revenue $ 2,176,028 $ 1,037,920 $ 5,186,303 $ 5,187,596
Product cost including inventory
restructuring cost in 2000 1,524,368 3,728,058 3,860,888 5,688,941
----------- ----------- ------------ -----------
Gross margin 651,660 (2,690,138) 1,325,415 (501,345)
----------- ----------- ------------ -----------
Operating expenses:
Research and development 884,252 329,911 3,262,381 997,776
Selling and marketing 1,364,027 657,856 3,176,607 1,664,500
General and administrative 1,254,178 713,844 3,040,865 1,702,631
Amortization of intangibles 707,934 186,855 2,123,802 186,855
Restructuring costs - 740,130 - 740,130
----------- ----------- ------------ -----------
Total operating expenses 4,210,391 2,628,596 11,603,655 5,291,892
----------- ----------- ------------ -----------
Operating loss (3,558,731) (5,318,734) (10,278,240) (5,793,237)
----------- ----------- ------------ -----------
Other income (expense):
Interest income (expense), net 69,671 (59,618) 258,339 (354,307)
Other expense (180,812) (249,828) (77,832) (128,854)
----------- ----------- ------------ -----------
Total (111,141) (309,446) 180,507 (483,161)
----------- ----------- ------------ -----------
Loss before income taxes (3,669,872) (5,628,180) (10,097,733) (6,276,398)
Provision for
income taxes - 13,763 1,214 13,763
----------- ----------- ------------ -----------
Net loss (3,669,872) (5,641,943) (10,098,947) (6,290,161)
Dividends on preferred stock
including amortization of the
beneficial conversion features (3,679,443) (991,841) (6,080,663) (1,613,191)
----------- ----------- ------------ -----------
Loss applicable to
common stockholders $(7,349,315) $(6,633,784) $(16,179,610) $(7,903,352)
=========== =========== ============ ===========
Loss applicable to common
stockholders per basic and
dilutive share $(.47) $(.53) $(1.03) $(.63)
=========== =========== ============ ===========
Basic and dilutive shares 15,785,925 12,522,675 15,658,455 12,417,098
=========== =========== ============ ===========
See Notes to Consolidated Financial Statements.
4
Storage Computer Corporation
Statements of Consolidated Cash Flows (Unaudited)
Nine Months Ended
-----------------
September 30, September 30,
2001 2000
------------ -----------
Cash flows from operating activities:
Net loss $(10,098,947) $ (6,290,161)
Reconciliation to operating cash flows:
Depreciation and amortization of property and equipment 408,113 572,262
Amortization of goodwill and other intangibles 2,123,802 186,855
Provision for restructuring costs - 3,737,712
Stock issued to 401(k) plan 42,707 30,868
Changes in operating assets and liabilities:
Accounts receivable (446,646) (472,256)
Inventories (54,443) 404,865
Advances to directors and officers (1,584,360)
Other current assets 119,877 517,523
Accounts payable and accrued expenses (662,152) 569,605
------------ ------------
Net cash used in operations (10,152,049) (742,727)
------------ ------------
Cash flows from investing activities:
Capital expenditures (221,287) (181,348)
Other assets 138,243 482,708
CyberStorage acquisition cost adjustments 238,885 -
------------ ------------
Net cash provided by investing activities 155,841 301,360
------------ ------------
Cash flows from financing activities:
Net payments on credit line - (6,600,445)
Reduction of long-term debt (260,324) 1,162,168
Net proceeds from issuance of common stock
for stock options and warrants 27,649 829,036
Issuance of preferred stock 4,830,217 9,324,169
Redemption of preferred stock (2,130,548) -
------------ ------------
Net cash provided by financing activities 2,466,994 4,714,928
------------ ------------
Effect of exchange rate changes on cash (9,840) (14,617)
------------ ------------
Net decrease in cash and cash equivalents (7,539,054) (4,258,944)
Cash and cash equivalents-beginning of period 14,852,259 1,182,194
------------ ------------
Cash and cash equivalents-end of period $ 7,313,205 $ 5,441,138
============ ============
Supplemental cash flow information:
Cash payments of interest $ 112,615 $ 167,809
Cash payments of income taxes $ 1,214 $ 10,380
Non-cash investing and financing activities:
Acquisition of CyberStorage:
Fair value of assets acquired $ 24,725,096
Common stock issued (22,440,000)
Liabilities assumed (2,285,096)
------------
$ -
============
Preferred stock dividends paid in common stock $ 300,492 $ 94,458
See Notes to Consolidated Financial Statements.
5
Storage Computer Corporation
Notes to Consolidated Financial Statements
September 30, 2001
Note A - The Company and Basis of Presentation
Storage Computer Corporation ("Company", "we" and "us") and our subsidiaries are
engaged in the development, manufacture, and sale of computer disk arrays and
computer equipment worldwide. The consolidated financial statements include the
accounts of the Company and those of our wholly-owned subsidiaries CyberStorage
Systems Corporation, Storage Computer Europe GmbH, Vermont Research Products,
Inc., Storage Computer UK, Ltd., and Storage Computer France S.A. All
significant intercompany accounts and transactions have been eliminated in
consolidation. We have a 20% investment in Storage Computer (Asia) Ltd. which is
accounted for by the equity method.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information. Accordingly, they do not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements and should be read in conjunction with the financial
statements and related notes included in our Annual Report on Form 10-K filed
with the Securities and Exchange Commission, containing our financial statements
for the fiscal year ended December 31, 2000. In our opinion, the accompanying
financial statements reflect all adjustments, all of which are of a normal,
recurring nature, to fairly present our consolidated financial position, results
of operations and cash flows. The results of operations for the nine months
ended September 30, 2001 are not necessarily indicative of the results to be
expected for the full year.
During the fourth quarter of 2000, the Financial Accounting Standards Board
issued Emerging Issues Task Force (EITF) 00-27 "Application of EITF issue No.
98-5, Accounting for Convertible Securities with Beneficial Conversion Features
or Contingency Adjustable Conversion Ratios, to certain Convertible
Instruments". EITF No. 00-27 requires the remeasurement of the original issue
discount on preferred stock with characteristics similar to the convertible
preferred stock issued by the Company, during fiscal year 2000. This accounting
change requires the value of the warrants issued with the preferred stock to be
included in the calculating the beneficial conversion value. This resulted in a
cumulative charge of $809,364 to loss applicable to common stockholders in the
fourth quarter of 2000 reported in our Annual Report Form 10-K for 2000. In
addition, the quarterly results of operations for the second and third quarters
of 2000 were restated in Note M of our Annual Report Form 10-K from the amounts
previously reported in our quarterly reports Forms 10-Q for the quarters ended
June 30, 2000 and September 30, 2000. The loss applicable to common stockholders
for the quarter ended September 30, 2000 has been restated in this Form 10-Q to
properly reflect the results for the three and nine months ended September 30,
2000 in accordance with EITF 98-5.
Certain 2000 amounts have been reclassified to conform with the current period
presentation.
6
Note B - Stockholders' Equity
A summary of changes in stockholders' equity in the nine months ended September
30, 2001follows:
Common Stock
------------ Additional
Par Paid-In Retained
Preferred Stock Shares Value Capital Deficit
--------------- ------ ----- ------- -------
Balance - December 31, 2000 $ _ 15,041,882 $ 15,042 $57,792,635 $(30,823,592)
Exercise of stock options 13,294 13 27,636
Stock issued to 401(k) plan 6,499 7 42,700
Dividends on preferred stock paid
in common shares 58,077 58 238,276
Accrued dividends on preferred stock (916,555)
Conversion of redeemable
convertible preferred stock and
accrued dividends into common shares 671,256 671 61,487
Issuance of Series E preferred
stock and warrants to purchase
common stock:
Proceeds, net of issuance costs 4,830,217
Allocation of fair value to
warrants using the Black-Scholes
option-pricing model (2,804,000) 2,804,000
Beneficial conversion feature at
commitment date charged
directly to accumulated deficit 3,112,672 (3,112,672)
Amortization of preferred stock
beneficial conversion feature, warrants
and other costs charged to accumulated
deficit 82,605 (2,051,436)
Net loss (10,098,947)
---------- ---------- -------- ----------- ------------
Balance - September 30, 2001 $2,108,822 15,791,008 $ 15,791 $64,079,406 $(47,003,202)
========== ========== ======== =========== ============
Note C - Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board finalized FASB Statements
No. 141, Business Combinations ("SFAS 141"), and No. 142, Goodwill and Other
Intangible Assets ("SFAS 142"). SFAS 141 requires the use of the purchase method
of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after June 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized. SFAS 142 requires the Company to complete a transitional
goodwill impairment test six months from the date of adoption. The Company is
also required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS 142.
The Company's previous business combinations were accounted for using the
purchase method. As of September 30, 2001, the net carrying amount of goodwill
is $16,756,000 and other intangible assets is $4,199,000. Amortization expense
during the nine-month period ended September 30, 2001 was $2,123,802. Currently,
the Company is assessing but has not yet determined how the adoption of SFAS 141
and SFAS 142 will impact its financial position and results of operations.
7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
CAUTIONARY STATEMENT
Forward-looking Statements
THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1996 CONTAINS CERTAIN SAFE
HARBORS REGARDING FORWARD-LOOKING STATEMENTS. FROM TIME TO TIME, INFORMATION
PROVIDED BY US OR STATEMENTS MADE BY OUR DIRECTORS, OFFICERS OR EMPLOYEES MAY
CONTAIN "FORWARD-LOOKING" INFORMATION SUBJECT TO NUMEROUS RISKS AND
UNCERTAINTIES. ANY STATEMENTS MADE HEREIN THAT ARE NOT STATEMENTS OF HISTORICAL
FACT ARE FORWARD-LOOKING STATEMENTS INCLUDING, BUT NOT LIMITED TO, STATEMENTS
CONCERNING THE CHARACTERISTICS AND GROWTH OF OUR MARKETS AND CUSTOMERS, OUR
OBJECTIVES AND PLANS FOR FUTURE OPERATIONS AND PRODUCTS AND OUR EXPECTED
LIQUIDITY AND CAPITAL RESOURCES. SUCH FORWARD-LOOKING STATEMENTS ARE BASED ON A
NUMBER OF ASSUMPTIONS AND INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES, AND,
ACCORDINGLY, ACTUAL RESULTS COULD DIFFER MATERIALLY. FACTORS THAT MAY CAUSE
SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO: THE CONTINUED AND FUTURE
ACCEPTANCE OF OUR PRODUCTS; THE RATE OF GROWTH IN THE INDUSTRIES OF OUR
PRODUCTS; THE PRESENCE OF COMPETITORS WITH GREATER TECHNICAL, MARKETING AND
FINANCIAL RESOURCES; OUR ABILITY TO PROMPTLY AND EFFECTIVELY RESPOND TO
TECHNOLOGICAL CHANGE TO MEET EVOLVING CUSTOMER NEEDS; RISKS ASSOCIATED WITH
SALES IN FOREIGN COUNTRIES; AND OUR ABILITY TO SUCCESSFULLY EXPAND OUR
OPERATIONS.
INTRODUCTION
This discussion summarizes the significant factors affecting the liquidity,
capital resources and result of all operations for the periods ended September
30, 2001 and 2000. The discussion should be read in connection with the
Consolidated Financial Statements and other financial information included in
our 2000 Annual Report on Form 10-K filed with the Securities and Exchange
Commission.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW
Operations used $10,152,000 of cash during the first nine months of 2001
compared to $743,000 in the first nine months of 2000.
The use of cash by operations in the first nine months of 2001 resulted from the
net loss for that period and net cash used for changes in operating assets and
liabilities including advances to directors and officers which were offset by
non-cash charges relating to depreciation and amortization of $2,532,000. The
cash used by operations in the first nine months of 2000 resulted primarily from
the net loss for that period which was offset in part by net cash provided by
changes in operating assets and liabilities, by non-cash charges relating to
depreciation and amortization of $759,000 and a provision for restructuring
costs of $3,738,000.
Investing activities provided cash flow of $156,000 in the first nine months of
2001 from an adjustment to the purchase price of CyberStorage and other assets
partially offset by capital expenditures. Investing activities provided cash
flow of $301,000 in the first nine months of 2000 primarily from other assets
partially offset by capital expenditures.
Financing activities provided $2,467,000 of cash in the first nine months of
2001 primarily from the proceeds of $4,830,217 from the sale of Series E
preferred stock, net of the costs of the redemption of Series A and B preferred
stock of $2,131,000. During the first nine months of 2000, our bank credit
facility was paid off with the proceeds of the sale of Series A preferred stock
and through the exercise of options and warrants.
BORROWING ARRANGEMENTS
We currently have no outstanding bank loans, lines of credit, or credit
facilities. We previously had a revolving credit facility that we repaid and
terminated in August 2000.
8
WORKING CAPITAL
Our working capital at September 30, 2001 was $10,776,000 compared with
$16,327,000 at December 31, 2000. In management's opinion, our current working
capital position and cash from operations, will be sufficient to accommodate
working capital requirements through the fiscal year ending December 31, 2001.
EQUITY FINANCING
During 2000, we successfully raised over $22 million from several investors
through the sale of Series A, Series B and Series C preferred stock, related
warrants and exercise of stock options. In August 2000 we designated a Series D
preferred stock but no shares were issued. The series expired on July 31, 2001
by its own terms. In August 2001 we raised an additional $5 million through the
sale of Series E preferred stock. These sales to investors have significantly
improved our cash availability to fund our working capital requirements.
RESULTS OF OPERATIONS
Our operating results have fluctuated in the past and may in the future
fluctuate significantly, depending upon a variety of factors. During 2000 we
undertook the following actions to facilitate our focus towards revenue growth:
appointed a new President, a new Chief Financial Officer and a new Chief
Operating Officer who is responsible for sales and marketing and, after the
acquisition of CyberStorage Systems Corporation, commenced a restructuring,
including the expansion of North America territories from three designated
regions to seven regions, the initiation of the plan to re-establish the re-
seller sales channel, and consolidation of the European sales, marketing and
service organizations; implemented strategic marketing programs and product
development and repositioning. We believe these actions and the recruitment of
new sales and marketing management, and staff, in 2001, will provide revenue
growth that will enable us to return to profitability. Currently, we are
experiencing an extended cycle for receipt of new orders due to the introduction
of our new sales and marketing management and staff persons, the marketing and
training cycles related to the new sales staff and the introduction of new
products and the current economic climate for the storage sector.
Additional factors that may contribute to variability of operating results
include: trends in national and world-wide economic growth or recession; the
pricing and mix of products offered by us; changes in pricing of our products
and services due to competitive pressures; our ability to obtain sufficient
supplies of sole or limited source components; the ability to manage future
growth and expansion; the continual development of new products; the ability to
successfully identify, target, acquire and integrate suitable acquisitions.
REVENUE
Revenue for the three month period and nine month periods ended September 30,
2001 were $2,176,000 and $5,186,000 compared to $1,038,000 and $5,188,000 for
the respective periods in 2000. Revenue growth for both international and
domestic products continue to be impacted by the factors described above. For
the three month period ended September 30, 2001, U.S. domestic product sales and
international product sales were 77% and 23%, respectively, of total revenue
compared to 47% and 53% for the same period in 2000. For the nine month period
ended September 30, 2001, U.S. domestic product sales and international product
sales were 73% and 27%, respectively, of total revenue compared to 65% and 35%
for the same period in 2000.
All United States export sales are denominated in United States dollars to limit
the amount of foreign currency risk. Export sales from the European sales
offices are denominated in United States dollars. Sales which occur through our
subsidiaries located in England, Germany and France are conducted in the local
currency.
PRODUCT COST
After adjusting for the $3 million inventory restructuring costs in the third
quarter of 2000, product costs for the three months ended September 30, 2001 and
2000 were approximately 70% of sales in both periods and for the nine month
periods ended September 30, 2001 and 2000 the product cost percentages were
approximately 74% and 52%, respectively. This was the result of increased
factory costs of enhanced quality assurance programs and higher technical
service expenditures both of which have been implemented in anticipation of our
planned growth in sales but are incurred currently on lower sales volumes
partially offset in the three months ended September 30, 2001 by higher margins
on product mix sold compared to the same period in 2000.
9
RESEARCH AND DEVELOPMENT
Research and development expenses for the three month periods ended September
30, 2001 and 2000 were $884,000 and $330,000, respectively, and $3,263,000 and
$998,000, respectively, for the nine month periods ended September 30, 2001 and
2000. The $883,000 increase in expenditures between the three month periods
ended March 31, 2000 and 2001 was reduced to an increase of $498,000 for the
three month periods ended June 30, 2001 and 2000 and increased to $554,000 for
the three months ended September 30, 2001 and 2000. This is a direct result of
increased research and product development personnel who have permanently joined
our staff and a reduction in the utilization of independent software engineers
for short term assignments.
SELLING AND MARKETING EXPENSES
Selling and marketing expenses for the three month period and the nine month
period ended September 30, 2001 continued to reflect the increased head count in
corporate, marketing and field sales organizations over the comparable period in
2000. During 2001 increased costs are associated with greater trade show
activity of $170,000 and marketing materials and web site development costs of
$80,000 and increases in salesmen's travel and commissions.
GENERAL AND ADMINSTRATIVE EXPENSES
General and administrative expenses for the three month period and the nine
month period September 30, 2001, reflect the higher level of personnel due to
the CyberStorage acquisition. In the three month and nine month period ended
September 30, 2001 costs were incurred by U.K. attorneys and by expert witnesses
aggregating $395,000 and $748,000, respectively, in connection with our
intellectual properties litigation.
AMORTIZATION OF INTANGIBLES
Amortization of intangibles relates to the amortization of goodwill and other
intangibles acquired in the CyberStorage acquisition over periods of five to ten
years.
INTEREST INCOME (EXPENSE)
The interest income (expense) for the three month periods and the nine month
periods ended September 30, 2001, respectively, reflect the elimination of bank
borrowing by us as compared to the same periods in the prior year and the
increase in cash and cash equivalents.
NET LOSS
We incurred a net loss for the three month period ended September 30, 2001 of
$3,670,000 compared to $1,902,000 for the three month period ended September 30,
2000 after adjusting for the $3,740,000 provision for restructuring in 2000. The
increase in net loss of $1,768,000 is lower compared to the increase in net loss
for the first and second quarter of $2,268,000 and $3,513,000, respectively, is
primarily attributable to the higher sales volume and product mix and related
effect on gross margin, the changes in operating expenses described above and
the non-cash charges for amortization of intangibles of $707,000 during the
three months ended September 30, 2001, in connection with the acquisition of
CyberStorage in 2000.
We are heavily committed in the near term to rebuilding our sales force and
increasing our revenue base, which will also require near term expenses for
marketing and new product development. This will negatively affect our short
term operating results.
FOREIGN CURRENCY TRANSACTIONS
We do not currently utilize any derivative products to hedge our minimal foreign
currency risk. Our foreign subsidiaries' obligations to us are denominated in
U.S. dollars. There is a potential for a foreign currency gain or loss based
upon fluctuations between the U.S. dollar and its subsidiaries' functional
currencies, currently German, British, and French. This exposure is limited to
the period between the time of accrual of such liability to us in our
subsidiaries' functional currency and the time of their payment to us in U.S.
dollars.
Other than the intercompany balances noted above, we do not believe we have
material unhedged monetary assets, liabilities or commitments that are
denominated in a currency other than the operations' functional currencies. We
expect such exposure to continue until our foreign subsidiaries reach a more
mature level of operation. We currently have no plans to utilize any derivative
products to hedge our foreign currency risk.
10
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board finalized FASB Statements
No. 141, Business Combinations ("SFAS 141"), and No. 142, Goodwill and Other
Intangible Assets ("SFAS 142"). SFAS 141 requires the use of the purchase method
of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after June 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized. SFAS 142 requires the Company to complete a transitional
goodwill impairment test six months from the date of adoption. The Company is
also required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS 142.
The Company's previous business combinations were accounted for using the
purchase method. As of June 30, 2001, the net carrying amount of goodwill is
$16,756,000 and other intangible assets is $4,199,000. Amortization expense
during the nine-month period ended September 30, 2001 was $2,123,802. Currently,
the Company is assessing but has not yet determined how the adoption of SFAS 141
and SFAS 142 will impact its financial position and results of operations.
FACTORS THAT MAY AFFECT FUTURE RESULTS
OUR STOCK PRICE IS VOLATILE
Our stock price, like that of other technology companies, is subject to
significant volatility because of factors such as the announcement of new
products, services or technological innovations by us or our competitors;
quarterly variations in our operating results; changes in revenue or earnings
estimates by the investment community; speculation in the press or investment
community; and failure to meet earning expectations.
In addition, our stock price may be affected by general market conditions and
domestic and international economic factors unrelated to our performance.
Further, until recently, our common stock was thinly traded. Because of these
factors, recent trends should not be considered reliable indicators of future
stock prices or financial results.
OUR BUSINESS MAY SUFFER IF WE CANNOT PROTECT OUR INTELLECTUAL PROPERTY
We generally rely upon patent, copyright, trademark and trade secret laws and
contract rights in the United States and in other countries to establish and
maintain our proprietary rights in our technology and products. However, there
can be no assurance that any of our proprietary rights will not be challenged,
invalidated or circumvented. In addition, the laws of certain countries do not
protect our proprietary rights to the same extent, as do the laws of the United
States. Therefore, there can be no assurance that we will be able to adequately
protect our proprietary technology against unauthorized third-party copying or
use, which could adversely affect our competitive position. Further, there can
be no assurance that we will be able to obtain licenses to any technology that
it may require to conduct its business or that, if obtainable, such technology
can be licensed at a reasonable cost.
We are aggressively pursuing the enforcement of our intellectual property rights
after an extensive patent review conducted in 1999. Subsequently, in 2000, we
retained a major law firm to enforce these rights against infringing parties,
which our management believes to be extensive. In 2001, we commenced litigation
against several companies in the United States and the United Kingdom, alleging
infringement of our patents. One of the defendants has filed a counterclaim,
alleging, among other things, that we have infringed upon a patent held by them.
Despite our legal representatives' efforts, there can be no assurance or
predictability as to any amount of recovery, if any, or the length of time it
will take us to recover any damages that may be recoverable. Additionally,
despite our efforts to protect our intellectual property rights, unauthorized
use may still occur, particularly in foreign countries.
11
TERRORIST ATTACKS MAY HAVE AN ADVERSE EFFECT ON OUR BUSINESS IN THE FUTURE
Following the September 11, 2001 terrorist attacks, we have experienced no
material adverse effect on our business. However, we are unable to predict with
certainty any future adverse impact from these types of attacks or related
outbreaks of hostilities.
DEVELOPMENT OF NEW PRODUCTS AND SOLUTIONS
We must make continuous investment in research and development to maintain our
ongoing effort to continually improve our products and provide innovative
solutions to our customers. The development of software products is a difficult
and costly process and subject to many other products' requirements. Our
inability to timely deliver new products in the past has had an adverse effect
on our operating and financial results. There can be no assurance that we will
be able to effectively develop new products in the future.
COMPETITION
We compete with many established companies in the computer storage and server
industries and certain of these companies have substantially greater financial,
marketing and technological resources, larger distribution capabilities, earlier
access to customers and more opportunity to address customers' various
information technology requirements than us. Our business may be adversely
affected by the announcement or introduction of new products by our competitors,
including hardware, software and services, price reductions of our competitors'
equipment or services and the implementation of effective marketing strategies
by our competitors.
Competitive pricing pressures exist in the computer storage and server markets
and have had and may in the future have an adverse effect on our revenues and
earnings. There also has been and may continue to be a willingness on the part
of certain competitors to reduce prices in order to preserve or gain market
share, which we cannot foresee. We currently believe that pricing pressures are
likely to continue. The relative and varying rates of product price and
component cost declines could have an adverse effect on our earnings.
RAPID TECHNOLOGICAL CHANGES
The computer industry is changing both dramatically and rapidly. The development
of "open systems computing", the introduction of the Internet, new fiber
technologies (SAN), network attached storage (NAS) and the increasing storage
density in disk drive technologies, have caused an increase in new product
development and shorter time to bring the new products to market. While we
believe that our Virtual Storage Architecture and StorageSuite products are
advanced when compared to competitive products, and complement many other
products utilized in total customer solutions, there can be no assurance that
this will continue in the future. The failure to remain consistently ahead of
competitive technologies would have a negative impact on our operating results
and financial condition.
BUSINESS ALLIANCES
Many companies have formed business alliances with their competitors, to be able
to provide totally integrated storage solutions to their customers. One result
of these alliances is to effectively preclude competitive products from being
offered to their customers. Many of the relationships are exclusive and our
failure to develop similar relationships will effectively reduce the number of
qualified sales opportunities we will have for our products in the future. We
believe that we address this issue by our return to the reseller channel sales
model and having the integrator/solution providers/value added-resellers perform
the solution selling required. Our failure to open these sales channels will
have a negative effect on our operating results and financial condition.
OPERATIONS
Our products operate near the limits of electronic and physical performance, and
are designed and manufactured with relatively small tolerances. If flaws in
design, production, assembly or testing were to occur by us or our suppliers, we
could experience a rate of failure in our products that would result in
substantial repair or replacement costs and potential damage to our reputation.
Continued improvement in manufacturing capabilities and control of material and
manufacturing quality and costs are critical factors in our future growth. We
frequently revise and update manufacturing and test processes to address
engineering and component changes to our products and evaluate the reallocation
of manufacturing resources among our facilities. There can be no assurance that
our efforts to monitor, develop and implement appropriate test and manufacturing
processes for our products will be sufficient to permit us to avoid a rate of
failure in our products that results in substantial delays in shipment,
significant repair or replacement costs and potential damage to our reputation,
any of which could have a material adverse effect on our business, results of
operations or financial condition.
12
We have had a decline in revenue in each of the three previous years and
comparable reduction in our work force. While we believe that we have the
required core personnel to effectively manage and grow, there can be no
assurance that key employees will not leave our employment in the future. The
failure to maintain key employees could adversely affect our operating and
financial results in the future.
LIQUIDITY AND WORKING CAPITAL
Our future success depends on maintaining adequate liquidity and working capital
to meet our operational requirements. Given the recent volatility in the
securities markets and, in particular, the securities of technology companies,
there can be no assurances that additional investors' capital will be available
to us and that we will receive additional equity financing. Our failure to
maintain adequate liquidity and working capital could have a material adverse
impact on us.
FAILURE OF SUPPLIERS TO PROVIDE QUALITY PRODUCTS
We purchase several sophisticated components and products from one or a limited
number of qualified suppliers. These components and products include disk
drives, high density memory components and power supplies. We have experienced
delivery delays from time to time because of high industry demand or the
inability of some vendors to consistently meet their quality and delivery
requirements. If any of our suppliers were to fail to meet the quality or
delivery requirements needed to satisfy customer orders for our products, we
could lose time-sensitive customer orders and have significantly decreased
quarterly revenues and earnings, which would have a material adverse effect on
our business, results of operations or financial condition. Additionally, we
periodically transition our product line to incorporate new technologies. The
importance of transitioning our customers smoothly to new technologies, along
with our historically uneven pattern of quarterly sales, intensifies the risk
that a supplier who fails to meet its delivery or quality requirements will have
an adverse impact on our revenues and earnings.
CHANGES IN LAWS, REGULATIONS OR OTHER CONDITIONS THAT COULD ADVERSELY IMPAIR OUR
CONDITION
Our business, results of operations and financial condition could be adversely
affected if any laws, regulations or standards, both foreign and domestic,
relating to us or our products were newly implemented or changed.
LITIGATION THAT WE MAY BECOME INVOLVED IN MAY ADVERSELY AFFECT US
In the ordinary course of business, we may become involved in litigation,
administrative proceedings and governmental proceedings. Such matters can be
time-consuming, divert management's attention and resources and cause us to
incur significant expenses. Furthermore, there can be no assurance that the
results of any of these actions will not have a material adverse effect on our
business, results of operations or financial condition.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The market risk inherent in our financial instruments relates primarily in
fluctuations in the prime rate of interest to be charged to us under the terms
of a promissory note to one of our senior executive officers. We do not use
derivative products or have any material unhedged monetary assets, except for
the inter-company balances outstanding, which are detailed above in Item 2
"Foreign Currency Transactions."
13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
During March 2001 we filed legal actions against Hitachi Data Systems Ltd. in
the United Kingdom for infringement of one of the patents in our intellectual
property rights portfolio. Additionally, we filed an action against XIOTech
Corporation and its parent company, Seagate Technology Inc., in the Federal
District Court for the Northern District of Texas claiming that one of their
products infringes one of our patents. In October 2001 we filed an action
against Veritas Software Corporation in the Federal District Court for the
Northern District of Texas claiming that certain of their products infringes one
of our patents. One of the defendants has filed a counterclaim, alleging, among
other things, that we have infringed upon a patent held by them. Our involvement
in these proceedings cannot possibly be predicted as to any recovery or length
of time required to recover our damages, but we intend to vigorously pursue our
claims against manufacturers whose products we believe infringe on our patents.
We are involved in several other minor legal claims in our ordinary course of
business. While we believe that our involvement in these claims will have no
material effect our operations or financial condition, we cannot predict what
our continuing involvement in, any judicial decision rendered, or the resolution
of the set of claims will have upon our business, operating results, or
financial condition.
Item 2. Changes in Securities and Use of Proceeds.
During the quarter ended September 30, 2001, we completed a $5,000,000 private
placement of a new Series E Convertible Preferred Stock to the holder of our
Series C Preferred Stock. The Series E shares are convertible into 771,605
shares at a fixed conversion price of $6.48 and may be converted at any time
until October 31, 2003 when conversion is automatic. In connection with the
investment we issued a warrant to purchase 771,605 shares of common stock at
$10.80 per share.
Item 3. Defaults Upon Senior Securities.
There has not been any material default in the payment of principal, interest,
or any other material default not cured within 30 days with respect to any of
our indebtedness and our subsidiaries during the nine month period ended
September 30, 2001.
Item 4. Submission of Matters to a Vote of Security Holders.
None
Item 5. Other Information.
None
Item 6. Exhibits and Reports on Form 8-K.
A. Exhibit
Number Description
4.2 Certificate of Designation of Series E Convertible Preferred Stock
of Storage Computer Corporation (incorporated by reference to
Exhibit 3.1 to our Report on Form 8-K filed August 22, 2001).
4.3 Registration Rights Agreement dated as of August 15, 2001 by and
among Storage Computer Corporation and the investors name therein
(incorporated by reference to Exhibit 4.1 to our Report on Form 8-K
filed August 22, 2001).
4.4 Stock Purchase Warrant dated as of August 16, 2001 to purchase
771,605 shares of Storage Computer Corporation common stock
(incorporated by reference to Exhibit 4.2 to our Report on Form 8-K
filed August 22, 2001).
10.1 Securities Purchase Agreement dated as of August 15, 2001 by and
among Storage Computer Corporation and the buyers named therein
(incorporated by reference to Exhibit 10.1 to our Report on Form 8-K
filed August 22, 2001).
10.2 Form of Demand Note (filed herewith).
14
B. Reports on Form 8-K
In our Report on Form 8-K filed August 22, 2001 we reported the completion of a
$5,000,000 financing through a private placement of our Series E Convertible
Preferred Stock to an existing institutional investor that is the holder of our
Series C Convertible Preferred Stock.
15
SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934, as
amended, the registrant duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
STORAGE COMPUTER CORPORATION
----------------------------
Registrant
/s/ PETER N. HOOD
-----------------
Peter N. Hood
Chief Financial Officer
Date: November 16, 2001
16