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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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, 2004
OR
|_| 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
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STORAGE COMPUTER CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 02-0450593
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
11 RIVERSIDE DRIVE, NASHUA, NH 03062
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(603) 880-3005
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE
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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 |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
Number of shares outstanding of the registrant's class of common stock, as
of the latest practicable date.
CLASS OUTSTANDING AT September 30, 2004
Common Stock $ .001 par value per share _______38,922,209
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Page
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PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited).
Consolidated Balance Sheets--September 30, 2004 and December 31,
2003. 3
Consolidated Statements of Operations--Three and nine months ended
September 30, 2004 and 2003. 4
Consolidated Statements of Cash Flows--Nine months ended September
30, 2004 and 2003. 5
Notes to Consolidated Financial Statements--September 30, 2004. 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations. 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 16
Item 4. Controls and Procedures 16
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings. 16
Item 2. Changes in Securities and Use of Proceeds. 17
Item 3. Defaults Upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders. 17
Item 5. Other Information. 18
Item 6. Exhibits and Reports on Form 8-K. 18
2
PART I -- FINANCIAL INFORMATION
ITEM 1. Financial Statements.
Storage Computer Corporation
Consolidated Balance Sheets
September December
30, 31,
2004 2003
------------ ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 9,837 $ 72,581
Accounts receivable, net 1,046 135,730
Inventories 1,052,516 1,390,291
Other current assets 54,407 187,247
------------ ------------
Total current assets 1,117,806 1,785,849
Property and equipment, net 235,155 345,709
Goodwill 2,692,611 2,692,611
Other intangibles, net 517,057 949,057
------------ ------------
Total assets $ 4,562,629 $ 5,773,226
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable $ 544,027 $ 565,182
Accrued expenses 1,952,927 1,320,405
Deferred revenue 50,047 133,538
Notes and amounts to officer and affiliate 2,067,700 1,333,823
------------ ------------
Total current liabilities 4,614,701 3,352,948
------------ ------------
Commitments and contingencies
Stockholders' equity (deficiency):
Preferred Stock 100,000
Common stock 38,922 38,650
Additional paid-in capital 85,815,286 85,612,531
Accumulated deficit (86,006,280) (83,230,903)
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Stockholders' equity (deficiency), net (52,072) 2,420,278
------------ ------------
Total liabilities and stockholders' deficiency $ 4,562,629 $ 5,773,226
============ ============
See Notes to Consolidated Financial Statements.
3
Storage Computer Corporation
Consolidated Statements of Operations (Unaudited)
Three Month Ended Nine Months Ended
----------------- -----------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
------------- ------------- ------------ -------------
Revenues:
Products and services $ 86,317 $ 215,047 $ 299,475 $ 640,807
License fees -- -- -- --
------------- ------------- ------------ -------------
Total revenues 86,317 215,047 299,475 640,807
------------- ------------- ------------ -------------
Costs and expenses:
Cost of products and services 158,473 218,442 552,241 697,144
Cost of license fees, primarily legal fees -- 188,468 -- 717,549
Research and development 239,137 220,413 670,228 865,984
Sales and marketing 218,792 115,449 438,758 439,565
General and administrative 214,829 425,993 733,498 1,159,402
Amortization of intangibles 144,000 144,000 432,000 432,000
------------- ------------- ------------ -------------
Total costs and expenses 975,231 1,312,765 2,826,725 4,311,614
------------- ------------- ------------ -------------
Operating loss (888,914) (1,097,718) (2,527,250) (3,670,807)
------------- ------------- ------------ -------------
Other income (expense), net:
Interest expense, net (41,248) (7,015) (141,099) (16,577)
Other income (expense) 81 4,742 (107,028) 198,843
------------- ------------- ------------ -------------
Total other income (expense), net (41,167) (2,273) (248,127) 182,266
------------- ------------- ------------ -------------
Net loss $ (930,081) $ (1,099,991) $(2,775,377) $ (3,488,541)
Dividends on preferred stock including amortization of the beneficial
conversion features -- -- -- (17,595)
------------- ------------- ------------ -------------
Net Loss applicable to common stockholders $ (930,081) (1,099,991) $(2,775,377) $ (3,506,136)
------------- ------------- ------------ -------------
Loss applicable to common stockholders per basic and dilutive share $ (0.02) $ (0.03) $ (0.07) $ (0.10)
Basic and dilutive shares outstanding 38,922,209 36,803,330 38,842,425 35,845,680
See Notes to Consolidated Financial Statements.
4
Storage Computer Corporation
Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended
-----------------
September 30, September 30,
2004 2003
------------- -------------
Cash flows from operating activities:
Net loss $ (2,775,377) $ (3,488,541)
Reconciliation to operating cash flows:
Depreciation and amortization of property and equipment 110,554 148,894
Amortization of other intangibles 432,000 432,000
Settlement of debt and advances with directors and officers -- (184,784)
Provision for obsolete inventory 118,243 --
Common stock issued to 401(k) plan 4,519 16,418
Preferred stock issued for services 100,000
Common stock issued for services 317,568 430,467
Non-cash compensation for services 677,213
Changes in current operating assets and liabilities:
Accounts receivable 134,684 108,691
Inventories 219,532 90,768
Due from officers and directors -- 3,097
Other current assets 13,780 (165,463)
Accounts payable, accrued expenses and deferred revenue (149,337) (35,338)
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Net cash used in operations (796,621) (2,643,791)
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Cash flows from investing activities:
Capital expenditures -- (8,542)
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Net cash (used in) investing activities -- (8,542)
------------- -------------
Cash flows from financing activities:
Increase in notes and amounts due to officer and affiliate 733,877 13,788
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Net cash (used in) provided by financing activities 733,877 13,788
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Effect of exchange rate changes on cash -- --
------------- -------------
Net decrease in cash and cash equivalents (62,744) (2,638,545)
Cash and cash equivalents-beginning of period 72,581 2,680,599
------------- -------------
Cash and cash equivalents-end of period $ 9,837 $ 42,054
============= =============
Supplemental cash flow information:
Cash payments of interest $ -- $ 8,889
Preferred stock dividends paid in common stock $ -- $ 44,917
See Notes to Consolidated Financial Statements.
5
Storage Computer Corporation
Notes to Consolidated Financial Statements
September 30, 2004
Note A - The Company
Storage Computer Corporation (the "Company "SCC" or "we"), a pioneer in
RAID ("Redundant Array of Independent Disks") technology is a provider of high
performance storage software solutions focused on developing advanced storage
architectures to address the emerging needs of high-bandwith and other
"performance-impaired" applications. Storage Computer's technology supports a
variety of applications including advanced database activities, wide area
network storage and sophisticated business continuity topologies including:
o Networked Attached Storage
o Storage Area Networks
o Direct Attached Storage
o Storage Wide Area Networking
Note B - Basis of Presentation
The condensed consolidated financial statements include the accounts of
Storage Computer Corporation and its wholly owned subsidiaries. All significant
inter-company balances and transactions have been eliminated in consolidation.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America 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, 2003.
In management's opinion, the accompanying consolidated financial statements
reflect all adjustments, all of which are of a normal, recurring nature, to
fairly present our consolidated financial position, consolidated results of
operations and consolidated cash flows. The results of operations for the three
and nine months ended September 30, 2004 are not necessarily indicative of the
results to be expected for the full year.
Note C- Liquidity Matters
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
suffered recurring losses from operations and negative cash flows that raise
substantial doubt about its ability to continue as a going concern.
Management recognizes that the Company's continuation as a going concern is
dependent upon its ability to generate sufficient cash flow to allow the Company
to satisfy its obligations on a timely basis. The generation of sufficient cash
flow is dependent on the successful expansion of the Company's share of the
market for its software, controlling costs and securing new financing.
Management's efforts in regard to these matters are described below. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
Our future success depends on maintaining adequate liquidity and working
capital to meet our operational requirements; Revenues from products and
services have fallen dramatically in the previous two fiscal years and continued
to fall in the first nine months of 2004. We did not receive any revenue from
license fees in 2003 or in the first nine months of 2004, and there can be no
assurances that we will be able to secure license fees at all during the coming
twelve months. Furthermore, given the continued volatility of the global
securities markets and, in particular, the market for the securities of
technology companies, as well as the recent results of our pending legal actions
concerning enforcement of our intellectual property rights, we cannot assure you
that we will be able to secure additional debt or equity financing. Our failure
to maintain adequate liquidity and working capital would have a material adverse
effect on the Company, our financial condition and results of operations.
6
We have incurred operating losses for the last several years and we
continue to incur operating losses at this time. While the development and
introduction of our new products continues, our actual sales revenue has
declined significantly over the last two fiscal years and continues to be at a
low level. In response, we have implemented cost reduction programs primarily in
employee headcount, the use of independent software subcontractors and the level
of expenses for development, marketing, sales and administration. In January
2004 salaries were reduced further in response to the need to preserve cash
flow. Reductions in 2004 salaries are compensated for through a stock based
compensation plan (requires no cash expenditure).
In August 2003 our Chief Executive Officer and principal stockholder,
through an affiliate of the Company controlled by him, began advancing funds to
supplement the Company's cash flow for operating expenses and occupancy costs
until operating cash flows improve and permanent additional financing can be
arranged. The amounts advanced were $1,081,021 and $ 488,245 at September 30,
2004 and December 31, 2003, respectively. Advances are secured by all the assets
of the Company and accrue interest at the affiliate's cost of funds, which is
currently 8.5% .The affiliates cost of funds have ranged from 8.5% to 26% during
the first nine months of 2004 compared with 21% for the same period in 2003.
Interest expense related to this obligation amounted to $ 121,555 and $3,022 for
the nine months ended September 30, 2004 and 2003 respectively.
In July 2003, we engaged iCapital Finance, Inc. of Irvine, California as
the Company's investment banking firm to assist us in structuring financing,
providing access to capital resources, identifying candidates for marketing and
distribution alliances, and to advise the Company on other strategic decisions.
In addition, in April 2004 we engaged another investment banking firm to pursue
a specific financing opportunity.
The Company is currently pursuing an opportunity that would provide new
financing However, there can be no assurances that the Company will be able to
obtain new financing and, if new financing, is obtained it could result in
significant dilution to existing shareholders.
We continued to focus our core business activity toward the Storage Wide
Area Networking (SWAN) market segment for our CyberNAS Network Attached Storage
and CyberVSA Storage Operating System. While our new products have been
available and we have entered into new strategic alliance relationships with
channel partners significant new sales have not materialized, as it has taken
longer and been more difficult than we anticipated for these channel partners to
become productive. We are continuing to explore and negotiate additional
strategic alliance relationships to market our products.
The Company received notification from the American Stock Exchange (AMEX)
on April 29, 2003 that the Company was not in compliance with certain listing
standards relating to stockholders' equity and net losses. In June 2003 the
Company submitted to AMEX a plan to regain compliance with the AMEX continuing
listing standards. On July 28, 2003, AMEX notified the Company that it had
accepted the proposed plan and granted an extension until October 31, 2004 to
regain compliance. During such period, the Company's common stock continued to
trade on AMEX and the Company was subject to periodic review of its progress
consistent with its plan. On November 10, 2004 the AMEX notified the Company
that it had determined that the Company had not regained compliance with the
continuing listing standards by October 31, 2004. and was subject to being
delisted from the Exchange. The Company will appeal this determination and
request a hearing before a Committee of the Exchange. There can be no assurance
the Company's request for continued listing will be granted.
If the Company's stock ceases to be listed on the AMEX a transfer of the
listing to the OTC Bulletin Board or other markets will be sought. The outcome
of these uncertainties and their impact on the price and liquidity of our common
stock and our access to the capital markets cannot be predicted.
There can be no assurances that our marketing efforts will be successful or
that we will obtain additional capital or continue to receive funds from the
affiliate of the Company as described above. If we are not successful in
obtaining financing or other capital, the ability of the Company to continue
operations at this level will be seriously impaired.
In addition, reference should be made to Liquidity and Capital Resources in
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations below.
7
Note D - Stockholders' Equity
At our Annual Meeting held on July 15,2004 stockholders voted to approve an
amendment to the Company's Certificate of Incorporation to increase the
authorized number of shares of Common Stock from 50,000,000 shares to
100,000,000 shares.
In January 2004 the Board of Directors authorized the designation and
issuance of up to 30,000 shares of Series F preferred stock valued at $1,000 per
share, convertible after one year of issuance into common stock, with interest
at 4%, payable in common stock. The shares have a five year maturity, and can be
redeemed by the Company for 115% of face value upon 30 days written notice.
Conversion to common stock is priced at 105% of the prior three day closing
average price of the common stock at the time of issue. The Company issued 100
shares of Series F stock for sales and marketing services in the quarter ended
September 30, 2004.
A summary of changes in stockholders' (deficiency) for the Nine months ended September 30, 2004 follows:
Preferred Stock Common Stock
--------------- ------------
Additional Total
Carrying Par Paid-In Accumulated Stockholders'
Shares Value Shares Value Capital Deficit (deficiency)
------ ----- ------ ----- ------- ------- -------------
Balance--December 31, 2003 38,650,060 $ 38,650 $ 85,612,531 $ (83,230,903) $ 2,420,278
Stock issued to 401(k) plan 12,149 12 4,507 4,519
Stock issued and compensatory stock
options granted for investment
banking and consulting services,
respectively 260,000 260 198,248 198,508
Preferred Stock Issued 100 $ 100,000 100,000
Net loss (2,775,377) (2,775,377)
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Balance-September 30, 2004 100 $ 100,000 38,922,209 $ 38,922 $ 85,815,286 $ (86,006280) $ (52,072)
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Note E - Related Party Transactions
In August 2001, the Company's Board of Directors approved the issuance of
advances secured by demand notes receivable with interest at prime plus 1% to
executive officers and directors of the Company in the aggregate amount of
$500,000 for the purpose of purchasing the common stock of the Company in the
public market. In May of 2003, $130,150 of demand notes receivable from three
directors were forgiven and charged to other income (expense) in recognition of
previous service on the Board of Directors
John Thonet resigned his position as a director of the Company on April 30,
2003. At the time of his resignation, the Company owed Mr. Thonet a balance of
$177,101 plus accrued and unpaid interest on a note payable representing the
balance of sums advanced by him to CyberStorage Systems that was acquired by the
Company in 2000, and Mr. Thonet was due $156,333 in accrued and unpaid salary by
CyberStorage Systems. The Company also had a note receivable due from Mr. Thonet
of $44,729 plus accrued interest. On April 30, 2003, the Company and Mr. Thonet
agreed to offset the note receivable and accrued interest against the note
payable and accrued interest and Mr. Thonet agreed to accept a cash payment of
$40,000 in exchange for cancellation by him of the balance of the note payable.
In addition, Mr. Thonet gave up any and all claims to accrued and unpaid salary
and any other amounts due to him as of that date in exchange for the extension
of the period for exercise of his vested stock options to purchase 62,500 shares
of common stock until May 1, 2004. There was no charge to income related to the
modification of the terms of this option since the exercise price was greater
than the market value at that date.
In August 2003 our Chief Executive Officer and principal stockholder,
through an affiliate of the Company controlled by him, began advancing funds to
supplement the Company's cash flow for operating expenses and occupancy costs
until operating cash flows improve and permanent additional financing can be
arranged. The amounts advanced were $1,081,021 and $ 488,245at September 30,
2004 and December 31, 2003, respectively. Advances are secured by all the assets
of the Company and accrue interest at the affiliate's cost of funds, which is
currently 8.5% .The affiliates cost of funds have ranged from 8.5% to 26% during
the first nine months of 2004 compared with 21% for the same period in 2003.
Interest expense related to this obligation amounted to $ 121,555 and $3,022 for
the nine months ended September 30, 2004 and 2003 respectively.
8
Notes payable in the amount of $487,899 at September 30, 2004 and December
31, 2003 is due to the Chief Executive Officer and principal shareholder of the
Company. The debt is unsecured, and $387,899 bears interest at prime plus 1%,
and $100,000 bears interest at 6% and is convertible into the Company's common
stock at $4.00 per share. Interest expense related to this obligation amounted
to $ 19,546 and $ 19,476 for the nine months ended September 30, 2004 and 2003
respectively. This debt is due upon demand.
The Company leases plant and office facilities from an affiliate of the
Company controlled by our Chief Executive Officer and principal stockholder
under a non-cancelable, five-year, triple net operating lease agreement, which
was entered into as of December 1, 2000. The lease provides for monthly rental
payments of $25,000 commencing in January 2001, and is increased annually based
on a change in the consumer price index. The monthly rental payments for 2004
and 2003 were $26,509 and $25,992 respectively. Additionally, the lease provides
for an additional five-year renewal option by the Company and contains no
purchase option. Minimum future rental payments on this lease amount to $318,104
annually for the years 2004 through 2005.
The total amount currently due to the Chief Executive Officer and the
affiliate of the Company described above, including accrued interest, amounted
to $ 2,067,700 and 1,333,823 at September 30, 2004 and December 31, 2003
respectively.
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 1995, Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934
contain certain safe harbors regarding forward-looking statements. From time to
time, information provided by the Company 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. See "Factors That May Affect Future Results" below. We undertake no
duty to update forward-looking statements.
Introduction
This discussion summarizes the significant accounting policies, accounting
estimates and other significant factors affecting the liquidity, capital
resources and results of operations of the Company for the periods ended
September 30, 2004 and 2003. This discussion should be read in conjunction with
the Consolidated Financial Statements and other financial information included
in our 2003 Annual Report on Form 10-K filed with the Securities and Exchange
Commission.
Critical Accounting Policies and Estimates
We prepare our financial statements in conformity with accounting
principles generally accepted in the United States of America. These accounting
principles require management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements. Our management
is also required to make certain judgments that affect the reported amounts of
revenues and expenses during the reporting period. We periodically evaluate our
estimates including those relating to the allowance for doubtful accounts;
inventory reserves for lower of cost or market adjustments, excess quantities
and discontinued products; estimated lives and impairment of tangible and
intangible long-life assets; litigation and other contingencies. We base our
estimates on historical experience and various other assumptions that we believe
to be reasonable based on the specific circumstances, the results of which form
the basis for making judgments about the carrying value of certain assets and
liabilities that are not readily apparent from other sources. Actual results
could differ from these estimates.
9
We believe the following critical accounting policies impact the most
significant judgments and estimates used in the preparation of our consolidated
financial statements:
Revenue Recognition
We recognize revenue from product sales at the time of shipment, provided
that the price is fixed and determinable, no significant obligations remain,
collectibility is probable and returns are estimable. Revenue is recognized at
the time of shipment since the terms of shipment are FOB shipping point and
legal title to the product passes to the customer at this time. We consider post
shipment obligations such as installation and training to be relatively
insignificant given the underlying nature of the product and of its
installation. Revenue from services is recognized over the contract period or as
services are provided. Revenue from license fees is recognized over the contract
period or when received for fully paid license agreements. These revenue
accounting policies do not require significant estimates by management.
Impairment of Goodwill and Intangible Assets
All of our goodwill and other intangibles resulted from our acquisition of
CyberStorage Systems in 2000 that was accounted for using the purchase method.
In connection with the implementation of Statement of Financial Accounting
Standards (SFAS) No. 142, as of January 1, 2002, we have ceased amortizing
goodwill and determined that our entire business constitutes one reporting unit
for purposes of assessing potential impairment of goodwill.
Our annual evaluation of goodwill required under SFAS 142 was conducted as
of September 30, 2004. Consistent with the accounting policy adopted in 2002, we
used a fair value approach to test our existing goodwill for impairment at
September 30, 2004. The market approach was used to determine the fair value of
the reporting unit. Under the fair value approach, the quoted market prices in
active securities markets are used as the basis for the determination of fair
value. The fair value so determined indicated no impairment of goodwill existed
as of September 30, 2004. Additionally, in accordance with SFAS No. 144, we
conducted an evaluation of the carrying values of our identifiable intangible
assets and found no impairment existed as of September 30, 2004.
Stock-Based Compensation
We account for our stock-based compensation plans under Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees", and accordingly account for employee stock-based compensation
utilizing the intrinsic value method. SFAS No.123, "Accounting for Stock-Based
Compensation," established a fair value based method of accounting for
stock-based compensation plans. We have adopted the disclosure only alternative
under SFAS No.123, which requires disclosure of the pro forma effects on
earnings and earnings per share as if SFAS No. 123 had been adopted as well as
certain other information.
In December 2002, the Financial Accounting Standards Board (FASB) issued
SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and
Disclosure--an amendment of SFAS Statement No. 123". This statement amends SFAS
No. 123 to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
In addition, SFAS No.148 amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. SFAS No. 148 also requires that
those effects be disclosed more prominently by specifying the form, content, and
location of those disclosures. We adopted the increased disclosure requirements
of SFAS No. 148 during the year ended December 31, 2002. We will continue to use
the intrinsic value method of accounting for stock-based employee compensation.
The additional disclosures required by SFAS No. 148 are as follows:
Three months ended Nine months ended
September 30 September 30
2004 2003 2004 2003
---- ---- ---- ----
Net loss applicable to common stockholders, as reported $ (930,081) $(1,099,991) $(2,775,377) $(3,506,136)
Deduct: Total stock based employee compensation expense determined under
the fair value based method of all awards, net of tax (460,238) (605,389) (1,374,575) (1,816,146)
-------------------------- -------------------------
Pro forma net loss applicable to common stockholders $(1,390,319) $(1,705,380) $(4,149,952) $(5,322,282)
-------------------------- -------------------------
Net loss applicable to common stockholders per basic and dilutive shares:
As reported $ (0.02) $ (0.03) $ (0.07) $ (0.10)
Pro forma $ (0.04) $ (0.05) $ (0.11) $ (0.15)
10
Allowance for Doubtful Accounts
We record an allowance for doubtful accounts based on specifically
identified amounts that we believe to be uncollectible which are determined
based on historical experience and our assessment of the general financial
conditions affecting our customer base. If our actual collections experience
changes, revisions to our allowance may be required. After all attempts to
collect a receivable have failed, the receivable is written off against the
allowance.
Inventory:
Inventories consist primarily of finished goods and are stated at the lower
of cost (average cost method) or market. We regularly monitor inventory values
and quantities on hand and record a provision for excess and obsolete
inventories based primarily on our estimate of the future realizable value of
this inventory
Intellectual Property Rights, Contingencies and Litigation
We have a substantial portfolio of patents, claims and other intellectual
property rights. Costs and expenses in connection with the development of and
the enforcement of our rights are expensed when incurred. Certain contingent
fees for legal services are due upon the receipt of license fees over contract
periods or upon receipt of payment for paid-up license arrangements. We
currently are in legal proceedings in connection with the enforcement of our
intellectual property rights the results of which cannot be predicted. Our
failure to successfully enforce our patent rights could have a material adverse
effect on our business, operating results and financial condition.
In the normal course of our business, we are subject to various other
proceedings, lawsuits and claims relating to product, technology, labor and
other matters as further described in Part II, Item 1. Legal Proceedings. We are
required to assess the likelihood of any adverse outcomes and the potential
range of probable losses in these matters. The amount of loss accrual, if any,
is determined after careful analysis of each matter, and is subject to
adjustment if warranted by new developments or revised strategies. We believe
that none of the existing matters will result in a material adverse effect on
our business, operating results and financial condition.
Liquidity and Capital Resources
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
suffered recurring losses from operations and negative cash flows that raise
substantial doubt about its ability to continue as a going concern.
Management recognizes that the Company's continuation as a going concern is
dependent upon its ability to generate sufficient cash flow to allow the Company
to satisfy its obligations on a timely basis. The generation of sufficient cash
flow is dependent on the successful expansion of the Company's share of the
market for its software, controlling costs and securing new financing.
Management's efforts in regard to these matters are described below. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
Our future success depends on maintaining adequate liquidity and working
capital to meet our operational requirements. Revenues from products and
services have fallen dramatically in the previous two fiscal years and continued
to fall in the first nine months of 2004. We did not receive any revenue from
license fees in 2003 or in the first nine months of 2004, and there can be no
assurances that we will be able to secure license fees at all during the coming
twelve months. Furthermore, given the continued volatility of the global
securities markets and, in particular, the market for the securities of
technology companies, as well as the recent results of our pending legal actions
concerning enforcement of our intellectual property rights, we cannot assure you
that we will be able to secure additional debt or equity financing. Our failure
to maintain adequate liquidity and working capital would have a material adverse
effect on the Company, our financial condition and results of operations.
We have incurred operating losses for the last several years and we
continue to incur operating losses at this time. While the development and
introduction of our new products continues, our actual sales revenue has
declined significantly over the last two fiscal years and continues to be at a
low level. In response, we have implemented cost reduction programs primarily in
employee headcount, the use of independent software subcontractors and the level
of expenses for development, marketing, sales and administration. In January
2004, salaries were reduced further in response to the need to preserve cash
flow. Reductions in 2004 salaries are compensated for through a stock based
compensation plan (requires no cash expenditure).
11
In August 2003, our Chief Executive Officer and principal stockholder,
through an affiliate of the Company controlled by him, began advancing funds to
supplement the Company's cash flow for operating expenses and occupancy costs
until operating cash flows improve and permanent additional financing can be
arranged. The amounts advanced were $1,081,021 and $ 488,245 at September 30,
2004 and December 31, 2003, respectively. Advances are secured by all the assets
of the Company and accrue interest at the affiliate's cost of funds, which is
currently 8.5% .The affiliates cost of funds have ranged from 8.5% to 26% during
the first nine months of 2004 compared with 21% for the same period in 2003.
Interest expense related to this obligation amounted to $ 121,555 and $3,022 for
the nine months ended September 30, 2004 and 2003 respectively
In July 2003, we engaged iCapital Finance, Inc. of Irvine, California as
the Company's investment banking firm to assist us in structuring financing,
providing access to capital resources, identifying candidates for marketing and
distribution alliances, and to advise the Company on other strategic decisions.
In addition, in April 2004 we engaged another investment banking firm to pursue
a specific financing opportunity.
The Company is currently pursuing an opportunity that would provide new
financing However, there can be no assurances that the Company will be able to
obtain new financing and, if new financing is obtained, it could result in
significant dilution to existing shareholders.
We continued to focus our core business activity toward the Storage Wide
Area Networking (SWAN) market segment for our CyberNAS Network Attached Storage
and CyberVSA Storage Operating System. While our new products have been
available and we have entered into new strategic alliance relationships with
channel partners significant new sales have not materialized, as it has taken
longer and been more difficult than we anticipated for these channel partners to
become productive. We are continuing to explore and negotiate additional
strategic alliance relationships to market our products.
The Company received notification from the American Stock Exchange (AMEX)
on April 29, 2003 that the Company was not in compliance with certain listing
standards relating to stockholders' equity and net losses. In June 2003 the
Company submitted plan to AMEX a plan to regain compliance with the AMEX
continuing listing standards. On July 28, 2003, AMEX notified the Company that
it had accepted the proposed plan and granted an extension until October 31,
2004 to regain compliance. During such period, the Company's common stock
continued to trade on AMEX and the Company was subject to periodic review of its
progress consistent with its plan. On November 10, 2004 the AMEX notified the
Company that it had determined that the Company had not regained compliance with
the continuing listing standards by October 31, 2004. and was subject to being
delisted from the Exchange. The Company will appeal this determination and
request a hearing before a Committee of the Exchange. There can be no assurance
the Company's request for continued listing will be granted.
If the Company's stock ceases to be listed on the AMEX a transfer of the
listing to the OTC Bulletin Board or other markets will be sought. The outcome
of these uncertainties and their impact on the price and liquidity of our common
stock and our access to the capital markets cannot be predicted.
Cash Flows
Position at
September 30, 2004 December 31, 2003
Cash and cash equivalents $ 9,837 $ 72,581
Working capital (deficiency) $ (3,496,895) $ (1,567,099)
Nine months ended
September 30, 2004 September 30, 2003
Net cash (used) in operations $ (796,621) $ (2,643,791)
Net cash (used) by investing activities -- $ (8,542)
Net cash provided (used) by financing activities $ 733,877 $ 13,788
The Company used cash of $796,621 to fund operations in the first nine
months of 2004. The cash used in operations was principally the result of a net
loss of $2,775,377 offset by non-cash expenses of $1,760,097 and a net reduction
in operating assets of $218,659. Included in non-cash expenses is depreciation
and amortization of $542,554, a provision for inventory obsolescence of $118,243
and non-cash charges for compensation and services of $1,099,300. The major
changes in operating assets were decreases accounts receivable of $134,684,
inventories of $219,532 and accrued expenses and deferred revenue of $149,337
(included in accrued expenses on the balance sheet is an increase $677,213 for
deferred compensation. It is anticipated that preferred stock will be issued to
satisfy this obligation)
Cash flow from financing activities consisted primarily of $733,877 in cash
advances received from an affiliate controlled by our Chief Executive Officer
and principal stockholder.
COMMITMENTS.
We lease office facilities from an affiliate under a non-cancelable
operating lease. Minimum future rental payments on this lease amount to $318,108
annually for the years 2004 and 2005.
Borrowing Arrangements
Other than advances from the affiliate of the Company as described above,
we currently have no outstanding bank loans, lines of credit, or credit
facilities. See comments under Liquidity and Capital Resources above with
respect to current advances received from an affiliate of the Company.
Results of Operations
Our operating results have fluctuated in the past and may in the future
fluctuate significantly, depending upon a variety of factors. After the
acquisition of CyberStorage Systems Corporation in September 2000, we commenced
a corporate-wide restructuring, including the expansion of our North America
sales territories to seven regions; the initiation of a plan to re-establish our
re-seller sales channel; consolidation of our European sales, marketing and
service organizations; and implemented strategic marketing initiatives and
programs for product development and repositioning. Although we believed these
actions and the introduction of new products would provide the revenue growth
that would enable us to return to profitability, this has not yet materialized
due to the time and difficulty of finding and training qualified channel
partners. In September 2003, we established a sales representation relationship
with Latin American Sales Solutions Consultants for our product offerings into
the Latin American market. In March 2004, we signed an OEM agreement with RAID
Incorporated (RAID). RAID will private label the CyberNAS software and integrate
it into their extensive software and hardware suite. In April 2004, we signed a
strategic alliance partnership agreement with MTC direct (Micro Technology
Concepts, Inc.). MTC Direct will carry Storage Computer's CyberNAS software
product offering in their portfolio for distribution and private labeling
worldwide. In May 2004, we signed a distribution agreement with Beijing
Challenger Group of China. Beijing Challenger will carry Storage Computer's
CyberNAS software product offering in their portfolio for distribution
throughout China.
We continue to explore and negotiate strategic alliance relationships to
market our new products and seek financial support from these alliances.
Revenue
Revenues from sales of products and services for the three and nine month
periods ended September 30, 2004 were $86,317 and $299,475 compared to $215,047
and $640,807 for the respective periods in 2003. Revenue from software sales was
not significant in either the 2004 or 2003 periods. Revenue from product and
services were primarily from domestic sources for the periods being reported.
There was no license fee revenue in the 2004 or 2003 periods and there can be no
assurance that we will be able to secure any license fee revenue in the coming
twelve months. We continued to focus our core business activity toward the
Storage Wide Area Networking (SWAN) market segment for our CyberNAS Network
Attached Storage and CyberVSA Storage Operating System. New products are
available and new channel partners have been added. However, significant new
sales have not materialized it has taken longer and been more difficult than we
anticipated to find and train qualified channel partners.
Cost of Products and Services
Product and service costs for the three and nine-month periods ended
September 30,2004 were $158,473 and $552,241, or 183% and 184% of revenue from
product and services compared to $218,442 and $697,144 or 102% and 109% of
revenue from products and services for the respective periods in 2003. The
decrease in aggregate dollars was due primarily to reductions in overhead costs,
primarily headcount. Cost of product and services includes a $118,243 increase
in the reserve for inventory obsolescence for the nine months ended September
30, 2004. There were no such adjustments in the 2003 periods. The change in
costs as a percentage of revenue from 2003 to 2004 periods is primarily related
to lower revenue and changes in costs.
12
Cost of License Fees
Costs associated with the enforcement of our patent and other intellectual
property rights for the three and nine month periods ended September 30, 2004
were $0, compared to $118,468 and $717,549 for the corresponding periods in
2003. These costs relate to legal fees for counsel and experts consulting fees
and expenses incurred in connection with the enforcement of our patent and other
intellectual property rights. Certain work performed by our legal counsel in
defending our intellectual property is done under a contingency fee arrangement.
The work performed in 2004 was done primarily under this arrangement.
Research and Development Expenses
Research and development expenses for the three and nine month periods
ended September 30, 2004 were $239,137 and $670,228, respectively compared to
$220,413 and $865,984 for the corresponding periods in 2003. The decrease in
research and development expenses for the nine month period in 2004 was due
primarily to reductions in staffing and salary levels Selling and Marketing
Expenses
Selling and marketing expenses for the three and nine month periods ended
September 30, 2004 were $218,792 and $438,758 respectively compared to $115,449
and $439,565 for the corresponding periods in 2003. The three and nine month
periods in 2004 reflect a charge for the issuance of $100,000 of Series F 4%
Redeemable Convertible Preferred Stock for sales and marketing services.
Excluding this charge selling and marketing expenses declined due primarily to
reductions in staffing, salary levels and other overhead costs.
General and Administrative Expenses
General and administrative expenses for the three and nine month periods
ended September 30, 2004 were $214,829 and $733,498 respectively compared to
$425,993 and $1,159,402 for the corresponding periods in 2003. The decrease in
general and administrative expenses in aggregate dollars was due primarily to
reductions in staffing, salary levels and other overhead costs.
Amortization of Intangibles
Amortization of other intangible assets for the three and nine month
periods ended September 30, 2004 was $144,000 and $432,000 respectively compared
to the same amounts for the corresponding periods in 2003. Identifiable
intangible assets are amortized over an estimated life of 5 to 7 years.
Other Income (Expense), Net
Interest expense, net for the three and nine month periods ended September
30, 2004 was $41,248 and $141,099 respectively compared to $7,015 and $16,577
for the corresponding periods in 2003. The increase in interest expense in 2004
is due to an increase in both the amount of outstanding debt and the related
rate of interest.
Other income (expense), net for the nine-month period ended September 30,
2004 was a net expense of $107,028 compared to income of $ 198,843 for the
corresponding period in 2003. The expense in the 2004 relates primarily to
foreign exchange translation adjustments related to an obligation denominated in
a non U.S, Currency. The income in the 2003 period relates primarily to gain on
settlement of a note payable and accrued compensation due to a former officer
and director. These gains were offset in part by the forgiveness of advances to
three directors during the second quarter of 2003 in recognition of previous
service on the Board of directors. The total amount of advances to directors
forgiven amounted to $130,150, including accrued interest,
Income Taxes
The effective tax rate for all periods reported was 0%. No tax benefit was
recognized relating to the loss in those periods, as the ability of the company
to use the tax benefit of its net operating losses is not assured.
Factors That May Affect Future Results
13
We caution you that the following important factors, among others, in the
future could cause our actual results to differ materially from those expressed
in forward-looking statements made by or on behalf of us in filings with the
Securities and Exchange Commission, press releases, communications with
investors and oral statements. Any and all forward-looking statements in this
quarterly report on Form 10Q, and in any other public statements we make may
turn out to be wrong. They can be affected by inaccurate assumptions we might
make or by known or unknown risks and uncertainties. Many factors mentioned in
the discussion below are important in determining future results. We undertake
no obligation to publicly update any forward-looking statements; whether as a
result of new information, future events or otherwise. You are advised, however,
to consult any further disclosures we make in our reports filed with the
Securities and Exchange Commission Liquidity and Capital Resources
See information with respect to our liquidity and capital resources
presented above.
Our Stock Price is Volatile
Our stock price is subject to significant volatility because of factors
such as:
o The announcement of new products, services or technological
innovations by us or our competitors
o Quarterly variations in our operating results
o Decreasing product and services revenues
o Speculation in the press or investment community
o Failure to meet earning expectations
o The results of intellectual property litigation
In addition, our stock price may be affected by general market conditions,
short selling activities, and domestic and international economic factors
unrelated to our performance. Further, until recently, our stock was thinly
traded. Because of these factors, any recent trends may 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, we
cannot assure you 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. In addition, the expense of pursuing these rights is substantial.
Therefore, we cannot assure you that we will be able to adequately protect our
proprietary technology against unauthorized third party copying or use. The
failure to adequately protect our intellectual property rights and to prevail in
any pending legal proceedings could have a material adverse effect on us.
Despite our efforts to protect these intellectual property rights, unauthorized
use may still occur, particularly in foreign countries. Refer to Item 1 of Part
II below. Further, we cannot assure you that we will be able to obtain licenses
to any technology that may be required to conduct our business or that, if
obtainable, such technology can be licensed at a reasonable cost.
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 and the
availability of substantial capital. 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
and timely deliver 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 we do. 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.
14
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) 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 (VSA), StorageSuite and CyberBORG products are advanced
when compared to competitive products, and complement many other products
utilized in total customer solutions, we cannot assure 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.
Workforce
Most companies in the high technology arena are under pressure to be able
to acquire and retain the services of talented individuals. 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, we cannot assure that key employees will not leave
the company in the future. The failure to maintain key employees could adversely
affect our future operating and financial results.
Business Alliances
Many companies are forming 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 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. We have had difficulty opening these sales
channels and any continued problems in doing so will have a negative effect on
our operating results and financial condition.
Operations
The Company no longer manufactures its own proprietary hardware and has
successfully ported its software products to operate on widely available
commodity server hardware. Virtually all of the Company's hardware
configurations are available from multiple sources on a subassembly or fully
configured basis, usually on an off-the-shelf delivery. Manufacturing activity
is now limited to systems integration, final test, quality control and
production of CD's for software license sales. As volumes increase these
activities may also be outsourced.
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 our products or us 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, we cannot assure you that the results
of any of these actions will not have a material adverse effect on our business,
results of operations or financial condition.
15
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.
We have the market risk inherent in financial instruments that relates
primarily to fluctuations in the prime rate of interest to be charged under the
terms of the several promissory notes due to our Chief Executive Officer and
other affiliate.
ITEM 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures: Under the direction
of our Chief Executive Officer and our Chief Financial Officer, we evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e)), and have concluded
that, as of September, 2004, our disclosure controls and procedures were
effective.
(b) Changes in internal controls over financial reporting: In connection
with the evaluation of our internal control over financial reporting (required
by paragraph (d) of Exchange Act Rule 13a-15), we have made no changes in, nor
taken any corrective actions regarding, our internal controls over financial
reporting that have materially affected, or are reasonable likely to materially
affect, our internal control over financial reporting subsequent to the date the
Company carried out its evaluation.
PART II--OTHER INFORMATION
ITEM 1. Legal Proceedings.
In December 2001, Marketlink Technologies, LLC filed a civil action against
the Company in the Circuit Court for Oakland County, Michigan, alleging that the
Company owed them a $156,000 termination payment under the terms of a
manufacturers representative agreement that the Company terminated for cause in
April 2001 because of Marketlink's inability to sell the Company's products and
perform the services required by the agreement. In January 2002, the Company
filed counterclaims against Marketlink in this matter, including a claim for
breach of contract. The case was tried in December 2003. Following the trial,
the Court entered its order finding that the Company is liable to Marketlink for
the $156,000. Several post-order motions are currently before the Court that
will affect the final amount due. The Company is considering an appeal.
During March 2001, we filed legal actions against Hitachi Data Systems
Limited in the United Kingdom for infringement of two of the European patents in
our intellectual property portfolio. Hitachi filed a counterclaim against the
Company alleging that these two patents were invalid. The trial was completed in
July 2002 and in August 2002 the Judge ruled that neither of our patents was
shown to be valid in the United Kingdom or infringed by Hitachi. On October 17,
2002, the judgment for the defendant, Hitachi, on their counterclaim was entered
and our European Patent (UK) 0,294,287 (`287) and European Patent (UK) 0,539,494
were revoked. The Order for the revocation of the `287 Patent was stayed pending
appeal and we were granted permission to appeal the judgment so far as it
concerns the `287 Patent. It was also ordered by consent of the parties that
there be no order as to costs. On October 31, 2002, we filed an appeal with the
Court of Appeal seeking that the judgment with respect to the `287 Patent be set
aside and that the Court of Appeal find that the claims of the `287 Patent are
valid, that Hitachi infringes the claims of the patent and that there be a
certificate of contested validity in respect of the claims of the `287 Patent.
On July 30, 2003, the Court of Appeals in London dismissed our appeal.
During October 2002, we entered into a Settlement Agreement and License
with Hitachi under which Hitachi agreed not to oppose our appeal of the judgment
discussed above and not to seek recovery of litigation costs. In return, we
granted Hitachi a nonexclusive, fully paid up, perpetual license to sell or
distribute products that may be subject to claims of our patents.
In October 2001, we filed a patent infringement action in the United States
District Court for the Northern District of Texas against Veritas Software
Corporation and Veritas Software Global Corporation alleging that certain
Veritas Software Corporation storage products infringe Storage Computer's
intellectual property patent number U.S. 5,893,919 entitled "Apparatus and
Method for Storing Data with Selectable Data Protection Using Mirroring and
Selectable Parity Inhibition." In February 2002, we filed an additional patent
infringement action in the United States District Court of the Northern District
of Texas, against Veritas Software Corporation and Veritas Software Global
Corporation alleging that certain Veritas Software Corporation storage products
infringe Storage Computer's intellectual property, specifically U.S. 5,257,367
entitled "Data Storage system with Asynchronous Host Operating System
Communication Link". However, we amended our complaint to dismiss claims arising
under this patent in September 2002. In March 2002, we filed a third patent
infringement action against Veritas Software Corporation and Veritas Software
Global Corporation alleging certain Veritas Software Corporation storage
products infringe Storage Computer's intellectual property patent number U.S.
6,098,128 entitled "Universal Storage Management System." Our claim is for
injunctive relief, damages and legal costs arising from the alleged
infringement.
16
These actions were referred to a court appointed mediator with an initial
mediation date in April 2002 and such mediation concluded without any mutually
agreeable basis for settlement having been reached. A trial date was scheduled
for November 10, 2003. However, on October 21, 2003, the Court ordered that all
matters in this case are stayed pending the resolution of plaintiff's and
defendants' motions for summary judgment. On March 12, 2004, the court issued a
memorandum opinion granting the Veritas entities motion for summary judgment
holding that there is no evidence that the patents in question are infringed by
the Veritas entities. To date the court has not entered a final judgment in the
case. The Company has filed a notice of appeal.
On September 23, 2002, Veritas asserted a counter claim for patent
infringement with respect to patent number U.S. 5,812,753 entitled " Methods for
Initializing or Reconstructing Data Consistency Within an Array of Storage
Elements." On November 18, 2003, the court issued an order staying all
proceedings in the case until there is a final resolution of the reexamination,
requested by the Company on September 23, 2003, of the patent by the U.S. Patent
and Trademark Office. We believe that this claim is without merit and intend to
vigorously defend this action. On March 12, 2004, the Company received through
its patent counsel the first office action of the U.S. Patent and Trademark
Office, where the majority of the claims of U.S. 5,812,753 were rejected based
on prior art.
The outcome in the Veritas patent proceeding is pending. We are currently
evaluating results of recent patent litigation and are considering various
strategies to protect our intellectual property. The future cost of litigation
to enforce our intellectual property rights could be substantial. There is a
current need to invest in the development of our core business whereas
litigation to enforce our intellectual property rights can, in some cases, be
deferred as certain of our patents run as far as 2020. The decision to pursue
litigation to enforce these rights will be made on the merits of each case and
the impact it will have on the overall success of the Company.
The Company is involved from time to time in various other minor legal
actions in the ordinary course of its business which management believes will
not have a material adverse effect on its business, operating results of
financial position.
ITEM 2. Changes in Securities and Use of Proceeds
During the quarter ended September 30, 2004 The Company issued 100 shares
of its previously authorized Series F 4% Redeemable Convertible Preferred stock
with a stated value of $1,000 per share. The shares were issued for sales and
marketing services valued at $100,000. These shares were issued in reliance upon
the exemption from securities registration afforded by Rule 506 under Regulation
D as promulgated by the United States Securities and Exchange Commission under
the Securities act of 1933, as amended.
ITEM 3. Defaults Upon Senior Securities
NONE
ITEM 4. Submission of Matters to a Vote of Security Holders
At our Annual Meeting of Stockholders held on July 15,2004 the following
matters were voted:
Proposal 1 Election of Directors Voted for Votes withheld
---------- --------------
Theodore J. Goodlander 35,686,325 620,394
Edward A. Gardner 35,595,133 711,586
Steven S. Chen 35,814,154 492,565
Roger E. Gauld 35,814,154 492,565
Thomas A. Wooters 35,719,825 586,894
17
Proposal 2 Amendment to the 1999 Incentive Stock Plan:
------------------------------------------------------
Voted for Voted against Votes withheld
---------- ------------- --------------
18,162,436 1,564,530 16,579,753
Proposal 3 Amendment to Certificate of Incorporation:
-----------------------------------------------------
Voted for Voted against Votes withheld
---------- ------------- --------------
35,208,544 1,063,787 34,388
Proposal 4 Ratification of Appointment of Auditors
--------------------------------------------------
Voted for Voted against Votes withheld
---------- ------------- --------------
35,934,231 254,728 117,760
ITEM 5. Other Information
See Part II, Item 1. Legal proceedings
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Number Description
------ -----------
31.1 Rule 13a-14(a) Certification of Theodore J. Goodlander, Chief
Executive Officer
31.2 Rule 13a-14(a) Certification of Michael J. O'Donnell, Chief Financial
Officer
32.1 Section 1350 Certification of Theodore J. Goodlander, Chief Executive
Officer
32.2 Section 1350 Certification of Michael J. O'Donnell, Chief Financial
Officer
(b) Reports On Form 8-K
On August 17, 2004 Storage Computer Corporation filed a Current Report on
Form 8K for purposes of filing under item 12 with the Securities and Exchange
Commission as an exhibit thereto Storage Computer's press release dated August
17, 2004 announcing its results of operations for the second quarter ended June
30, 2004.
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
By: /s/ Michael J. O'Donnell
------------------------
Michael J. O'Donnell
Chief Financial Officer
Date: November 22, 2004
18