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 JUNE 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
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(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 JULY 31, 2001
----- -------------
Common Stock. 15,784,479
1
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited). Page
Consolidated Balance Sheets - June 30, 2001 3
and December 31, 2000.
Statements of Consolidated Operations - Three and six months 4
ended June 30, 2001 and 2000.
Statements of Consolidated Cash Flows - Six months 5
ended June 30, 2001 and 2000.
Notes to Consolidated Financial Statements - June 30, 2001 6
Item 2. Management's Discussion and Analysis of Financial Condition and 7
Results of Operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 15
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings. 16
Item 2. Changes in Securities and Use of Proceeds. 16
Item 3. Defaults Upon Senior Securities. 16
Item 4. Submission of Matters to a Vote of Security Holders. 16
Item 5. Other Information. 16
Item 6. Exhibits and Reports on Form 8-K. 16
2
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Storage Computer Corporation
Consolidated Balance Sheets
June 30, December 31,
2001 2000
----------- ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 7,965,305 $14,852,259
Accounts receivable, net 701,374 847,829
Inventories 4,549,056 4,316,104
Other current assets 395,744 399,302
----------- -----------
Total current assets 13,611,479 20,415,494
Property and equipment, net 994,286 1,141,299
Goodwill and other intangibles, net 21,662,685 23,317,443
Other assets 117,770 244,040
----------- -----------
Total assets $36,386,220 $45,118,276
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,179,947 $ 896,049
Accrued expenses 1,938,861 2,436,291
Deferred revenue and customer deposits 996,976 492,028
Current maturities of long-term debt 267,364 263,863
------------ ------------
Total current liabilities 4,383,148 4,088,231
------------ ------------
Long-term debt, less current maturities 1,366,571 1,489,299
------------ ------------
Commitments and contingencies
Redeemable convertible preferred stock 12,152,548 12,556,661
------------ ------------
Shareholders' equity:
Preferred stock - -
Common stock 15,778 15,042
Additional paid-in capital 58,122,062 57,792,635
Accumulated deficit (39,653,887) (30,823,592)
------------ ------------
Total shareholders' equity 18,483,953 26,984,085
------------ ------------
Total liabilities and shareholders' equity $ 36,386,220 $ 45,118,276
============ ============
See Notes to Consolidated Financial Statements.
3
Storage Computer Corporation
Statements of Consolidated Operations (Unaudited)
Three Months Ended Six Months Ended
----------------------- -----------------------
June 30, June 30, June 30, June 30,
2001 2000 2001 2000
----------- ---------- ----------- ----------
Revenue $ 950,913 $2,054,678 $ 3,010,275 $4,149,676
Product Cost 973,956 1,058,001 2,336,520 1,960,883
----------- ---------- ----------- ----------
Gross margin (23,043) 996,677 673,755 2,188,793
----------- ---------- ----------- ----------
Operating expenses:
Research and development 781,000 283,494 2,378,129 667,865
Selling and marketing 1,154,696 477,074 1,812,580 1,006,644
General and administrative 1,416,915 625,114 1,786,687 988,787
Amortization of intangibles 701,938 - 1,415,868 -
----------- ---------- ----------- ----------
Total operating expenses 4,054,549 1,385,682 7,393,264 2,663,296
----------- ---------- ----------- ----------
Operating loss (4,077,592) (389,005) (6,719,509) (474,503)
----------- ---------- ----------- ----------
Other income (expense):
Interest income (expense), net 77,590 (125,769) 188,668 (294,689)
Other income (expense) (12,330) 17,584 102,980 120,974
----------- ---------- ----------- ----------
Total 65,260 (108,185) 291,648 (173,715)
----------- ---------- ----------- ----------
Loss before income taxes (4,012,332) (497,190) (6,427,861) (648,218)
Provision (credit) for
income taxes ( 1,889) - 1,214 -
----------- ---------- ----------- ----------
Net loss (4,010,443) (497,190) (6,429,075) (648,218)
Dividends on preferred
stock including
amortization of the
beneficial conversion
features (811,853) (621,350) (2,401,220) (621,350)
=========== ========== =========== ==========
Loss applicable to
common stockholders $(4,822,296) $(1,118,540) $( 8,830,295) $(1,269,568)
=========== ========== =========== ==========
Loss applicable to common
stockholders per basic
and dilutive share $(.31) $(.09) $(.57) $(.10)
=========== ========== =========== ==========
Basic and dilutive shares 15,777,717 11,837,807 15,593,664 11,837,807
=========== ========== =========== ==========
See Notes to Consolidated Financial Statements.
4
Storage Computer Corporation
Statements of Consolidated Cash Flows (Unaudited)
Six Months Ended
----------------------
June 30, June 30,
2001 2000
---- ----
Cash flows from operating activities:
Net loss $(6,429,075) $ (648,218)
Reconciliation to operating cash flows:
Depreciation and amortization of property
and equipment 256,804 319,694
Amortization of goodwill and other intangibles 1,415,868 --
Stock issued to 401(k) plan 20,958 20,500
Changes in operating assets and liabilities:
Accounts receivable 146,455 (198,450)
Inventories (191,664) 484,909
Other current assets 3,558 282,172
Accounts payable and accrued expenses (82,873) (326,776)
----------- -----------
Net cash used in operations (4,859,969) (66,169)
----------- -----------
Cash flows from investing activities:
Capital expenditures (109,797) (17,065)
Other assets 126,270 (9,385)
CyberStorage acquisition cost adjustments 238,890 --
----------- -----------
Net cash provided by (used in) investing activities 255,363 (26,450)
----------- -----------
Cash flows from financing activities:
Net payments on credit line -- (6,593,770)
Reduction of long-term debt (119,227) --
Net proceeds from issuance of common stock
for stock options and warrants 8,715 919,223
Issuance (redemption) of preferred stock (2,130,548) 5,683,809
----------- -----------
Net cash provided by (used in) financing activities (2,241,060) 9,262
----------- -----------
Effect of exchange rate changes on cash (41,288) (21,915)
----------- -----------
Net decrease in cash and cash equivalents (6,886,954) (105,272)
Cash and cash equivalents-beginning of period 14,852,259 1,182,194
----------- -----------
Cash and cash equivalents-end of period $ 7,965,305 $ 1,076,922
=========== ===========
Supplemental cash flow information:
Cash payments of interest $ 75,444 $ 129,933
Cash payments of income taxes $ 1,214 --
Noncash financing activities:
Preferred stock dividends paid in common stock $ 333,081 --
See Notes to Consolidated Financial Statements.
5
Storage Computer Corporation
Notes to Consolidated Financial Statements
June 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 six months
ended June 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 June 30, 2000 has been restated in this Form 10-Q to
properly reflect the results for the three and six months ended June 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 six months ended June 30,
2001 and 2000 follows:
Common Stock
------------- Additional
Par Paid-In Retained
Shares Value Capital Deficit
------------- ---------- ----------- -------------
Balance--December 31, 1999 11,434,880 $ 11,435 $13,968,263 $ (9,963,058)
Exercise of stock options 571,630 572 852,460
Stock issued to 401 (k) plan 3,248 3 20,497
Net loss (618,218)
---------- -------- ----------- ------------
Balance--June 30, 2000 12,009,758 $ 12,010 $14,841,220 $(10,611,276)
========== ======== =========== ============
Balance--December 31, 2000 15,041,882 $ 15,042 $57,792,635 $(30,823,592)
Exercise of stock options 3,433 4 8,709
Stock issued to 401(k) plan 3,069 3 20,955
Conversion of redeemable
convertible preferred
shares into common shares
and related accrued dividends
paid in common shares 671,256 671 61,487
Amortization of beneficial
conversion feature of
preferred stock (1,770,886)
Dividends on preferred stock 58,077 58 238,276 (630,334)
Net loss (6,429,075)
---------- -------- ----------- ------------
Balance-June 30, 2001 15,777,717 $15,778 $58,122,062 $(39,653,887)
========== ======== =========== ============
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 June 30, 2001, the net carrying amount of goodwill is
$17,223,635 and other intangible assets is $4,439,050. Amortization expense
during the six-month period ended June 30, 2001 was $1,415,868. 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.
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
7
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 June 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 $4,860,000 of cash during the first six months of 2001 compared
to $66,000 in the first six months of 2000.
The use of cash by operations in the first six months of 2001 resulted from the
net loss for that period and net cash used for changes in operating assets and
liabilities partially offset by a $540,000 customer order deposit, which were
offset in part by non cash charges relating to depreciation and amortization of
$1,673,000. The cash used by operations in the first six months of 2000 resulted
primarily from the net loss for that period and net cash provided by changes in
operating assets and liabilities, which were offset in part by non cash charges
relating to depreciation and amortization of $320,000.
Investing activities generated positive cash flow of $255,000 in the first six
months of 2001 from other assets partially offset by capital expenditures.
Investing activities used cash flow in the first six months of 2000 primarily
for capital expenditures.
Financing activities used $2,241,000 of cash in the first six months of 2001
primarily for the redemption of Series A and B preferred stock for $2,131,000 in
May. During the first six months of 2000, our bank credit facility was virtually
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 June 30, 2001 was $9,228,000 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 112,000 shares of Series A, Series B and Series C Preferred
Stock and related warrants. These sales to investors have significantly
improved our cash liquidity and working capital position.
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
sales and marketing management, and staff, which was substantially completed in
June of 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 six month periods ended June 30, 2001
were $951,000 and $3,010,000 compared to $2,055,000 and $4,150,000 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 June 30, 2001, U.S. domestic product sales and international
product sales were 73% and 27%, respectively, of total revenue compared to 67%
and 37% for the same period in 2000. For the six month period ended June 30,
2001, U.S. domestic product sales and international product sales were 69% and
31%, respectively, of total revenue compared to 49% and 51% for the same period
in 2000.
9
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
The increase in product cost percentage between 2000 and 2001 of approximately
23% experienced in the first quarter continued to increase to 31% for the year
to date and 99% for the three months ended June 30, 2001. 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 and lower margin product mix.
RESEARCH AND DEVELOPMENT
Research and development expenses for the three month periods ended June 30,
2001 and 2000 were $781,000 and $283,000, respectively, and $2,378,000 and
$668,000, respectively, for the six month periods ended June 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. 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 periods and the six month
periods ended June 30, 2001 and 2000 continue to reflect the increased head
count in corporate marketing and field sales organizations and in the three
months ended June 30, 2001 costs associated with greater trade show activity of
$170,000 and marketing materials and web site development costs of $80,000.
GENERAL AND ADMINSTRATIVE EXPENSES
General and administrative expenses for the three month periods and the six
month periods ended June 30, 2001 and 2000, respectively, reflect the higher
level of personnel due to the CyberStorage acquisition. In the three months
ended June 30, 2001 costs were incurred by U.K. attorneys and by expert
witnesses aggregating $280,000 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 EXPENSE
The interest income (expense) for the three month periods and the six month
periods ended June 30, 2001, respectively, reflect the elimination of bank
borrowing by us as compared to the same periods in the prior year and the
dramatic increase in cash and cash equivalents.
10
NET LOSS
We incurred a net loss for the three month period ended June 30, 2001 of
$4,010,000 compared to $497,000 for the three month period ended June 30, 2000.
The increase in net loss of $3,513,000 compared to the increase in net loss for
the first quarter of $2,268,000 is primarily attributable to the lower sales
volume and related effect on gross margin, the changes in operating expenses
described above and the non-cash charges for amortization of intangibles of
$714,000 during the three months ended June 30, 2001, in connection with the
acquisition of CyberStorage Systems Corporation 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.
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
$17,223,635 and other intangible assets is $4,439,050. Amortization expense
during the six-month period ended June 30, 2001 was $1,415,868. 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
- 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.
11
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. During the first quarter in
2000, we retained a major law firm to enforce these rights against infringing
parties, which we believe to be extensive. During the first quarter in 2001, we
filed lawsuits against Hitachi Data Systems Ltd. in the United Kingdom and
Seagate Technologies, Inc. in Federal District Court in Texas, regarding their
alleged infringement of our patents. Despite our efforts and those of our legal
representatives, there can be no assurance or predictability as to any amount of
recovery or the length of time it will take us to recover any royalties or
license fees which may be recoverable. Despite our efforts to protect our
intellectual property rights, unauthorized use may still occur, particularly in
foreign countries.
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.
12
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 fibre
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.
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Additionally, most companies in the high technology arena are under pressure to
be able to acquire and retain the services of talented individuals. At present,
there is a shortage in the number of qualified employees who are available,
creating a lucrative job market for qualified and talented high tech employees.
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.
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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."
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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 infringe one of our patents. Our involvement in both of these
proceedings can not 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
June 30, 2001, Series B Preferred Stockholders converted 2,000 shares of Series
B Preferred stock and accrued dividends into 60,233 shares of our common stock.
No cash was received as a result of these conversions. Also, during this quarter
we redeemed 7,000 shares of Series A Preferred Stock and 10,000 shares of Series
B Preferred Stock, together with accrued dividends, for $2,171,844.
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 six month period ended June 30, 2001.
Item 4. Submission of Matters to a Vote of Security Holders. At our Annual
Meeting of Stockholders held on May 18, 2001 the following matters were voted:
The following individuals were elected to the Board of Directors:
Votes For Votes Withheld
--------- --------------
Theodore J. Goodlander 9,677,237 53,855
Edward A. Gardner 9,677,309 53,783
Steven S. Chen 9,677,309 53,783
Roger E. Gauld 9,677,309 53,783
John Thonet 9,677,309 53,783
The vote to ratify the action of the Board of Directors in appointing BDO
Seidman, LLP as the Company's auditors for the year ending December 31, 2001
was:
Votes For Votes Against Votes Withheld
--------- ------------- --------------
9,709,286 7,844 13,962
The vote to approve the issuance of shares of the Company's Common Stock upon
conversion of the Company's Series B 8% Convertible Preferred Stock was:
Votes For Votes Against Votes Withheld
--------- ------------- --------------
9,582,863 131,191 17,038
The vote to approve the issuance of shares of the Company's Common Stock upon
conversion of the Company's Series C 8% Convertible Preferred Stock was:
Votes For Votes Against Votes Withheld
--------- ------------- --------------
9,572,003 141,601 17,488
The vote to approve the issuance of shares of the Company's Common Stock upon
conversion of the Company's Series D 8% Convertible Preferred Stock was:
Votes For Votes Against Votes Withheld
--------- ------------- --------------
9,573,148 140,093 17,851
The vote to amend the Company's Certificate of Incorporation to increase the
authorized number of shares of Common Stock of the Company from 25,000,000 to
50,000,000 shares was:
Votes For Votes Against Votes Withheld
--------- ------------- --------------
9,615,241 99,143 16,708
Item 5. Other Information.
None
Item 6. Exhibits and Reports on Form 8-K.
A. Exhibits -None
B. Reports on Form 8-K - None
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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: August 14, 2001
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