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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the fiscal year ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-11578
DISC, Inc.
(Exact name of Registrant as specified in its charter)
California 77-0129625
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
372 Turquoise Street, Milpitas, CA 95035
(Address of principal executive offices)
Registrant's telephone number, including area code: (408) 934-7000
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
Common Stock, no par value None
Warrants, each to purchase
one share of Common Stock
----------------
Securities registered pursuant to Section 12(g) of the Act: None
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the closing sales price of the Common Stock as of March
24, 1998 as quoted on the NASDAQ Small-Cap Market, was approximately $2,170,000.
The number of outstanding shares of the Registrant's Common Stock as of March
24, 1998 was 3,395,304.
Page 1 of 65 Pages
Exhibit Index appears on Page 37
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DISC, INC.
FORM 10-K
INDEX
PAGE
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Part I:
Item 1. Business 3
Item 2. Facilities 7
Item 3. Legal Proceedings 7
Item 4. Submission of Matters to a Vote of Security Holders 7
Part II:
Item 5. Market for Registrant's Common
Equity and Related Shareholder Matters 7
Item 6. Selected Financial Data 8
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Item 8. Financial Statements and Supplementary Data 10
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 10
Part III:
Item 10. Directors and Executive Officers of the Registrant 11
Item 11. Executive Compensation 12
Item 12. Security Ownership of Certain Beneficial Owners 14
and Management
Item 13. Certain Relationships and Related Transactions 16
Part IV:
Item 14: Exhibits, Financial Statement Schedules and 17
Reports on Form 8-K
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PART I
Introductory Note
This Annual Report on Form 10-K contains certain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934 and the Company intends that such
forward-looking statements are subject to the safe harbors created thereby.
These forward-looking statements include (i) the existence and development of
the Company's technical and manufacturing capabilities, (ii) anticipated
competition, (iii) potential future growth in revenues and income, (iv)
potential future decreases in costs, and (v) the need for, and availability of,
additional financing. For this purpose, any statements contained in this Annual
Report on Form 10-K except for historical information may be deemed to be
forward-looking statements. Without limiting the generality of the foregoing,
words such as "may", "will", "expect", "believe", "anticipate", "intend",
"could", "estimate", or "continue", or the negative or other variations thereof,
or comparable terminology are intended to identify forward-looking statements.
The forward-looking statements included herein are based on current expectations
that involve a number of risks and uncertainties. These forward-looking
statements are based on assumptions regarding the Company's business, which
involve judgments with respect to, among other things, future economic,
competitive and market conditions, and future business decisions, all of which
are difficult or impossible to predict accurately and many of which are beyond
the control of the Company. Although the Company believes that the assumptions
underlying the forward-looking statements are reasonable, any of the assumptions
could prove inaccurate and, therefore, there can be no assurance that the
results contemplated in forward-looking statements will be realized. In
addition, the business and operations of the Company are subject to substantial
risks which increase the uncertainty inherent in such forward-looking statements
(see "Additional Factors that May Affect Future Operating Results" on page 6).
In light of the significant uncertainties inherent in the forward-looking
information included herein, the inclusion of such information should not be
regarded as a representation by the Company or any other person that the
objectives or plans of the Company will be achieved.
ITEM 1. BUSINESS
General
DISC, Inc. ("DISC" or the "Company") was incorporated under the laws of the
State of California in 1986. The Company operates in one business segment, the
computer mass storage system business. The Company designs, manufactures, and
markets a family of high-end computer mass storage systems which use 5.25 inch
rewritable, magneto optical disks (MO) and CD-ROM disks. The Company believes it
is the only supplier of information storage products currently offering a range
of storage capacities up to 2.7 terabytes in the 5.25 inch optical disk
libraries and up to 1,470 CD-ROM platters.
Products
Products consist of a family of optical disk storage libraries based on the 5.25
inch optical or CD media. Their capabilities cover the spectrum of high
performance, transaction-oriented information systems such as archival storage,
imaging, COLD, network file server and video/multimedia servers.
DISC's modular automated library design houses a combination of optical disks,
disk drives and an advanced robotic picking mechanism. Each library contains an
array of cubes, each of which can hold either a group of disks or one to two
optical disk drives. The modular design of DISC's libraries allows users to
choose the configuration which best suits their needs. By adding more cells of
either optical disks or drives, users can easily expand the system as storage
requirements grow. The modular design of the system also caters to various types
of drives or media, allowing users the opportunity to easily upgrade their
systems as higher performance drives and media are introduced. Software,
developed by and proprietary to the Company, allows a user's computer to
communicate with the DISC library and command a high performance robotic device
to select a desired disk from the array and insert it into a drive. Once in the
drive, the information access time for optical disks is approaching that of
magnetic disks.
The Company is currently shipping four different sizes of frames for the arrays,
to allow for different sized applications in the user's operation. The 5.25 inch
optical disk libraries range in capacity from 130 to over 1,050 optical disks.
The CD-ROM Libraries range in capacity from 300 CDs to 1400 CDs and can handle
up to 48 CD-ROM readers. List prices for the Company's products range from
approximately $40,000 to $140,000 not including the costs of media.
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All of the Company's products have been designed to meet high duty cycles while
achieving high levels of reliability and ease of serviceability.
Marketing and Sales
Applications for the Company's products include federal and local government and
military applications and insurance, banking, legal, entertainment and medical
applications on a worldwide basis. Sales of the Company's initial product line
commenced in 1991 and have been primarily to distributors, value added resellers
(VARs), original equipment manufacturers (OEMs), and system integrators (SIs),
who combine DISC libraries with software and/or other products and resell the
combination to the end-user or other members of the supply channel.
The Company's products are installed and serviced by an international network of
maintenance technicians pursuant to contracts between the Company, Tab Products
Co. and International Business Machines Corp. Technical assistance and second
level support is provided by the Company's support staff located in Milpitas,
California.
The Company's sales offices are located in Milpitas, California, Boston,
Massachusetts, Washington, DC, Dallas, Texas, Chicago, Illinois, Atlanta,
Georgia, and Crowborough, England. The Company's sales staff currently consists
of seven professional salespersons.
The Company has not experienced, and does not expect, sales of the Company's
products to be subject to seasonality in any material respect.
Competition
The computer information storage industry is highly competitive and price
erosion is typical over the life of a product. The Company's products compete
directly with other data storage products, including optical media, magnetic
tape cartridges and magnetic disk subsystems. The Company's competitors include
Hewlett-Packard Co., Storage Technology Corporation, ATG/Cygnet, Kodak, Plasmon
and Sony. Other companies, including computer manufacturers and other peripheral
manufacturers, could enter the market at any time. Such competitors may compete
with the Company's products with lower prices for similar products or by
introducing new products which provide greater storage capacity, faster access
time or other improved features, any of which could reduce demand for the
Company's products or require the Company to reduce its prices. Such competition
could have a materially adverse effect on the Company's results of operations.
Many of the Company's competitors have significantly greater financial,
technical, manufacturing and marketing resources than the Company, as well as
significant market shares and installed customer bases in certain market areas
addressed by the Company. As a result, the Company may not have the ability to
keep pace with rapid technological advances to the same extent as its
competitors.
However, the Company maintains an active program of research and development in
an effort to keep pace with potential competition. In addition, the Company has
expanded its marketing capabilities and its trade show coverage, but has engaged
in only limited advertising.
The principal market requirements for the Company's products are large storage
capacity, high recording speeds, reliability, compact physical size and low cost
per megabyte of storage. While desired capabilities generally vary by product
family and end user application, the Company believes that, because of its
modular design, easy scalability, high performance and reliability, DISC will
compete favorably with respect to the requirements of the secondary mass data
storage market.
Manufacturing and Components
The Company's manufacturing operations consist of final system assembly and
product test activities. The majority of the parts and subassemblies in the DISC
libraries are standard, off-the-shelf components or are fabricated to DISC's
manufacturing documentation. These include power supplies, castings, motors,
bearings, timing belts and electronic components. The Company's proprietary
components, such as the frame, backplane, printed circuit assemblies and other
machined and fabricated parts are subcontracted out to independent vendors.
Certain components used by the Company are purchased from a single source of
supply. Where it relies on single sources of supply, the Company has been able
to obtain supplies of these components in a timely manner and maintains an
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adequate inventory of components to meet its needs. The Company believes
alternative supplies for all such components are available on reasonable terms.
However, failure of sources of supply and the inability of the Company to
develop alternative sources of supply as required in the future could have a
material adverse effect on the Company's operations.
Research and Development
The Company has an active program of research and development consisting of 8
full-time employees in the areas of mechanical and electrical engineering and
software design and one part-time consultant in the mechanism design area. The
Company's research and development activities include robotics mechanism design
and control and power system design and development. The Company expended
$1,439,000, $1,297,000, and $1,336,000 on research and development for the years
ended December 31, 1997, 1996, and 1995, respectively. The Company recently
completed a major new library development effort with respect to its 5.25 inch
optical and CD products. The Company intends to continue to expand its research
and development team in order to conduct on-going development of existing
products and to develop new products similar to its current products.
Backlog
The Company's backlog at December 31, 1997 was approximately $479,000 as
compared to a backlog of approximately $840,000 at December 31, 1996. The
Company includes in backlog only orders for products which are believed to be
firm and which are due to be shipped within 12 months. The Company includes in
backlog orders which may be canceled by customers upon payment of cancellation
charges which vary depending on the scheduled shipment date of the order.
Because of the possibility of customer changes in delivery schedules or
cancellation of orders, the Company's backlog as of any particular date may not
be indicative of actual revenues for any specific future period. Although the
Company has never experienced material cancellation problems, no assurance can
be given that the Company will continue to avoid cancellation problems in the
future.
Patents and Other Intellectual Property
The Company has received U.S. patents covering various aspects of its
technology, including its overall system design. There can be no assurance that
any subsequent patent applications will be granted. However, the Company
believes that the improvement of its existing products, reliance upon trade
secrets and copyrights and on unpatented proprietary know-how and innovation in
the development of new products are generally as important as patent protection
in establishing and maintaining the Company's technological advantage. The
Company believes that the value of its products is partly dependent upon its
proprietary confidentiality and invention assignment agreements with its
employees. While the Company believes that copyright and trade secret laws
should afford adequate protection of its proprietary technology, there can be no
assurance that the Company's proprietary technology will remain a trade secret
or that others will not develop a similar technology and use such a technology
to compete with the Company. Such competition could have a material adverse
effect on the Company. In addition, policing unauthorized use of the Company's
technology, particularly in foreign countries, may be difficult. The Company has
not received claims from third parties alleging that the Company's products
infringe the proprietary rights of third parties, or seeking indemnification
against such infringements and knows of no basis for any such claims. However,
there can be no assurance that such claims will not be made in the future. Such
claims, if asserted, may involve costly and protracted litigation and there can
be no assurance that the Company would be able to obtain licenses from third
parties on commercially reasonable terms.
Employees
As of February 15, 1998, the Company employed 52 people on a full-time basis,
including 6 employees in administration and accounting, 8 employees in marketing
and sales, 9 employees in engineering, 20 employees in manufacturing, 2
employees in quality control and 7 in service. The Company also employed 1
part-time employee in manufacturing. The Company believes that its relations
with all employees are satisfactory. None of the employees are covered by a
collective bargaining agreement.
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Additional Factors that May Affect Future Operating Results
The Company's future operating results and stock price may be affected by a
number of factors that could cause actual results to differ from those stated
herein. These factors include the following:
Fluctuations in Quarterly Operating Results. The Company's quarterly
operating results fluctuate in part due to new product enhancements and to the
timing of product shipments, marketing and product development expenditures and
promotional programs. Accordingly, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as an indication of future performance. A significant
portion of the Company's operating expenses are relatively fixed, and planned
expenditures, such as the expansion of the Company's direct sales force, are
based primarily on sales forecasts. If revenues do not meet the Company's
expectations in any given quarter, operating results may be adversely affected.
There can be no assurance that the Company will be profitable in any quarter or
at all.
Volatility of Stock Price; NASDAQ Delisting; Low Stock Prices. The securities
of computer and technology companies have experienced extreme price and volume
fluctuations, which have often been unrelated to the companies' operating
performance. Announcements of technological innovations for new commercial
products by the Company or its competitors, developments concerning proprietary
rights or general conditions in the software and computer industries may have a
significant effect on the Company's business and on the market price of the
Company's securities. Sales of a substantial number of shares of Common Stock by
existing security holders could also have an adverse effect on the market price
of the Company's securities. The trading of the Company's Common Stock and
Warrants on the NASDAQ System is conditioned upon the Company meeting certain
asset, revenues and stock price tests. If the Company fails any of these tests,
Common Stock and Warrants may be delisted from trading on the NASDAQ System,
which could materially adversely affect the trading market and prices for such
securities. In addition, low price stocks are subject to additional risks
including additional state regulatory requirements and the potential loss of
effective trading markets.
Highly Competitive Industry. The Company's products compete with those
offered by larger companies which possess substantially greater financial,
technical, and marketing resources than those of the Company. Competition from
computer companies and others diversifying into the field is expected to
increase as the market develops. The Company may face substantial competition
from new entrants in the industry and from established and emerging companies in
related industries. There is no assurance that the Company will not experience
increased competition in the future from these or other companies which would
adversely affect the Company's ability to successfully market its products.
Rapid Changes in Technology; Maintenance of Technological Advantage. The
technology underlying the Company's products and services is subject to rapid
change. The Company maintains an ongoing research and development program, and
its success will depend in part upon its continuing ability to respond quickly
and successfully to technological advances by developing and introducing new or
improved products. There can be no assurance that the Company will be able to
foresee and respond to such advances or that competitors will succeed in
developing technologies and products that are more effective than any of those
which have been or are being developed by the Company. In the past, the Company
has experienced delays in the introduction of some new products. There can be no
assurance that the Company will be able to introduce new products on schedule or
that such new products will achieve market acceptance.
History of Losses and Expectations of Future Losses; Need for Additional
Financing. The Company has experienced significant operating losses since its
inception, and as of December 31, 1997 had an accumulated deficit of
$22,724,000. The Company expects to continue to incur net losses for the
foreseeable future, and the Company's ability to sustain its operations for a
significant period after December 31, 1998 will depend on the Company's ability
to significantly increase sales or raise significant additional debt or equity
financing. There can be no assurance that the Company will be able to increase
sales or that additional financing will be available on acceptable terms, or at
all.
Year 2000 Compliance. Many currently installed computer systems and software
products are coded to accept only two digit entries in the date code field.
These date code fields will need to accept four digit entries to distinguish
21st century dates from 20th century dates. As a result, in less than two years,
computer systems and software used by many companies may need to be upgraded to
comply with such Year 2000 requirements. The Company believes that the software
components of its products, which are self-contained software programs that run
independently of external chronology, will not be significantly affected by Year
2000 problems. The Company is currently in the process of investigating whether
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its internal accounting systems and other operational systems are Year 2000
compliant. The Company has been informed by the vendor of its internal
accounting software that upgrades that will bring such software into Year 2000
compliance will be provided to the Company under its existing software
maintenance agreement by the third quarter of 1998. The Company expects to
effect the conversion of its internal accounting system to such upgraded
software by the end of 1998. There can be no assurance that such upgrades will
be provided on a timely basis or will be free of errors. In addition, there can
be no assurance that certain of the Company's products or the Company's internal
computer systems and networks or those of its key vendors, developers and
distributors will not be adversely affected by Year 2000 issues, which could
have a material adverse effect on the Company's business, operating results and
financial condition.
ITEM 2. FACILITIES
The Company's executive offices and engineering/manufacturing operations are
located in approximately 17,000 square feet of space in Milpitas, California.
The Company leases the facility pursuant to a lease which will expire on October
31, 2000, and the Company believes that this facility will be sufficient to
support operations for the foreseeable future. However, the Company believes
that, if necessary, additional space will be available in the area to house the
Company's operations.
ITEM 3. LEGAL PROCEEDINGS
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during the
fourth quarter of the fiscal year ended December 31, 1997.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The Company's Common Stock is traded on the NASDAQ Small-cap Market under the
symbol DCSR. The high and low sales prices set forth below are as reported by
the NASDAQ Small Cap Market System.
1997 1997 1996 1996
HIGH LOW HIGH LOW
---- --- ---- ---
First quarter end $5 1/4 $3 17/32 $6 3/4 $2
Second quarter end 4 13/64 1 15/16 4 7/8 2 3/4
Third quarter end 3 5/8 2 1/4 5 3/4 4 1/8
Fourth quarter end 3 7/8 6 3 1/2
------ ----- ------ -------
As of March 24, 1998, the Company had approximately 400 shareholders. The
Company has never paid cash dividends and has no present plans to pay dividends.
See Note 5 of Notes to Financial Statements regarding dividend requirements on
the Convertible Preferred Stock.
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ITEM 6. SELECTED FINANCIAL DATA
(In thousands, except per share amounts)
FOR THE YEARS ENDED DECEMBER 31, 1997 1996 1995 1994 1993
-------------------------------- ------- ------- ------- ------- -------
Net sales $ 8,655 $ 7,761 $ 6,605 $ 4,326 $ 3,425
Cost of sales (6,704) (6,549) (5,478) (3,727) (3,063)
Research and development (1,439) (1,297) (1,336) (1,414) (1,392)
Marketing and sales (1,960) (2,155) (1,295) (1,146) (1,008)
General and administrative (924) (984) (1,195) (962) (750)
------- ------- ------- ------- -------
Loss from operations (2,372) (3,224) (2,699) (2,923) (2,788)
Interest and other income (expense), net (117) (118) (127) (22) 37
------- ------- ------- ------- -------
Net loss $(2,489) $(3,342) (2,826) $(2,945) $(2,751)
------- ------- ------- ------- -------
Basic and diluted net loss per share $ (0.75) $ (1.08) $ (0.94) $ (0.99) $ (0.94)
Weighted average common shares for
basic and diluted net loss per share
calculation 3,308 3,106 3,005 2,963 2,932
======= ======= ======= ======= =======
AT DECEMBER 31, 1997 1996 1995 1994 1993
--------------- ------ ------ ------ ------ ------
Working capital $ 689 $ 691 $ 567 $ 264 $1,186
Total assets 4,144 4,110 3,781 2,675 2,783
Long-term obligations, excluding current 20 -- -- 43 97
portion
Mandatorily Redeemable Convertible -- -- -- 2,089 1,977
Preferred Stock
Shareholders' equity (deficit) $1,071 $1,132 $1,004 $(1,501) $ (426)
====== ====== ====== ======= ======
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This Annual Report on Form 10-K contains certain forward looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934 and the Company intends that such
forward-looking statements are subject to the safe harbors created thereby. See
"Introductory Note" on page 3 hereof and "Additional Factors that May Affect
Future Operating Results" on pages 6 hereof.
The Company had net sales of $8,655,000 in 1997, $7,761,000 in 1996 and
$6,605,000 in 1995. Management believes that the increase in sales is due to an
expanded customer base resulting from an increase in the Company's direct sales
personnel. Management believes that this increase would have been greater if not
for a delay in the fourth quarter of 1997 in expected orders from Pacific Rim
customers due to the uncertainty in their economies. Although sales in the
Pacific Rim have historically been less than ten percent of total revenue, the
Company was expecting an increase in revenue from this geographic area. The
general sales cycles for distribution of the Company's products are similar to
those of most businesses selling products designed for use as part of large
systems, and range from three to six months for Value Added Resellers (VAR) and
small System Integrators and from one to two years for Original Equipment
Manufacturers (OEM), Product Integrators and large System Integrators.
Cost of sales, as a percentage of sales, was approximately 77% in 1997, 84% in
1996 and 83% in 1995. Cost of sales as a percentage of sales decreased by seven
percentage points in 1997 as compared to 1996 primarily due to reductions in
manufacturing and material cost and increased sales volume. Cost of sales as a
percentage of sales in 1996 was principally impacted by a price reduction for
all units of 15% in the fourth quarter of 1995 and a shift in product mix
towards higher sales of smaller capacity units which have lower margins than the
larger capacity units. This shift was due in part to the federal government
shutdown which began in late fourth quarter of 1995 and continued until March
1996, which impacted sales of the large capacity units favored by governmental
agencies. In addition, gross margins in 1996 were also affected by an increase
in manufacturing engineering personnel to allow for a shift of sustaining
product responsibility from research and development to manufacturing. Although
gross margin improved in 1997 as compared to 1996, the Company's relatively low
gross margins reflect the Company's low levels of net sales, which have resulted
in unabsorbed manufacturing costs and high costs of materials due to the
inability to achieve purchasing economies of scale due to low sales volume. The
Company expects that as product sales continue to increase, costs of sales per
unit of product will decrease because fixed manufacturing costs will be
distributed over the larger sales volume, and material costs will decrease as a
result of volume purchases.
Research and development expenses were $1,439,000 in 1997, $1,297,000 in 1996
and $1,336,000 in 1995. The primary reason for the increase in 1997 as compared
to 1996 was an increase in project material related to the Company's next
generation product line. Expenses remained relatively flat in 1996 as compared
to 1995 as an increase in headcount was offset by a decrease in development
materials. The Company has restructured its research and development group
reducing management overhead and is focused on building core competencies
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internally and new product development. The Company believes that research and
development expenses will increase moderately in 1998 due to current projects
under development.
Marketing and sales expenses were $1,960,000 in 1997, $2,155,000 in 1996 and
$1,295,000 in 1995. The decrease in 1997 as compared to 1996 was due to a
reduction in marketing management headcount. The primary reason for the increase
in 1996 as compared to 1995 was the expansion of the Company's direct sales
personnel. The Company believes that marketing and sales expenses in 1998 will
increase in connection with the Company's continued efforts to broaden market
acceptance of its products.
General and administrative expenses were $924,000 in 1997, $984,000 in 1996 and
$1,195,000 in 1995. The primary reason for the decrease in expenses in 1996 as
compared to 1995 was due to a decrease in legal expenses related to litigation
that was resolved at the end of 1995.
Interest and other expense were $120,000 in 1997, $123,000 in 1996 and $130,000
in 1995. The decrease in 1996 as compared to 1995 was a result of payment on
fewer capital lease agreements as several of the agreements expired in 1996.
Liquidity and Capital Resources
During 1997, 1996 and 1995, the Company used net cash of $2,510,000, $3,541,000
and $3,088,000, respectively, primarily to fund operating losses. In February
1998, the Company issued $1,400,000 of Preferred Stock to its largest investor.
The Company believes this cash, together with borrowing from the credit line and
cash generated from operations, will be sufficient to meet its operating
requirements at least through the end of 1998, although the Company anticipates
that it will continue to incur net losses for the foreseeable future. As of
December 31, 1997 the Company had borrowings of $1,330,000 under the bank line
of credit. The ability to sustain its operations for a significant period after
December 31, 1998, will depend on the Company's ability to significantly
increase sales or raise significant additional equity or debt financing. There
is no assurance that any of these conditions will be achieved.
The Company expects to require increasing amounts of cash to finance the
Company's efforts to increase sales, which the Company plans to achieve by
increasing selling efforts to large system integrators and OEMs by hiring
additional direct sales staff and by making evaluation units available. In
addition, the Company intends to expand its current network of resellers. The
Company may also require cash to finance purchases of inventory to satisfy
anticipated increased sales as the Company's products achieve market acceptance.
Although the Company has not committed to make any material capital
expenditures, the budget for capital equipment expenditures for 1998 is
approximately $300,000. The majority of these purchases are expected to be in
the areas of process and molding tooling to reduce the cost and improve
producibility of the Company's products.
The Company is developing plans to address the Year 2000 issues, which include
upgrading the software to a Year 2000 version. The Company has estimated the
cost of the upgrade to be immaterial to the Company's business. However, the
Year 2000 computer issue creates some risk for the Company from unforeseen
problems with its computer system. In addition, there is risk from third parties
with whom the Company does business. Computer failures of the Company or third
parties could have a material impact on the Company's ability to conduct
business.
The terms of the Series C Preferred Stock and outstanding warrants may limit the
availability of financing for the Company, particularly equity financing.
Holders of Series C Preferred Stock are entitled to receive cumulative dividends
in the amount of approximately $112,000 per year. The Company has never paid
cash dividends and has no present plans to pay dividends.
New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard (SFAS) No. 130, "Reporting Comprehensive
Income". SFAS 130 establishes standards for reporting and display of
comprehensive income and its components in a financial statement that is
displayed with the same prominence as other financial statements for periods
beginning after December 15, 1997. Comprehensive income, as defined, includes
all exchanges in equity (not assets) during a period from non-owner sources
including unrealized gains and losses on available for sale securities.
Reclassification of financial statements for earlier periods for comparative
purposes is required. The Company will adopt SFAS No. 130 beginning in 1998 and
does not expect such adoption to have a material effect on the consolidated
financial statements.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Company's financial statements required by this item are submitted as a
separate section of this Form 10-K. See Item 14.(a)1 for a listing of financial
statements provided in the section titled "Financial Statements".
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
Not applicable.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
J. RICHARD ELLIS, 52, joined the Company as President and Chief Operating
Officer in July 1994 and became Chief Executive Officer in January 1995. Mr.
Ellis was appointed to the Board of Directors on July 13, 1994 and became
Chairman of the Board of Directors in August 1996. From November 1993 to June
1994, Mr. Ellis worked as an independent management consultant. From June 1991
to October 1993, Mr. Ellis was employed by Cygnet Systems Inc. ("Cygnet"), a
manufacturer of optical disk library units as President and Chief Executive
Officer. From December 1988 to May 1991, Mr. Ellis was employed by Cygnet as
Vice President of Operations and then as Chief Operating Officer. In June 1993,
Cygnet filed a voluntary petition of bankruptcy under Chapter 11 of the federal
bankruptcy law. The plan of reorganization was approved and the bankruptcy
proceedings terminated in October 1993.
FRANK T. CONNORS, 64, has been Secretary of the Company since May 1990 and was
Chairman of the Board of Directors of the Company from June 1988 to August 1996,
Chief Executive Officer of the Company from May 1990 to December 1994. Since
October 1994, Mr. Connors has been Vice Chairman of the Board of Directors and
Executive Vice President of STM Wireless, Inc., a publicly held manufacturer of
satellite communication networks.
MICHAEL D. KAUFMAN, 57, became a director of the Company in December 1988. Since
October 1987, he has been the Managing General Partner of each of MK Global
Ventures, MK Global Ventures II and MK GVD FUND of Palo Alto, California,
venture capital firms specializing in early-stage and start-up financing of high
technology companies. From August 1981 until October 1987, Mr. Kaufman was
General Partner and Special Limited Partner of Oak Investment Partners I, II,
and III, venture capital firms, which also focused on the formation of high
technology companies. Mr. Kaufman also serves on the Boards of Directors of
Davox Corp., a telecommunications company, Document Technologies, Inc., which
also develops and sells high resolution document image processing subsystems,
Hypermedia Communications, Inc., which publishes Newmedia magazine, a periodical
dedicated to interactive multimedia technology, and Proxim, Inc., a wireless
communications company.
F. RIGDON CURRIE, 67, became a director of the Company in December 1988. Since
February 1988, he has been Special Limited Partner of MK Global Ventures II and
MK GVD FUND. Mr. Currie serves on the Boards of Directors of Document
Technologies, Wonderware Corporation, a supplier of software to the process
control and industrial automation markets and QMS Inc., a laser printer systems
company .
ARCH J. MCGILL, 65, became a director of the Company in August 1993. Since
October 1985, he has been President of Chardonnay, Inc., a venture capital
investment and executive business advisory services company. From March 1983 to
October 1985, Mr. McGill was President and Chief Executive Officer of Rothchild
Ventures, Inc., a venture capital fund. From January 1981 to March 1983, Mr.
McGill was President of AIS/American Bell, a subsidiary of AT&T. Mr. McGill
serves on the Boards of Directors of Apertus Technologies, Inc., a data
networking company, and Employee Benefit Plans, Inc., a managed health-care
company.
MICHAEL A. MCMANUS, JR., 54, became a director of the Company in August 1993.
Since November 1991, he has been President and Chief Executive Officer of New
York Bancorp, Inc., the holding company for Home Federal Savings Bank. From July
1990 to October 1991, Mr. McManus was President and Chief Executive Officer of
Jencor Pharmaceuticals, Inc., a pharmaceutical company. From July 1986 to July
1990, Mr. McManus was Vice President, Business Planning & Development for the
Consumer Division of Pfizer, Inc., a health-care company. Mr. McManus also
serves on the Board of Directors of New York Bancorp, Inc.
HENRY MADRID, 41, joined the Company as Vice President of Finance and Chief
Financial Officer in January 1990. From July 1987 to December 1989, Mr. Madrid
was employed by Zentec Corporation, a manufacturer of computer terminals, as
Controller and later Vice President, Finance. From August 1979 to May 1987, Mr.
Madrid was employed by Price Waterhouse, San Jose, California, in various
positions, the last of which was as manager in the Audit Department. Mr. Madrid
is a Certified Public Accountant.
BRIAN IRVINE, 52, joined the Company in April 1990, and has held various
engineering positions in the Company including Director of Engineering before
being promoted to Vice President of Engineering in December 1997.
11
12
RONALD F. REYNOLDS, 60, joined the Company in February 1996, as Vice President
of Sales. From March 1995 to February 1996, Mr. Reynolds was an independent
consultant for start-up companies. From December 1992 to February 1995, Mr.
Reynolds served as Vice President of Sales for the Lago Division of Storage Tek,
a manufacturer of storage products for the Unix marketplace. From January 1988
to November 1992, Mr. Reynolds was Chief Executive Officer of Century Financial,
a leasing and consulting company for computer related products.
There are no family relationships between any director, executive officer or
person nominated or chosen by the Company to become a director or executive
officer.
Based upon its review of the copies of reporting forms furnished to the Company,
the Company believes that all filing requirements under Section 16(a) of the
Securities Exchange Act of 1934 applicable to its directors, officers and any
persons holding ten percent or more of the Company's Common Stock with respect
to the Company's fiscal year ended December 31, 1997, were satisfied.
ITEM 11. EXECUTIVE COMPENSATION
The following Summary Compensation Table shows compensation paid by the Company
for services rendered during fiscal years 1997, 1996 and 1995 to the person who
was the Company's Chief Executive Officer and the other executive officers of
the Company who received salary and bonus compensation which exceeded $100,000
in fiscal year 1997.
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION COMPENSATION AWARDS
NAME AND -------------------- LONG-TERM ALL OTHER
PRINCIPAL POSITION YEAR SALARY($) OPTIONS(1) COMPENSATION($)
- ------------------ ---- --------- ---------- --------------------
J. Richard Ellis 1997 152,000 75,000 1,000(2)
President and Chief 1996 152,000 50,000 1,000(2)
Executive Officer 1995 152,000 -- 1,000(2)
---- ------- ------- -----
Henry Madrid 1997 108,000 50,000 1,000(2)
Vice President - Finance 1996 110,000 -- 1,000(2)
1995 111,000 -- 1,000(2)
---- ------- ------- -----
Ronald F. Reynolds 1997 141,000 45,000 1,000(2)
Sr. Vice President, 1996 118,000 100,000 1,000(2)
Sales and Marketing (3) ---- ------- ------- -----
(1) Options are awarded pursuant to the Company's Stock Plan, which is
administered by the Board of Directors. The Board of Directors
determines the eligibility of employees and consultants, the number of
shares to be granted and the terms of such grants. Options generally
have a term of ten years from the date of grant.
(2) The amounts shown represent life insurance premiums paid by the Company.
(3) Mr. Reynolds joined the Company in February 1996.
OPTION GRANTS IN LAST FISCAL YEAR
PERCENT OF TOTAL
SECURITIES UNDERLYING OPTIONS GRANTED TO EXERCISE
NAME OPTIONS GRANTED(#) EMPLOYEES IN FY 1997 PRICE ($/SH) EXPIRATION DATE
---- ------------------ -------------------- ------------ ---------------
J. Richard Ellis 75,000 15.8% $1.16 December 2002
Henry Madrid 50,000 10.5% $1.16 December 2002
Ronald F. Reynolds 45,000 9.5% $1.16 December 2002
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AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
The following table provides information on the value of unexercised
in-the-money options held by the named executive officers as of December 31,
1997.
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
OPTIONS IN-THE-MONEY OPTIONS AT
SHARES AT DECEMBER 31, 1997 DECEMBER 31, 1997(1)
ACQUIRED ON VALUE -------------------------- ---------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ----------- ----------- ------------- ----------- -------------
J. Richard Ellis -- -- 98,959 126,041 $ -- $ --
Henry Madrid -- -- 14,000 50,000 -- --
Ronald F. Reynolds -- -- 33,334 111,666 -- --
(1) Market value of underlying securities at year-end minus the exercise price
of "in-the-money" options. The closing sale price for the Company's Common
Stock as of December 31, 1997 on the NASDAQ Small Cap Market System was
$0.875.
COMPENSATION OF DIRECTORS
Pursuant to the Company's 1995 Stock Option Plan for Non-Employee Directors,
each non-employee director receives an initial grant of options to purchase
25,000 shares of the Company's Common Stock upon commencement of service as a
director. In addition to such initial grant of 25,000 options, each non-employee
director is granted an option to purchase 5,000 shares of the Company's Common
Stock during each year of service as a director commencing with fiscal year
1995.
13
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information regarding the beneficial
ownership of Common Stock of the Company as of February 28, 1998, as to (a) all
directors, (b) the named executive officers identified in the Summary
Compensation Table located at page 12, (c) all directors and executive officers
as a group, and (d) each person known to the Company to be the beneficial owner
of more than 5% of the Company's voting securities. Each share of the Company's
Series C, Series D, Series E, Series I, Series J, Series K, Series L, Series M,
Series N and Series O Preferred Stock is convertible into one share of Common
Stock and is entitled to one vote per share. Each share of the Company's Series
F Preferred Stock is convertible into two shares of Common Stock and is entitled
to two votes per share. Each share of Series G and Series H Preferred Stock is
convertible into ten shares of Common Stock and is entitled to ten votes per
share. Because the Company's outstanding Preferred Stock votes together with and
has the same rights to cumulative voting as the Common Stock, the number of
shares held by such owner, includes all shares of Common Stock and Preferred
Stock on an as-if-converted basis, and "Percentage of Class" represents the
total Common and outstanding Preferred Stock, on an as-if-converted basis, of
the Company issued and outstanding as of February 28, 1998. Except as otherwise
indicated, the Company believes, based on information furnished by such owners,
that the beneficial owners of the Common Stock and Preferred Stock have sole
investment and voting power with respect to such shares, subject to applicable
community property laws.
NAME AND ADDRESS AMOUNT AND NATURE OF PERCENT
OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP OF CLASS
------------------- -------------------- --------
MK Global Ventures 773,744 (1) 8.1%
2471 E. Bayshore Road
Palo Alto, CA 94303
MK Global Ventures II 913,982 (2) 9.4%
2471 E. Bayshore Road
Palo Alto, CA 94303
MK GVD FUND 6,556,490 (3) 60.9%
2471 E. Bayshore Road
Palo Alto, CA 94303
J.F. Shea Co, Inc. 509,682 (4) 5.2%
655 Brea Canyon Road
Walnut, CA 91789
Michael D. Kaufman 8,284,216 (5)(8) 75.4%
2471 E. Bayshore Road
Palo Alto, CA 94303
Frank T. Connors 112,558 (6) 1.2%
J. Richard Ellis 114,583 (7) 1.2%
F. Rigdon Currie 40,000 (8) *
Arch J. McGill 40,000 (8) *
Michael A. McManus, Jr. 40,000 (8) *
Ronald F. Reynolds 43,750 (9) *
Henry Madrid 44,661 (10) *
Directors and Executive 8,717,685 (11) 74.9%
Officers as a group (9) persons
- ----------
* Less than 1%
(1) According to a report filed with the Securities and Exchange Commission,
MK Global Ventures beneficially owns 759,093 shares of the Company's
Common Stock and 10,465 Shares, or 3%, of the Company's Series C
Preferred Stock. Also includes warrants for 4,186 shares of Common Stock
exercisable during the 60-day period ending May 31, 1998.
14
15
(2) According to a report filed with the Securities and Exchange Commission,
MK Global Ventures II beneficially owns 310,462 shares of the Company's
Common Stock, 361,831 shares, or 97%, of the Company's Series C
Preferred Stock, and 77,566 shares, or 46%, of the Company's Series I
Preferred Stock. Also includes warrants for 164,123 shares of Common
Stock exercisable during the 60-day period ending May 31, 1998.
(3) According to a report filed with the Securities and Exchange Commission,
MK GVD FUND beneficially owns 333,333 shares, or 75%, of the Company's
Series D Preferred Stock, 375,000 shares, or 75%, of the Company's
Series E Preferred Stock, 250,000 shares, or 100%, of the Company's
Series F Preferred Stock, 97,500 shares, or 89%, of the Company's Series
G Preferred Stock, 26,109 shares, or 100%, of the Company's Series H
Preferred Stock, 89,499 shares, or 54%, of the Company's Series I
Preferred Stock , 244,966 shares, or 100%, of the Company's Series J
Preferred Stock, 235,110 shares, or 100%, of the Company's Series K
Preferred Stock, 199,275 shares, or 100%, of the Company's Series L
Preferred Stock, 179,372 shares, or 100%, of the Company's Series M
Preferred Stock, 666,667 shares, or 100%, of the Company's Series N
Preferred Stock and 1,320,755 shares, or 100%, of the Company's Series O
Preferred Stock. Shares of Series C, D, E, I and J Preferred Stock are
convertible into Common Stock on a one to one basis and Series F
Preferred Stock is convertible on a one to two basis and Series G and H
stock are convertible on a one to ten basis at the option of the holder.
Also includes warrants for 1,176,423 shares of Common Stock exercisable
during the 60-day period ending May 31, 1998.
(4) According to a report filed with the Securities and Exchange Commission,
J.F. Shea Co., Inc. beneficially owns 33,571 shares of the Company's
Common Stock, 111,111 shares, or 25%, of the Company's Series D
Preferred Stock, 125,000 shares, or 25%, of the Company's Series E
Preferred Stock and 12,500 shares, or 11%, of the Company's Series G
Preferred Stock. Shares of Series D and E Preferred Stock are
convertible into Common Stock on a one to one basis and Series G
Preferred Stock is convertible on a one to ten basis at the option of
the holder. Also includes warrants for 115,000 shares of Common Stock
exercisable during the 60-day period ending May 31, 1998.
(5) Includes 759,093 shares of Common Stock owned by MK Global Ventures,
310,462 shares of Common Stock owned by MK Global Ventures II, 10,465
shares of Series C Preferred Stock owned by MK Global Ventures, 361,831
shares of Series C Preferred Stock owned by MK Global Ventures II,
333,333 shares of Series D Preferred Stock, 375,000 shares of Series E
Preferred Stock, 250,000 shares of Series F Preferred Stock, 97,500
shares of Series G Preferred Stock, 26,109 shares of Series H Preferred
Stock, 244,966 shares of Series J Preferred Stock, 235,110 shares of
Series K Preferred Stock, 199,275 shares of Series L Preferred Stock,
179,372 shares of Series M Preferred Stock, 666,667 shares of Series N
Preferred Stock and 1,320,755 shares of Series O Preferred Stock owned
by MK GVD Fund and 77,566 shares of Series I Preferred Stock owned by MK
Global Ventures II and 89,499 shares of Series I Preferred Stock owned
by MK GVD Fund. Also includes warrants for 1,344,732 shares of Common
Stock exercisable during the 60-day period ending May 31, 1998. Mr.
Kaufman, a director of the Company, is a general partner of these funds
and may be deemed to have voting and investment power with respect to
such shares. Mr. Kaufman disclaims beneficial ownership of all shares of
Common Stock and Preferred Stock so owned; however, the aggregate voting
power represented by Mr. Kaufman's beneficial ownership of all such
Common Stock, Series C Preferred Stock, Series D Preferred Stock, Series
E Preferred Stock, Series F Preferred Stock, Series G Preferred Stock,
Series H Preferred Stock, Series I Preferred Stock, Series J Preferred
Stock, Series K Preferred Stock, Series L Preferred Stock, Series M
Preferred Stock, Series N Preferred Stock and Series O Preferred Stock
is indicated in the appropriate column.
(6) Includes 55,000 shares issuable upon exercise of stock options
exercisable during the 60-day period ending May 31, 1998.
(7) Includes 114,583 shares issuable upon exercise of stock options
exercisable during the 60-day period ending May 31, 1998.
(8) Includes 40,000 shares issuable upon exercise of stock options
exercisable during the 60-day period ending May 31, 1998.
(9) Includes 43,750 shares issuable upon exercise of stock options
exercisable during the 60-day period ending May 31, 1997.
(10) Includes 14,000 shares issuable upon exercise of stock options
exercisable during the 60-day period ending May 31, 1997.
(11) Includes 397,125 shares issuable upon exercise of stock options and
warrants exercisable during the 60-day period ending May 31, 1997.
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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Preferred Stock
On March 29, 1996, the Company entered into a Series G Preferred Stock Purchase
Agreement with MK GVD FUND whereby MK GVD FUND agreed to purchase 47,500 shares
of Series G Preferred Stock, each initially convertible into ten (10) shares of
Common Stock at a price of $20.00 per share, and 118,750 warrants to purchase
additional shares of Common Stock at an exercise price of $2.50 per share, at a
price of $0.01 per warrant.
In connection with such sale, in satisfaction of the Company's antidilution
obligations under the Series F Purchase Agreement, the Company issued to J.F.
Shea Co., Inc. an additional 12,500 shares of Series G Preferred Stock. J.F.
Shea Co., Inc. is a holder of more than 5% of the voting stock of the Company.
Also in connection with such sale, in satisfaction of the Company's antidilution
obligations under the Series E and Series F Purchase Agreement, the Company
issued to MK GVD FUND an additional 93,750 and 50,000 shares of Series F and
Series G Preferred Stock, respectively. Michael D. Kaufman, a director of the
Company, is a general partner of MK GVD FUND, and is a beneficial owner of more
than 5% of the voting stock of the Company.
On March 29, 1996, the Company entered into a Convertible Debenture Purchase
Agreement with MK GVD FUND whereby MK GVD FUND agreed to purchase an aggregate
of $1,400,000 in principal amount of subordinated convertible debentures, each
mandatorily convertible into shares of Preferred Stock and warrants to purchase
Common Stock at a conversion price based on the average closing price for the
Common Stock for the five trading days ended three days prior to the conversion
date. In December 1996, the agreement was amended to increase the amount to a
total of $3,400,000 and the Conversion Price was changed to the closing bid
price of the Company's Common Stock on the last day of the calendar quarter. In
addition, MK GVD FUND assigned a portion of its obligations under the agreement
to MK Global Ventures II. During the quarters ended June 30, September 30 and
December 31, 1996, the Company issued $1,000,000, $700,000 and $730,000 in
principal amount of such debentures. On June 30, September 30 and December 31,
1996 such debentures were converted by MK GVD Fund into 26,109, 89,499 and
244,966 shares of Series H, Series I and Series J Preferred Stock and MK Global
Ventures II converted into 77,566 shares of Series I Preferred Stock at $38.30,
$4.19 and $2.98 for Series H, Series I and Series J Preferred Stock,
respectively. In addition, MK GVD Fund received for Series H, Series I and
Series J Preferred Stock warrants to purchase 65,272, 22,375 and 61,241 shares
of Common Stock at exercise prices of $4.85, $5.24 and $3.73 per share,
respectively. MK Global Ventures II received with Series I Preferred Stock a
warrant to purchase 19,291 shares of Common Stock at an exercise price of $5.24
per share.
In April 1997, the agreement was amended to increase to $4,430,000 the total
principal amount of subordinated debentures which MK GVD FUND has agreed to
purchase. During the quarters ended March 31, June 30, September 30 and December
31, 1997, the Company issued $750,000, $550,000, $400,000 and $600,000,
respectively, in principal amount of such debentures to MK GVD Fund. On March
31, June 30, September 30 and December 31, 1997, such debentures were converted
into 235,110, 199,275, 179,372 and 666,667 shares of Series K, Series L, Series
M and Series N Preferred Stock, and warrants to purchase 58,777, 49,819, 44,843
and 166,666 shares of Common Stock at exercise prices of $3.98, $3.45, $2.78 and
$1.13, respectively. In December 1997, the agreement was further amended to
increase to $4,730,000 the total principal amount of subordinated convertible
debentures which MK GVD FUND has agreed to purchase.
In February 1998, the Company sold 1,320,755 shares of Series O Preferred Stock
and warrants to purchase 330,188 shares of Common Stock at an exercise price of
$1.33 per share to MK GVD FUND for a total purchase price of $1,400,000.
The above transactions were unanimously approved by the Board of Directors of
the Company. One of the directors of the Company was, and continues to be, an
affiliate of MK GVD FUND and MK Global Ventures II. However, the Company
believes that the terms and provisions of the above transactions were as fair to
the Company as they could have been if made with unaffiliated third parties.
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17
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements.
The Financial Statements of the Company as set forth under Item 8 of this
Annual Report on Form 10-K are presented herein at the pages noted.
PAGE NUMBERS
------------
Report of Independent Accountants 36
Balance Sheet - December 31, 1997 and 1996 24
Statement of Operations - For the Three Years Ended 25
December 31, 1997
Statement of Shareholders' Equity - For the Three 26
Years Ended December 31, 1997
Statement of Cash Flows - For the Three Years Ended 27
December 31, 1997
Notes to Financial Statements 28-35
2. Financial Statement Schedules
Financial Statement Schedules have been omitted because they are not required
or applicable, or the information required to be set forth therein is included
in the Financial Statements or notes thereto.
(b) Exhibits.
The Exhibits set forth below, and listed on the accompanying index to
exhibits are filed as part of, or incorporated by reference into, this Annual
Report on Form 10-K.
EXHIBIT
NUMBER DESCRIPTION
------ -----------
3.1 Amended and Restated Articles of Incorporation as filed with the
California Secretary of State on December 15, 1992, incorporated
herein by this reference to Exhibit 3.1 to the Company's
Registration Statement on Form S-1, No. 33-52144 (the "S-1
Registration Statement").
3.2 Certificate of Determination of Preferences of Series D Preferred
Stock, as filed with the California Secretary of State on April
15, 1994, incorporated herein by this reference to Exhibit 3.2 to
the Company's Annual Report on Form 10-K for the year ended
December 31, 1994 (the "1994 Form 10-K").
3.3 Certificate of Determination of Preferences of Series E Preferred
Stock, as filed with the California Secretary of State on March
30, 1995, incorporated herein by this reference to Exhibit 3.3 to
the Company's 1994 Form 10-K.
3.4 Certificate of Amendment to Amended and Restated Articles of
Incorporation, as filed with the California Secretary of State on
September 18, 1995, incorporated herein by this reference to
Exhibit 3.4 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1995 (the "1995 Form 10-K").
17
18
EXHIBIT
NUMBER DESCRIPTION
------ -----------
3.5 Certificate of Determination of Preferences of Series F Preferred
Stock, as filed with the California Secretary of State on
September 18, 1995, incorporated herein by this reference to
Exhibit 3.5 to the Company's 1995 Form 10-K.
3.6 Certificate of Determination of Preferences of Series G Preferred
Stock, as filed with the California Secretary of State on
February 22, 1996, incorporated herein by this reference to
Exhibit 3.6 to the Company's 1995 Form 10-K.
3.7 Certificate of Amendment to Certificate of Determination of
Preferences of Series G Preferred Stock, as filed with the
California Secretary of State on April 1, 1996, incorporated
herein by this reference to Exhibit 3.7 to the Company's 1995
Form 10-K.
3.8 Certificate of Determination of Preference of Series H Preferred
Stock, as filed with the California Secretary of State on
November 18, 1996, incorporated herein by this reference to
Exhibit 3.8 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1996 (the "1996 Form 10-K").
3.9 Certificate of Determination of Preferences of Series I Preferred
Stock, as filed with the California Secretary of State on
November 18, 1996, incorporated herein by this reference to
Exhibit 3.9 to the Company's 1996 Form 10-K.
3.10 Certificate of Amendment to Amended and Restated Articles of
Incorporation, as filed with the California Secretary of State on
April 14, 1997, incorporated herein by this reference to Exhibit
3.10 to the Company's 1996 Form 10-K.
3.11 Certificate of Determination of Preferences of Series J Preferred
Stock, as filed with the California Secretary of State on April
14, 1997, incorporated herein by this reference to Exhibit 3.11
to the Company's 1996 Form 10-K.
3.12 Certificate of Determination of Preferences of Series K Preferred
Stock, as filed with the California Secretary of State on August
15, 1997.
3.13 Certificate of Determination of Preferences of Series L Preferred
Stock, as filed with the California Secretary of State on August
15, 1997.
3.14 Certificate of Determination of Preferences of Series M Preferred
Stock, as filed with the California Secretary of State on January
6, 1998
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EXHIBIT
NUMBER DESCRIPTION
------ -----------
3.15 Certificate of Determination of Preferences of Series N Preferred
Stock, as filed with the California Secretary of State on January
7, 1998
3.16 Bylaws, incorporated herein by this reference to Exhibit 3.3 to
the S-1 Registration Statement
10.1 DISC, Inc. 1990 Stock Option, Plan, as amended (the "Plan"),
incorporated by reference to Exhibit 10.1 to the S-1 Registration
Statement.
10.2 Form of Stock Option Agreement for use with the Plan,
incorporated herein by this reference to Exhibit 10.2 to the S-1
Registration Statement.
10.3 Form of Stock Bonus Agreement for use with the Plan, incorporated
herein by this reference to Exhibit 10.3 to the S-1 Registration
Statement.
10.4 Form of Stock Purchase Agreement for use with the Plan,
incorporated herein by this reference to Exhibit 10.4 to the S-1
Registration Statement.
10.5 DISC, Inc. 1995 Stock Option Plan for Non-Employee Directors (the
"Director Plan"), incorporated herein by this reference to
Exhibit 10.5 to the Company's 1995 Form 10-K.
10.6 Form of Stock Option Agreement for use with the Director Plan,
incorporated herein by this reference to Exhibit 10.6 to the
Company's 1995 Form 10-K.
10.7 Form of Indemnification Agreement entered into by the Company and
its executive officers and directors, incorporated by reference
to Exhibit 10.5 to the S-1 Registration Statement.
10.8 Series D Preferred Stock Purchase Agreement dated April 14, 1994,
incorporated herein by this reference to Exhibit 10.6 to the
Company's 1994 Form 10-K.
10.9 Series E Preferred Stock Purchase Agreement dated March 31, 1995,
incorporated herein by this reference to Exhibit 10.7 to the
Company's 1994 Form 10-K.
10.10 Series F Preferred Stock Purchase Agreement dated September 29,
1995, incorporated herein by this reference to Exhibit 10.10 to
the Company's 1995 Form 10-K.
10.11 Series G Preferred Stock Purchase Agreement dated March 29, 1996,
incorporated herein by this reference to Exhibit 10.11 to the
Company's 1995 Form 10-K.
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20
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.12 Convertible Debenture Purchase Agreement dated March 29, 1996,
incorporated herein by this reference to Exhibit 10.12 to the
Company's 1995 Form 10-K.
10.13 Sublease dated October 19, 1994, between the Company and Dolch
American Instruments, Inc., for property located in Milpitas,
California, incorporated herein by this reference to Exhibit 10.8
to the Company's 1994 Form 10-K
10.14 Loan and Security Agreement dated December 14, 1994 between the
Company and CoastFed Business Credit Corporation, as amended to
date, incorporated herein by this reference to Exhibit 10.14 to
the Company's 1995 Form 10-K.
10.15 First Amendment to Convertible Debenture Purchase Agreement,
dated December 31, 1996, incorporated herein by this reference to
Exhibit 10.15 to the Company's 1996 Form 10-K.
10.16 Second Amendment to Convertible Debenture Purchase Agreement,
dated April 11, 1997, incorporated herein by this reference to
Exhibit 10.16 to the Company's 1996 Form 10-K.
10.17 Third Amendment to Convertible Debenture Purchase Agreement,
dated December 31, 1997.
10.18 Amendment No. 2 to Loan Documents, dated January 13, 1998.
23 Consent of Price Waterhouse LLP.
25 Power of Attorney (included on Signature Page).
EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS
10.1 DISC, Inc. 1990 Stock Option, Plan, as amended (the "Plan"),
incorporated by reference to Exhibit 10.1 to the S-1 Registration
Statement.
10.2 Form of Stock Option Agreement for use with the Plan, ,
incorporated herein by this reference to Exhibit 10.2 to the S-1
Registration Statement.
10.3 Form of Stock Bonus Agreement for use with the Plan, incorporated
herein by this reference to Exhibit 10.3 to the S-1 Registration
Statement.
10.4 Form of Stock Purchase Agreement for use with the Plan,
incorporated herein by this reference to Exhibit 10.4 to the S-1
Registration Statement.
10.5 DISC, Inc. 1995 Stock Option Plan for Non-Employee Directors (the
"Director Plan"), incorporated herein by this reference to
Exhibit 10.5 to the Company's 1994 Form 10-K.
20
21
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.6 Form of Stock Option Agreement for use with the Director Plan,
incorporated herein by this reference to Exhibit 10.6 to the
Company's 1994 Form 10-K.
10.7 Form of Indemnification Agreement entered into by the Company and
its executive officers and directors, incorporated by reference
to Exhibit 10.5 to the S-1 Registration Statement.
(c) Reports on Form 8-K.
No reports on Form 8-K were filed by the Company during the quarter ended
December 31, 1997.
21
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FINANCIAL STATEMENTS
DISC, INC.
BALANCE SHEET
DECEMBER 31,
1997 1996
------------ ------------
ASSETS
Cash $ 436,000 $ 305,000
Accounts receivable, net 1,768,000 1,430,000
Inventories 1,465,000 1,862,000
Prepaids and deposits 73,000 72,000
------------ ------------
Total current assets 3,742,000 3,669,000
Property and equipment, net 402,000 441,000
------------ ------------
$ 4,144,000 $ 4,110,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable $ 1,332,000 $ 1,585,000
Borrowings under bank line of credit 1,338,000 1,087,000
Other accrued liabilities 280,000 211,000
Accrued warranty 79,000 95,000
Current portion of capitalized lease obligations 24,000 --
------------ ------------
Total current liabilities 3,053,000 2,978,000
Capitalized lease obligations, less current portion 20,000 --
Shareholders' equity:
Convertible Preferred Stock; no par value, 5,000,000
shares authorized; 3,395,304 and 2,114,880
shares issued and outstanding 12,742,000 10,442,000
Common Stock; no par value, 20,000,000 shares
authorized; 3,334,323 and 3,279,532 shares
issued and outstanding 11,053,000 10,925,000
Accumulated deficit (22,724,000) (20,235,000)
------------ ------------
Total shareholders' equity 1,071,000 1,132,000
------------ ------------
$ 4,144,000 $ 4,110,000
============ ============
See accompanying notes to financial statements.
22
23
DISC, INC.
STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1997 1996 1995
------------ ------------ -----------
Net sales $ 8,655,000 $ 7,761,000 $ 6,605,000
------------ ------------ -----------
Costs and expenses:
Cost of sales 6,704,000 6,549,000 5,478,000
Research and development 1,439,000 1,297,000 1,336,000
Marketing and sales 1,960,000 2,155,000 1,295,000
General and administrative 924,000 984,000 1,195,000
------------ ------------ -----------
Total costs and expenses 11,027,000 10,985,000 9,304,000
------------ ------------ -----------
Loss from operations (2,372,000) (3,224,000) (2,699,000)
Interest and other expense, net (117,000) (118,000) (127,000)
------------ ------------ -----------
Net loss $ (2,489,000) $ (3,342,000) $(2,826,000)
------------ ------------ -----------
Basic and diluted net loss per share $ (0.75) $ (1.08) $ (0.94)
------------ ------------ -----------
Weighted average common shares for
basic and diluted net loss per
share calculation 3,308,000 3,106,000 3,005,000
------------ ------------ -----------
See accompanying notes to financial statements.
23
24
DISC, INC.
STATEMENT OF SHAREHOLDERS' EQUITY
ACCRETION OF
MANDATORILY
REDEEMABLE
CONVERTIBLE
PREFERRED STOCK COMMON STOCK PREFERRED STOCK
------------------------ ----------------------- REDEMPTION ACCUMULATED
SHARES AMOUNT SHARES AMOUNT VALUE DEFICIT TOTAL
--------- ----------- --------- ----------- --------- ------------ -----------
Balance at December 31, 1994 400,000 $ 1,971,000 2,988,285 $10,823,000 $(228,000) $(14,067,000) $(1,501,000)
Exercise of Common Stock
Options -- -- 41,260 12,000 -- -- 12,000
Exercise of Warrant -- -- 5,000 -- -- -- --
Issuance of Series D
Preferred Stock 44,444 -- -- -- -- -- --
Issuance of Series E
Convertible Preferred
Stock, net 500,000 1,980,000 -- -- -- -- 1,980,000
Issuance of Series F
Convertible Preferred
Stock, net 156,250 1,250,000 -- -- -- -- 1,250,000
Series C Preferred Stock 372,296 1,861,000 -- -- -- -- 1,861,000
(Note 5)
Series C Accretion (Note 5) -- -- -- -- 228,000 -- 228,000
Net loss for the period -- -- -- -- -- (2,826,000) (2,826,000)
--------- ----------- --------- ----------- --------- ------------ -----------
Balance at December 31, 1995 1,472,990 7,062,000 3,034,545 10,835,000 -- (16,893,000) 1,004,000
Exercise of Common Stock -- -- 244,987 90,000 -- -- 90,000
Options
Issuance of Series F
Convertible Preferred
Stock, net 93,750 -- -- -- -- -- --
Issuance of Series G
Convertible Preferred
Stock, net 110,000 950,000 -- -- -- -- 950,000
Issuance of Series H
Convertible Preferred
Stock, net 26,109 1,000,000 -- -- -- -- 1,000,000
Issuance of Series I
Convertible Preferred
Stock, net 167,065 700,000 -- -- -- -- 700,000
Issuance of Series J
Convertible Preferred
Stock, net 244,966 730,000 -- -- -- -- 730,000
Net loss for the period -- -- -- -- -- (3,342,000) (3,342,000)
--------- ----------- --------- ----------- --------- ------------ -----------
Balance at December 31, 1996 2,114,880 10,442,000 3,279,532 10,925,000 -- (20,235,000) 1,132,000
Exercise of Common Stock -- -- 54,791 128,000 -- -- 128,000
Options
Issuance of Series K
Convertible Preferred
Stock, net 235,110 750,000 -- -- -- -- 750,000
Issuance of Series L
Convertible Preferred
Stock, net 199,275 550,000 -- -- -- -- 550,000
Issuance of Series M
Convertible Preferred
Stock, net 179,372 400,000 -- -- -- -- 400,000
Issuance of Series N
Convertible Preferred
Stock, net 666,667 600,000 -- -- -- -- 600,000
Net loss for the period -- -- -- -- -- (2,489,000) (2,489,000)
--------- ----------- --------- ----------- --------- ------------ -----------
Balance at December 31, 1997 3,395,304 $12,742,000 3,334,323 $11,053,000 $ -- $(22,724,000) $ 1,071,000
========= =========== ========= =========== ========= ============ ===========
See accompanying notes to financial statements.
24
25
DISC, INC.
STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31,
---------------------------------------------
1997 1996 1995
----------- ----------- -----------
Cash flows from operating activities:
Net loss $(2,489,000) $(3,342,000) $(2,826,000)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation expense 121,000 226,000 299,000
Changes in assets and liabilities:
Accounts receivable (338,000) (286,000) (85,000)
Inventories 397,000 (40,000) (852,000)
Prepaids and deposits (1,000) 8,000 86,000
Accounts payable (253,000) 58,000 292,000
Other accrued liabilities 69,000 (154,000) 57,000
Accrued warranty (16,000) (11,000) (59,000)
----------- ----------- -----------
Net cash used in operating activities (2,510,000) (3,541,000) (3,088,000)
----------- ----------- -----------
Cash used in investing activities for capital
expenditures (18,000) (230,000) (369,000)
----------- ----------- -----------
Cash flows from financing activities:
Borrowings under bank line of credit, net 251,000 356,000 459,000
Proceeds from issuance of Common Stock 128,000 90,000 12,000
Proceeds from issuance of Preferred Stock 2,300,000 3,380,000 3,230,000
Payment of capitalized lease obligations (20,000) (48,000) (59,000)
----------- ----------- -----------
Net cash provided by financing activities 2,659,000 3,778,000 3,642,000
----------- ----------- -----------
Net increase in cash 131,000 7,000 185,000
Cash at beginning of the year 305,000 298,000 113,000
----------- ----------- -----------
Cash at end of the year $ 436,000 $ 305,000 $ 298,000
----------- ----------- -----------
Supplemental disclosure of cash flow information:
Interest paid $ 114,000 $ 122,000 $ 130,000
----------- ----------- -----------
Capital leases to finance capital expenditures $ 64,000 $ -- $ --
----------- ----------- -----------
See accompanying notes to financial statements.
25
26
DISC, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - THE COMPANY:
DISC, Inc. ("the Company") is engaged in the marketing, development and
manufacturing of optical disk storage units.
In February 1998, the Company issued $1,400,000 of Preferred Stock to its
largest investor (See Note 5). The largest investor also agreed to provide up
to an additional $600,000 of equity financing to the Company, if needed. The
Company believes that this cash and the committed additional equity financing,
together with cash generated from operations, will be sufficient to meet its
operating requirements at least through the end of 1998, although the Company
anticipates that it will continue to incur net losses for the foreseeable
future. The ability to sustain its operations for a significant period after
December 31, 1998, will depend on the Company's ability to significantly
increase sales or raise significant additional equity or debt financing.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
USE OF ESTIMATES
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
reported amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates.
REVENUE RECOGNITION
Revenue from product sales is recognized upon shipment of the product when the
Company has no significant obligations remaining and collection of the resulting
receivable is probable.
INVENTORIES
Inventories are stated at the lower of cost or market, with cost being
determined on a first-in, first-out method.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is computed using the
straight line method over the shorter of the estimated useful lives of the
assets, which range from three to five years, or the lease term of the
respective assets, if applicable.
RESEARCH AND DEVELOPMENT
Research and development costs are charged to expense as incurred.
STOCK COMPENSATION PLANS
The Company accounts for stock-based compensation arrangements using the
intrinsic value method as prescribed in Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
Interpretations thereof. Compensation cost for stock grants is measured as the
excess, if any, of the market price of the Company's stock at the date of grant
over the stock exercise price. The Company's policy is to grant stock options
with an exercise price equal to the quoted market price of the Company's stock
on the date of grant. Accordingly, the Company does not have compensation cost
related to its stock compensation plans. In addition, the Company complies with
the disclosure provisions of Statement of Financial Accounting Standard No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123").
INCOME TAXES
The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standard No. 109, "Accounting for Income Taxes" ("SFAS 109"). SFAS
109 accounts for income taxes under an asset and liability approach, which
requires the recognition of deferred tax liabilities and assets for the expected
future tax consequences of timing differences between the carrying amounts and
the tax bases of assets and liabilities.
NET LOSS PER SHARE
The Company adopted Statement of Financial Accounting Standard No. 128,
"Earnings per Share" ("SFAS 128"), during the fourth quarter of fiscal 1997.
SFAS 128 requires presentation of both basic and diluted EPS on the face of the
26
27
income statement. Under the new standard, primary earnings per share is replaced
by basic earnings per share and fully diluted earnings per share is replaced by
diluted earnings per share. Basic net loss per share is computed using the
weighted average number of common shares outstanding and diluted net loss per
share gives effect to all potential common shares outstanding during the period,
including Common Stock equivalents related to Convertible Preferred Stocks,
Stock Options and Warrants outstanding, unless antidilutive. As required, the
Company has applied the new standard to all periods presented.
NOTE 3 - BALANCE SHEET DETAILS:
DECEMBER 31,
-----------------------------
1997 1996
----------- -----------
Accounts Receivable:
Trade accounts receivable $ 1,857,000 $ 1,544,000
Less: Allowance for doubtful
accounts (89,000) (114,000)
----------- -----------
$ 1,768,000 $ 1,430,000
=========== ===========
Inventories:
Raw materials $ 1,052,000 $ 1,286,000
Work-in-process 382,000 545,000
Finished goods 31,000 31,000
----------- -----------
$ 1,465,000 $ 1,862,000
=========== ===========
Property and Equipment:
Computer and other equipment $ 752,000 $ 667,000
Tooling 220,000 203,000
Evaluation units 586,000 607,000
Leasehold improvements 22,000 22,000
Furniture and fixtures 59,000 58,000
----------- -----------
1,639,000 1,557,000
Less: Accumulated depreciation
and amortization (1,237,000) (1,116,000)
----------- -----------
$ 402,000 $ 441,000
=========== ===========
NOTE 4 - DEBT:
The Company has had a line of credit agreement with a bank since 1994 and the
agreement was amended in December 1997 to extend the expiration date to December
1998. This agreement requires the Company to comply with certain financial
covenants. Borrowings under this facility are limited to the lesser of
$1,500,000 or 80% of eligible receivables through December 31, 1997, and to the
lesser of $2,000,000 or 80% of eligible receivables thereafter. At December 31,
1997 and 1996, $1,338,000 and $1,087,000, respectively, was outstanding under
the line. Borrowings under this facility bear interest at the bank's prime rate
plus 2% (10.5% at December 31, 1997) with a minimum of 9% and are secured by
substantially all of the assets of the Company. In addition, the agreement
requires a minimum interest charge of $9,000 per month.
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28
NOTE 5 - CONVERTIBLE PREFERRED STOCK:
Information with regard to the Company's Preferred Stock as of December 31,
1997 is summarized in the following tables:
PROCEEDS
SHARES COMMON STOCK NET OF
SHARES ISSUED AND CONVERSION LIQUIDATION ISSUANCE
SERIES AUTHORIZED OUTSTANDING RATIO PREFERENCES COST
- ------ ---------- ----------- ------------ ----------- --------
C 372,296 372,296 1 to 1 $ 5.00 $ 1,861,000
D 600,000 444,444 1 to 1 5.00 1,971,000
E 500,000 500,000 1 to 1 4.00 1,980,000
F 250,000 250,000 1 to 2 8.00 1,250,000
G 110,000 110,000 1 to 10 20.00 950,000
H 26,109 26,109 1 to 10 38.30 1,000,000
I 167,065 167,065 1 to 1 4.19 700,000
J 244,966 244,966 1 to 1 2.98 730,000
K 235,110 235,110 1 to 1 3.19 750,000
L 199,275 199,275 1 to 1 2.76 550,000
M 179,372 179,372 1 to 1 2.23 400,000
N 666,667 666,667 1 to 1 $ 0.90 600,000
---------- --------- -----------
3,550,860 3,395,304 12,742,000
Undesignated 1,449,140 -- --
---------- --------- -----------
Total 5,000,000 3,395,304 $12,742,000
========== ========= ===========
The holders of Series C Preferred Stock are entitled to receive $0.30 per share
per annum cumulative dividends prior to and in preference to Common
Shareholders. Such dividends are cumulative whether or not declared by the Board
of Directors. The holders of Series D through N Preferred Stock are entitled to
receive, when and if declared by the Board of Directors, dividends in the same
amount per share as declared on the Company's Common Stock, with each share of
Preferred Stock being treated for this purpose as the number of shares of Common
Stock into which it is then convertible.
Each share of Preferred Stock has the number of votes equal to the number of
shares of Common Stock into which it is then convertible. The Company has
reserved sufficient shares of Common Stock to allow for the conversion of all
outstanding Preferred Stock.
Shares of Series H through N Preferred Stock were issued pursuant to an
agreement entered into in March 1996, as amended in September 1996, December
1996, April 1997 and December 1997, with the Company's largest shareholder
whereby the Company agreed to sell and the shareholder agreed to purchase,
subordinated convertible debentures. The conversion price of the debentures is
85% of the lower of the average closing price of the Company's Common Stock for
the five trading days ended three days prior to the end of the quarter or the
closing bid price on the last day of the quarter in which the convertible
debentures are issued.
Holders of Preferred Stock received warrants for the purchases of Common Stock
as follows:
WARRANTS EXERCISE
ISSUED AND PRICE
SERIES OUTSTANDING PER SHARE DATE ISSUED
- ------ ----------- --------- -----------
C 148,918 $ 5.50 Mar 95
D 260,000 5.50 Apr 94-Mar 95
E 200,000 5.50 Mar-Sep 95
F 125,000 5.50 Sep-Dec 95
G 118,750 2.50 Mar 96
H 65,273 4.85 Jun 96
I 41,766 5.24 Sep 96
J 61,242 3.73 Dec 96
K 58,778 3.98 Mar 97
L 49,819 3.45 Jun 97
M 44,843 2.78 Sep 97
N 166,666 $ 1.13 Dec 97
-----------
1,341,055
===========
All Warrants expire five years from the date of issuance.
28
29
SUBSEQUENT EVENT
In February 1998, the Company sold $1,400,000 of Preferred Stock to its largest
investor. The Company issued 1,320,755 shares of Series O Preferred Stock at
$1.06 per share in connection with such sale of Preferred Stock. The holders of
Series O Preferred Stock are entitled to receive, when and if declared by the
Board of Directors, dividends in the same amount per share as declared on the
Company's Common Stock. Upon liquidation, after payment of the liquidation
amounts of the Series C Preferred Stock, holders of Series O Preferred Stock are
entitled to receive $1.06 per share, plus any declared and unpaid dividends on
such shares, prior to any distribution to Common Shareholders. In addition,
holders of Series O Preferred Stock received 330,188 Common Stock Purchase
Warrants. The Warrants have an exercise price of $1.33 and expire in February
2003.
NOTE 6 - COMMON STOCK:
In addition to the Common Stock Purchase Warrants issued in connection with the
sales of Preferred Stock described in Note 5, the Company has issued Warrants to
purchase its Common Stock at various times in conjunction with its initial
public offering ("IPO"), in connection with the issuance of promissory notes and
in conjunction with various employment and consulting service agreements.
29
30
Information with regard to the Warrants outstanding as of December 31, 1997 is
summarized in the following table.
DATE ISSUED NUMBER EXERCISE PRICE EXPIRATION
ISSUED IN CONNECTION WITH OF SHARES PER SHARE DATE
------ ------------------ --------- --------- ----
Feb 94 Consulting Services 11,666 5.50 Feb 99
Aug 94 Consulting Services 10,000 5.25 Aug 99
In 1995, Warrants issued in connection with consulting services were exercised
to purchase 5,000 shares of Common Stock at $0.05 per share. In 1996 Warrants
issued to Underwriter in connection with the IPO to purchase 65,000 shares at
$12.38 per share expired. In 1997 Warrants issued in connection with a
promissory note to purchase 228,000 shares at an exercise price of $3.93 per
share expired. In addition, Warrants issued in connection with the IPO to
purchase 1,440,000 shares at $7.50 per share also expired. The value of warrants
issued in connection with consulting services and the promissory note issued
were immaterial.
All Warrants outstanding as of December 31, 1997 are exercisable.
NOTE 7 - STOCK OPTION PLAN:
At December 31, 1997, the Company had two stock-based compensation plans, which
are described below:
THE 1990 PLAN
Under the 1990 Stock Option Plan, as amended in 1995 (the "1990 Plan"),
employees, consultants and non-employee directors (prior to 1995) may be granted
options for up to 1,150,000 shares of Common Stock which vest over a four year
period from the date of grant. The options vest equally on a monthly basis
unless it is the employee's or consultant's first stock grant, in which case
vesting commences six months from the date of grant.
At December 31, 1997, 102,452 shares were available for grant under the 1990
Plan.
On May 20, 1996, the Company canceled options to purchase 72,600 shares of
Common Stock with exercise prices ranging from $4.25 to $6.25, previously
granted to employees and reissued all such options at an exercise price of
$3.88, the fair market value of the stock on that date. The reissued options
vest over a four year period from the date of reissuance.
THE NON-EMPLOYEE OPTION PLAN
In 1995, the Board of Directors adopted and the Shareholders approved, the 1995
Stock Option Plan for Non-Employee Directors (the "Non-Employee Option Plan").
The Company has reserved 150,000 shares of Common Stock for issuance under this
Plan. Under the Non-Employee Option Plan, each newly-elected non-employee
director of the Company will be granted a non-statutory option to purchase
25,000 shares of the Company's Common Stock. This option vests over a three year
period. In addition, each non-employee director of the Company will be granted a
non-statutory option to purchase 5,000 shares of the Company's Common Stock
during each year of service as a director of the Company commencing in 1995.
These options vest immediately upon grant and are immediately exercisable.
At December 31, 1997, 75,000 shares were available for grant under the
Non-Employee Option Plan.
Under both plans, the options will be granted at prices equal to the fair market
value on the date of grant and expire five years from the date of grant.
30
31
The following table summarizes the activity for the 1990 Plan for the years
ended December 31, 1997, 1996 and 1995:
1997 1996 1995
--------------------------- --------------------------- ----------------------------
WEIGHTED-AVERAGE WEIGHTED-AVERAGE WEIGHTED-AVERAGE
FIXED OPTIONS SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
------------- ------ ---------------- ------ ---------------- ------ ----------------
Outstanding at
beginning of year 721,600 $ 5.24 786,661 $ 4.05 799,892 $ 3.79
Granted 474,900 1.82 361,600 4.52 132,150 5.61
Exercised -- -- (244,987) 0.37 (41,281) 0.29
Forfeited (260,000) 3.90 (181,674) 5.25 (104,100) 5.49
-------- ------ -------- ------ -------- ------
Outstanding at
end of year 936,500 $ 3.87 721,600 $ 5.24 786,661 $ 4.05
======= ====== ======= ====== ======= ======
Options exercisable
at year-end 377,200 333,130 481,015
Weighted-average
fair value of
options granted
during the year $ 1.11 $ 2.35 $ 2.96
The following table summarizes information about options outstanding under the
1990 Plan at December 31, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------ ----------------------------------
RANGE NUMBER WEIGHTED-AVERAGE NUMBER
OF OUTSTANDING REMAINING WEIGHTED-AVERAGE EXERCISABLE WEIGHTED-AVERAGE
EXERCISE PRICES AT 12/31/97 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/97 EXERCISE PRICE
--------------- ------------ ---------------- ---------------- ----------- ----------------
$1.58 to $3.14 373,000 4.9 $1.62 1,646 $2.88
$3.88 to $4.97 146,750 3.4 $4.32 55,951 $4.29
$5.13 to $5.75 212,650 2.2 $5.36 131,836 $5.35
$6.00 to $7.13 204,100 1.1 $6.13 187,767 $6.12
The following table summarizes the activity for the Non-Employee Option Plan for
the years ended December 31, 1997, 1996 and 1995:
1997 1996 1995
------------------------- --------------------------- ----------------------------
WEIGHTED-AVERAGE WEIGHTED-AVERAGE WEIGHTED-AVERAGE
FIXED OPTIONS SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
------------- ------ ---------------- ------ ---------------- ------ ----------------
Outstanding at 50,000 $ 4.95 25,000 $ 5.25 -- $ --
beginning of year
Granted 25,000 2.70 25,000 4.64 25,000 5.25
Exercised -- -- -- -- -- --
Forfeited -- -- -- -- -- --
------ ----- ------ ----- ------ -----
Outstanding at end
of year 75,000 $ 4.20 50,000 $ 4.95 25,000 $ 5.25
====== ====== ====== ====== ====== ======
Options exercisable
at year-end 75,000 50,000 25,000
Weighted-average fair
value of options
granted during
the year $ 1.80 $ 2.69 $ 3.01
The following table summarizes information about options outstanding under the
Non-Employee Option Plan at December 31, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------- -------------------------------------
RANGE OF NUMBER WEIGHTED-AVERAGE
EXERCISE OUTSTANDING REMAINING WEIGHTED-AVERAGE NUMBER EXERCISABLE WEIGHTED-AVERAGE
PRICES AT 12/31/97 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/97 EXERCISE PRICE
-------- ----------- ---------------- ---------------- ------------------ ----------------
$1.16 to $4.19 25,000 4.7 $ 2.70 25,000 $ 2.70
$4.25 to $6.38 50,000 3.2 $ 4.95 50,000 $ 4.95
31
32
The Company applies APB 25 and related Interpretations in accounting for its
plans. Since all the stock options were granted at fair market value at the date
of grant, no compensation cost has been recognized for its fixed stock option
plans. Had compensation cost for the Company's two stock-based compensation
plans been determined consistent with SFAS 123, the Company's net loss and net
loss per share would have been increased to the pro forma amounts indicated
below:
1997 1996 1995
----------- ---------- ------------
Net loss As reported $(2,489,000) $(3,342,000) $(2,826,000)
Pro forma $(2,678,000) $(3,456,000) $(2,962,000)
Basic and diluted net As reported $ (0.75) $ (1.08) $ (0.94)
loss per share Pro forma $ (0.81) $ (1.11) $ (0.99)
The compensation cost calculated under SFAS 123 is based on options granted in
1995, 1996 and 1997, and because additional option grants are expected to be
made each year, the above pro forma disclosures are not representative of the
pro forma effects of option grants on reported net income for future years.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions used for
grants in 1997, 1996 and 1995: expected volatility of 76.7% and dividend yield
of 0% for all years; risk-free interest rates for the last day of the month in
which the options were granted; and weighted-average expected lives of 4 years
for the 1990 Option Plan and 5 years for the Non-Employee Option Plan.
NOTE 8 - INCOME TAXES:
No provisions for federal or state income taxes were recorded for the years
ended December 31, 1997 and 1996 as the Company incurred net operating losses
during the period.
Deferred tax assets consist of the following:
DECEMBER 31,
1997 1996
----------- -----------
Net operating loss carryforwards $ 7,718,000 $ 6,763,000
Credit carryforwards 817,000 789,000
Capitalized research and 183,000 179,000
development expenses
Reserves and other 156,000 213,000
----------- -----------
Deferred tax assets 8,874,000 7,944,000
Valuation allowance (8,874,000) (7,944,000)
----------- -----------
$ -- $ --
=========== ===========
Management believes that it is more likely than not that the deferred tax assets
will not be utilized. Accordingly, a full valuation allowance has been
recorded.
At December 31, 1997, the Company had approximately $21,220,000 of federal and
$8,626,000 of state net operating loss carryforwards available to offset future
taxable income which expire in varying amounts beginning in 2002. Under the Tax
Reform Act of 1986, the amounts of and benefits from net operating loss
carryforwards may be impaired or limited in certain circumstances. Events which
cause limitations in the amount of net operating losses that the Company may
utilize in any one year include, but are not limited to, a cumulative ownership
change of more than 50%, as defined, over a three year period.
The benefit for income taxes differed from the amount determined by applying
U.S. statutory income tax rate to income before income taxes. A reconciliation
is summarized below:
DECEMBER 31,
-----------------------
1997 1996
------ --------
Tax benefit at statutory rate $ (846) $ (1,136)
State income taxes, net of federal benefit (145) (201)
Non-recognition of tax benefit and other 991 1,337
------ --------
$ -- $ --
------ --------
32
33
NOTE 9 - GEOGRAPHIC SALES AND MAJOR CUSTOMERS:
The Company sells its products predominately in the United States. No other
geographic region accounted for more than 10% of net sales in fiscal 1997,
1996, or 1995.
No customer accounted for 10% of net sales in fiscal 1997 or 1996. One customer
accounted for 10% of net sales in fiscal 1995.
At December 31, 1997, one customer represented 22% of the accounts receivable
balance. At December 31, 1996, one customer represented 10% of the accounts
receivable balance.
NOTE 10 - COMMITMENTS:
The Company occupies its facility under a non-cancelable lease agreement which
expires on October 31, 2000. The lease requires the Company to pay property
taxes and insurance.
The Company leases certain property and equipment under capital leases. Computer
and other equipment under capital leases total $64,000 and $0, with related
accumulated depreciation of $4,000 and $0 at December 31, 1997 and 1996
respectively.
The aggregated minimum rental commitments and equipment lease payments at
December 31, 1997, excluding insurance, normal maintenance and certain property
taxes, are payable as follows:
FISCAL YEAR OPERATING LEASE CAPITAL LEASE
----------- --------------- -------------
1998 $ 155,000 $ 26,000
1999 158,000 15,000
2000 134,000 9,000
2001 -- --
2002 -- --
--------- ---------
Total minimum lease payments $ 447,000 50,000
---------
Less: amount representing interest 6,000
---------
Present value of minimum lease payments 44,000
Less current portion 24,000
---------
$ 20,000
---------
Total rental expense under non-capitalized leases, including month-to-month
rentals, was $183,000, $164,000 and $154,000 for the years ended December 31,
1997, 1996 and 1995, respectively.
NOTE 11 - NET LOSS PER SHARE
Options and Warrants to purchase shares, and Convertible Preferred Stock
outstanding were not included in the computation of diluted net loss per share,
as their effect was antidilutive for the periods presented. Therefore, both the
basic and diluted net loss per share computations resulted in the same number
and there were no reconciling items.
33
34
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF DISC, INC.
In our opinion, the accompanying balance sheet and the related statements of
operations, shareholders' equity and cash flows present fairly, in all material
respects, the financial position of DISC, INC. at December 31, 1997 and 1996,
and the results of its operations and its cash flows for each of the three years
in the period ended December 31, 1997, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
Price Waterhouse LLP
San Jose, California
February 12, 1998, except
as to Notes 1 and 5, which
are as of March 18, 1998
34
35
STOCK MARKET INFORMATION.
DISC, Inc.'s stock is traded on the NASDAQ Small-Cap Market under the symbol
DCSR. The high and low prices set forth below are as reported by the NASDAQ
Small Cap Market System.
1997 1996
-------------------- ------------------
HIGH LOW HIGH LOW
---- --- ---- ---
First quarter ended $ 5 1/4 $3 17/32 $6 3/4 $2
Second quarter ended 4 13/64 1 15/16 4 7/8 2 3/4
Third quarter ended 3 5/8 2 1/4 5 3/4 4 1/8
Fourth quarter ended 3 7/8 6 3 1/2
---------- -------- ------ -------
As of March 23, 1998, the Company had approximately 400 shareholders. The
Company has never paid cash dividends and has no present plans to pay dividends.
See Note 5 of Notes to Financial Statements regarding dividend requirements on
the Convertible Preferred Stock.
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36
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to
be signed on its behalf by the undersigned, thereunto duly authorized, at
Milpitas, California this 10th day of April, 1998.
DISC, Inc.
By /s/ J. Richard Ellis
---------------------------------------
J. Richard Ellis
President and Chief Executive Officer
POWER OF ATTORNEY
I, the undersigned director and officer of DISC, Inc., do hereby constitute and
appoint our true and lawful attorney and agent with power of substitution, to do
any and all acts and things in our name and behalf in our capacities as
directors and officers and to execute any and all instruments for us and in our
names in the capacities indicated below, which said attorney and agent, may deem
necessary or advisable to enable said corporation to comply with the Securities
Exchange Act of 1934, as amended and any rules, regulations and requirements of
the Securities and Exchange Commission, in connection with this Annual Report on
Form 10-K, including specifically but without limitation, power and authority to
sign for us or any of us in our names in the capacities indicated below, any and
all amendments (including post-effective amendments) hereto: and we do hereby
ratify and confirm all that said attorney and agent, shall do or cause to be
done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the date indicated.
/s/ J. Richard Ellis President, Chief Executive Officer April 10, 1998
- -------------------------- and Chairman of the Board of
(J. Richard Ellis) Directors
(Principal Executive Officer)
/s/ Henry Madrid Vice President of Finance April 10, 1998
- --------------------------- and Chief Financial Officer
(Henry Madrid) (Principal Financial and
Accounting Officer)
/s/ Frank T. Connors Director April 10, 1998
- ---------------------------
(Frank T. Connors)
/s/ F. Rigdon Currie Director April 10, 1998
- ---------------------------
(F. Rigdon Currie)
/s/ Michael D. Kaufman Director April 10, 1998
- ---------------------------
(Michael D. Kaufman)
/s/ Arch J. McGill Director April 10, 1998
- ---------------------------
(Arch J. McGill)
/s/ Michael A. McManus, Jr. Director April 10, 1998
- ---------------------------
(Michael A. McManus, Jr.)
36
37
DISC, INC.
FORM 10-K
EXHIBIT INDEX
SEQUENTIAL
PAGE NUMBER
-----------
3.12 Certificate of Determination of Preference of Series K Preferred
Stock, as filed with the California Secretary of State on
August 15, 1997. 38
3.13 Certificate of Determination of Preference of Series L Preferred
Stock, as filed with the California Secretary of State on
August 15, 1997. 43
3.14 Certificate of Determination of Preference of Series M Preferred
Stock, as filed with the California Secretary of State on
January 6, 1998. 49
3.15 Certificate of Determination of Preference of Series N Preferred
Stock, as filed with the California Secretary of State on
January 6, 1998. 55
10.17 Third Amendment to Convertible Debenture Purchase Agreement,
dated December 31, 1997. 61
10.18 Amendment No. 2 to Loan Documents, dated January 13, 1998. 63
23. Consent of Price Waterhouse LLP 65
25. Power of Attorney (included on Signature Page).
37