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Securities and Exchange Commission
Washington, DC 20549
REPORT ON FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended APRIL 30, 2001
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to _______________
Commission file number 0-21053
PROCOM TECHNOLOGY, INC.
(Exact name of registrant as specified in its charter)
California 33-0268063
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
58 Discovery, Irvine California 92618
(Address of principal executive office) (Zip Code)
(949) 852-1000
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed since
last report.)
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 [ ]
The number of shares of Common Stock, $.01 par value, outstanding on
June 8, 2001 was 15,953,955.
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PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
APRIL 30, JULY 31,
2001 2000
------------ ------------
ASSETS
Current assets:
Cash ................................................ $ 185,000 $ 1,450,000
Short-term marketable securities, held to maturity .. 7,500,000 14,065,000
Accounts receivable, less allowance for doubtful
accounts and sales returns of $3,160,000
and $2,752,000, respectively ...................... 13,548,000 6,699,000
Inventories, net .................................... 9,788,000 8,430,000
Income tax receivable ............................... 26,000 2,699,000
Deferred income taxes ............................... 2,143,000 1,833,000
Prepaid expenses .................................... 1,661,000 372,000
Other current assets ................................ 367,000 296,000
------------ ------------
Total current assets ............................ 35,218,000 35,844,000
Property and equipment, net ........................... 17,204,000 16,034,000
Other assets .......................................... 2,375,000 918,000
------------ ------------
Total assets .................................... $ 54,797,000 $ 52,796,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Lines of credit ..................................... $ 4,590,000 $ 610,000
Loan payable ........................................ -- 10,750,000
Flooring line obligation ............................ 1,147,000 1,511,000
Accounts payable .................................... 5,871,000 8,888,000
Accrued expenses and other current liabilities ...... 2,538,000 1,837,000
Accrued compensation ................................ 972,000 1,213,000
Deferred service revenues ........................... 373,000 431,000
Income taxes payable ................................ 115,000 --
Convertible debenture ............................... 14,533,000 --
------------ ------------
Total current liabilities ....................... 30,139,000 25,240,000
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value; 10,000,000 shares
authorized, no shares issued and outstanding ...... -- --
Common stock, $.01 par value; 65,000,000 shares
authorized, 12,143,805 and 11,531,357 shares
issued and outstanding, respectively .............. 121,000 115,000
Additional paid-in capital .......................... 26,847,000 19,685,000
Retained earnings (accumulated deficit) ............. (1,992,000) 8,007,000
Accumulated other comprehensive loss ................ (318,000) (251,000)
------------ ------------
Total shareholders' equity ...................... 24,658,000 27,556,000
------------ ------------
Total liabilities and shareholders' equity ............ $ 54,797,000 $ 52,796,000
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------- -------------------------------
APRIL 30, APRIL 30, APRIL 30, APRIL 30,
2001 2000 2001 2000
------------ ------------ ------------ ------------
Net sales $ 8,002,000 $ 13,811,000 $ 32,988,000 $ 49,047,000
Cost of sales 4,829,000 10,478,000 20,319,000 36,667,000
------------ ------------ ------------ ------------
Gross profit 3,173,000 3,333,000 12,669,000 12,380,000
Selling, general and administrative expenses 4,385,000 5,145,000 13,352,000 17,405,000
Research and development expenses 1,472,000 1,819,000 4,925,000 5,207,000
Acquired research and development expenses --- --- 4,262,000 ---
------------ ------------ ------------ ------------
Operating loss (2,684,000) (3,631,000) (9,870,000) (10,232,000)
Interest income 139,000 246,000 597,000 811,000
Interest expense (434,000) --- (1,005,000) (6,000)
------------ ------------ ------------ ------------
Loss before income taxes (2,979,000) (3,385,000) (10,278,000) (9,427,000)
Provision (benefit) for income taxes 61,000 (904,000) (279,000) (2,689,000)
------------ ------------ ------------ ------------
Net loss $ (3,040,000) $ (2,481,000) $ (9,999,000) $ (6,738,000)
============ ============ ============ ============
Net loss per common share:
Basic $ (0.25) $ (0.22) $ (0.84) $ (0.60)
============ ============ ============ ============
Diluted $ (0.25) $ (0.22) $ (0.84) $ (0.60)
============ ============ ============ ============
Weighted average number of common shares:
Basic 12,139,000 11,321,000 11,835,000 11,260,000
============ ============ ============ ============
Diluted 12,139,000 11,321,000 11,835,000 11,260,000
============ ============ ============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
RETAINED ACC. OTHER
COMMON STOCK ADDITIONAL EARNINGS COMPREHENSIVE
------------------------- PAID IN (ACCUM. INCOME
SHARES AMOUNT CAPITAL DEFICIT) (LOSS) TOTAL
---------- ---------- ----------- ------------ ------------- ----------
BALANCE AT JULY 31, 1998 11,178,742 $ 112,000 $17,751,000 $18,866,000 $ 3,000 $ 36,732,000
Comprehensive loss:
Net loss -- -- -- (2,875,000) -- (2,875,000)
Foreign currency translation adjustment -- -- -- -- (18,000) (18,000)
------------
Comprehensive loss (2,893,000)
Exercise of employee stock options 41,013 -- 152,000 -- -- 152,000
Issuance of stock to employees 5,531 -- 39,000 -- -- 39,000
Tax benefit from stock option exercises -- -- 71,000 -- -- 71,000
Stock repurchases (77,845) (1,000) (400,000) -- -- (401,000)
Acquisitions 79,600 1,000 585,000 -- -- 586,000
---------- ---------- ----------- ----------- ---------- ------------
BALANCE AT JULY 31, 1999 11,227,041 112,000 18,198,000 15,991,000 (15,000) 34,286,000
Comprehensive loss:
Net loss -- -- -- (7,984,000) -- (7,984,000)
Foreign currency translation adjustment -- -- -- -- (236,000) (236,000)
------------
Comprehensive loss (8,220,000)
Compensatory stock options -- -- 62,000 -- -- 62,000
Exercise of employee stock options 278,587 3,000 1,112,000 -- -- 1,115,000
Issuance of stock to employees 25,729 -- 313,000 -- -- 313,000
---------- ---------- ----------- ----------- ---------- ------------
BALANCE AT JULY 31, 2000 11,531,357 115,000 19,685,000 8,007,000 (251,000) 27,556,000
Comprehensive loss:
Net loss -- -- -- (9,999,000) -- (9,999,000)
Foreign currency translation adjustment -- -- -- -- (67,000) (67,000)
------------
Comprehensive loss (10,066,000)
Acquisition of Scofima 480,000 5,000 5,755,000 -- -- 5,760,000
Compensatory stock options -- -- 30,000 -- -- 30,000
Exercise of employee stock options 119,351 1,000 670,000 -- -- 671,000
Issuance of stock to employees 13,097 -- 145,000 -- -- 145,000
Issuance of stock warrant to investor -- -- 562,000 -- -- 562,000
---------- ---------- ----------- ----------- ---------- ------------
BALANCE AT APRIL 30, 2001 12,143,805 $ 121,000 $26,847,000 $(1,992,000) $ (318,000) $ 24,658,000
========== ========== =========== =========== ========== ============
(UNAUDITED)
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED APRIL 30,
-------------------------------
2001 2000
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .............................................. $ (9,999,000) $ (6,738,000)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization, including
amortization of debt issuance costs ............. 1,109,000 667,000
Compensatory stock options ........................ 30,000 --
Acquired research and development ................. 4,262,000 --
Changes in assets and liabilities,
net of effects of acquisitions:
Accounts receivable ............................. (6,838,000) 3,581,000
Inventories ..................................... (1,358,000) 365,000
Income tax receivable ........................... 2,673,000 --
Deferred income taxes ........................... (310,000) 472,000
Prepaid expenses ................................ (1,289,000) (150,000)
Other current assets ............................ (71,000) 42,000
Other assets .................................... 64,000 (36,000)
Accounts payable ................................ (3,125,000) (1,499,000)
Flooring line obligation ........................ (364,000) (542,000)
Accrued expenses and compensation ............... 460,000 (44,000)
Deferred service revenues ....................... (58,000) (357,000)
Income taxes payable ............................ 115,000 (18,000)
------------ ------------
Net cash used in operating activities ........ (14,699,000) (4,257,000)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ................ (1,860,000) (3,572,000)
Acquisitions, net of cash acquired ................ (250,000) --
------------ ------------
Net cash used in investing activities ........ (2,110,000) (3,572,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of convertible debt ...................... 15,000,000 --
Repayment of loan ................................. (10,750,000) 1,000,000
Net borrowings (repayments) on lines of credit .... 3,980,000 (184,000)
Issuance of common stock .......................... 145,000 142,000
Stock option exercises ............................ 671,000 652,000
------------ ------------
Net cash provided by financing activities .... 9,046,000 1,610,000
Effect of exchange rate changes ................. (67,000) (241,000)
------------ ------------
Decrease in cash ................................ (7,830,000) (6,460,000)
Cash and cash equivalents at beginning of period ...... 15,515,000 22,433,000
------------ ------------
Cash and cash equivalents at end of period ............ $ 7,685,000 $ 15,973,000
============ ============
Supplemental disclosures of cash flow information:
CASH PAID (RECEIVED) DURING THE PERIOD FOR:
Interest .......................................... $ 235,000 $ 6,000
Income taxes ...................................... $ (2,759,000) $ (3,179,000)
SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING
ACTIVITIES:
Common stock warrant issued to convertible
debenture investor .............................. $ 562,000 $ --
The accompanying notes are an integral part of these
condensed consolidated financial statements.
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PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. GENERAL.
The accompanying financial information is unaudited, but in the opinion
of management, reflects all adjustments (which include only normal recurring
adjustments) necessary to present fairly the financial position of Procom
Technology, Inc. and its consolidated subsidiaries (the "Company") as of the
dates indicated and the results of operations for the periods then ended.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted pursuant to the
rules and regulations of the Securities and Exchange Commission. While the
Company believes that the disclosures are adequate to make the information
presented not misleading, the financial information should be read in
conjunction with the audited financial statements and notes thereto included in
the Company's Report on Form 10-K for fiscal 2000. Results for the interim
periods presented are not necessarily indicative of the results for the entire
year.
NOTE 2. INVENTORIES.
Inventories are summarized as follows:
April 30, 2001 July 31, 2000
-------------- -------------
Raw materials $ 5,000,000 $ 4,225,000
Work-in process 718,000 255,000
Finished goods 4,070,000 3,950,000
------------ ------------
Total $ 9,788,000 $ 8,430,000
============ ============
NOTE 3. NET LOSS PER SHARE.
Basic net loss per share is computed using the weighted average number of
shares of common stock outstanding during the period. Diluted net loss per share
is computed using the weighted average number of shares of common stock
outstanding and potentially dilutive common shares outstanding during the
period. Potentially dilutive common shares consist of stock options and
warrants. For the periods presented, basic and diluted net loss per share was
based on the weighted average number of shares of common stock outstanding
during the period. For the three months ended April 30, 2001 and 2000,
respectively, the dilutive effect of options and warrants to purchase 640,427
and 1,309,551 shares of common stock, respectively, and for the nine months
ended April 30, 2001 and 2000, respectively, the dilutive effect of options and
warrants to purchase 1,000,871 and 1,146,746 shares of common stock,
respectively, were not included in the computation of net loss per share as the
effect would have been antidilutive.
NOTE 4. COMPREHENSIVE LOSS.
For the nine months ended April 30, 2001 and 2000, the only differences
between reported net loss and comprehensive loss were foreign currency
translation adjustment losses of $67,000 and $241,000, respectively.
NOTE 5. BUSINESS SEGMENT INFORMATION.
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The Company operates in one industry segment: The design, manufacture
and marketing of data storage devices. The Company has two major distinct
product families: network attached storage products ("NAS Products") and other
data storage and access products. Net sales of network attached storage (NAS)
products represented approximately 72.5% and 35.4% of total product net sales
for the three months ended April 30, 2001 and 2000, respectively, and 67.1% and
21.5% of total net sales for the nine months ended April 30, 2001 and 2000,
respectively.
International sales as a percentage of net sales amounted to 50.0% and
44.5% for the three months ended April 30, 2001 and 2000, respectively.
International sales were primarily to European customers, and, secondarily, to
Middle Eastern, Latin American and Pacific Rim customers. Identifiable assets
used in connection with the Company's foreign operations were $7.3 million at
April 30, 2001 and $7.6 million at July 31, 2000.
NOTE 6. LINES OF CREDIT AND CONVERTIBLE DEBENTURE.
On October 10, 2000, the Company entered into a term loan agreement and
a three-year working capital line of credit with CIT Business Credit. A term
loan of $4.0 million is due and payable upon the Company's finalization of a
long-term mortgage on its corporate headquarters, or it will be repaid in 12
monthly installments commencing April 1, 2001, while an initial term loan of
$1.0 million was due and payable in 90 days, and was repaid on November 1, 2000.
The term loans bear interest at the lender's prime rate (8.0% at April 30,
2001), plus .5%, with increases if the loan is not reduced according to a fixed
amortization. The working capital line of credit allows for the Company to
borrow, on a revolving basis, for a period of three years, a specified
percentage of its eligible accounts receivable and inventories (approximately
$2.8 million at April 30, 2001), up to a limit of $5.0 million. Amounts
outstanding under the working capital line bear interest at the lender's prime
rate plus .25%. At April 30, 2001, $4.3 million was outstanding under the
various credit arrangements. The lender charged approximately $130,000 for the
credit facilities, which is being amortized as interest expense over the term of
the loan. The lines accrue various monthly maintenance, minimum usage and early
termination fees. The lines require certain financial and other covenants,
including the maintenance of a minimum EBITDA requirement for each fiscal
quarter beginning in the quarter ending January 31, 2001. The Company was in
compliance with all covenants of the lines at April 30, 2001. The combined lines
of credit are collateralized by all of the assets of the Company. In May 2001,
the Company reduced the amounts outstanding under the various credit
arrangements by $4.3 million.
In addition to the two lines noted above, the Company replaced the
Finova flooring line of credit with a flooring line with IBM Credit who has
committed to make $2.5 million in flooring inventory commitments available to
the Company. The flooring line is collateralized by the specific inventory
purchased pursuant to the flooring commitments, and the two lenders have entered
into an intercreditor agreement which determines the level of priority of either
lender's security interest. The flooring line requires the maintenance by the
Company of a minimum net worth of $16.0 million. The Company was in compliance
with the terms of the flooring line at April 30, 2001.
On October 31, 2000, the Company issued a $15.0 million convertible
unsecured debenture to a private investor. The debenture bears interest at 6.0%
per annum, and is repayable in full on October 31, 2003, unless otherwise
converted into the common stock of the Company. The debenture is convertible
into the common stock of the Company at the investor's option at an initial
conversion price of $22.79 per share, subject to antidilution adjustments, and
at the Company's option, if the common stock of the Company trades at more than
135% of the conversion then in effect for at least 20 consecutive trading days.
The conversion price under the debenture automatically re-sets periodically.
During these re-set periods, the conversion price will, for five consecutive
trading days, adjust to 90% of the average closing price of the Company's stock
during the 10 trading days preceding each re-set period if this amount is less
than the conversion price that would otherwise apply. The first re-set period
began on May 15,2001 and ended May 21, 2001. The next re-set period begins on
October 31, 2001 and additional re-set periods will occur every six months
thereafter. During the first re-set period the investor elected to convert $5.0
million of the debenture at a re-set conversion price of approximately $9.71 per
share. The Company elected to pay the investor in cash the $5.0 million
principal amount of the debenture that the investor elected to
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convert during the first re-set period. Up to an additional $5.0 million of the
debentures, plus any unpaid interest on that amount, may be converted at the
re-set conversion price beginning on October 31, 2001, and any remaining portion
of the debenture, plus any unpaid interest, may be converted at the re-set
conversion price during any subsequent re-set period. The Company has the right
to pay the investor in cash the principal amount of any portion of the debenture
the investor elects to convert during a re-set period. If the Company were to
issue shares at 90% of the trading price of its common stock upon conversion of
the debenture during a re-set period, the Company would incur a charge to its
income statement, which could be significant, based on the difference between
the issuance price of the Company's common stock and the value of the common
stock at October 31, 2000. In connection with the issuance of the debenture, the
Company issued to the investor a 5-year warrant to purchase up to 32,916 shares
of its common stock at an initial exercise price of $32.55 per share, with the
number of shares for which the warrant is exercisable and the exercise price
subject to antidilution adjustments. The Company has valued the warrant using a
Black-Scholes model, with the following assumptions: Expected life -- 5 years,
Risk free interest rate -- 6%, and Volatility, 1.20. These factors yield a value
of $562,000, which will be amortized over the life of the debt, or if conversion
of the debenture occurs, the Company will reclassify the remaining value to
interest expense.
The principal amount of the debenture is classified as a current
liability, net of the remaining unamortized warrant value. At April 30, 2001,
the debenture amount repayable was $15,000,000 and the unamortized warrant value
was $467,000, for a net debenture value of $14,533,000 on the balance sheet. In
addition to the warrant cost, costs of approximately $700,000 were incurred in
the debt transactions noted above, and the amounts will be classified as prepaid
expenses, and amortized as interest expense over the life of the debt
instruments.
Subsequent to April 30, 2001, the Company completed the sale of
3,800,000 shares of its common stock raising gross proceeds of approximately
$34.2 million. The Company will set aside $10.0 million of the offering proceeds
in a separate account to pay in the future any remaining indebtedness under the
debenture. As a result of this offering, the conversion price of the Company's
outstanding debenture was adjusted pursuant to a weighted average adjustment
under the terms of the debenture. The adjusted conversion price is $19.57.
NOTE 7. ACQUISITION
On December 28, 2000, the Company acquired all of the issued and
outstanding capital stock of Scofima Software S.r.l., a company organized under
the laws of Italy ("Scofima"), in exchange for 480,000 shares of the Company's
common stock. Pursuant to its agreement with the former shareholders of Scofima,
the Company registered for resale by those shareholders the shares issued to
them in the acquisition. Scofima had an option to acquire a software system
designed as a caching and content distribution solution. Immediately prior to
the Company's acquisition of Scofima, Scofima exercised its option, and acquired
the software system. The purpose of the software is to provide functionalities
that are necessary for the content delivery market of the internet. The software
had been in development for approximately 2-3 years, involving 5 programmers and
system developers. The software was not complete at the date of acquisition, and
has yet to be determined to be technologically feasible. The Company is
currently completing the software, but final release is not expected for several
months. The Company issued 480,000 shares valued at $12 per share and incurred
approximately $250,000 in acquisition costs in exchange for the outstanding
shares of Scofima. Scofima had net assets of approximately $500,000 at the date
of acquisition. The transaction was accounted for as a purchase of assets. The
Company has employed an appraiser to identify the values of the assets acquired,
including, among other assets, certain in-process research and development
costs. The amount of purchase price allocated to in-process research and
development was determined by estimating the stage of development of the
software, estimating future cash flows from projected revenues, and discounting
those cash flows to present value. The discount rate applied was 25%. The
incremental product sales resulting from the products incorporating the software
are estimated to be $44 million over the initial four years of sales with sales
growing from approximately $1.5 million in the initial year to $13.4 million in
the fourth year. The appraiser concluded, and the Company has determined that
approximately $4.3 million of the purchase price was related to the Company's
research and development efforts that had not attained technological feasibility
and for which no future alternative use was expected. The Company has expensed
the value of the research and development as of the date of the acquisition of
Scofima and capitalized the fair value of the other assets acquired as
determined and allocated by the appraiser, including the value of the assembled
workforce of
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approximately $0.2 million and developer relationships valued at $0.1 million
which will be amortized over 4 years, with the remainder of $1.4 million
assigned to goodwill, which will amortized over 4 years. The following is a
summary of the net fair value of the assets acquired, the liabilities assumed,
and the total consideration paid for Scofima:
Net fair value of assets acquired $ 6,120,000
Liabilities assumed (110,000)
Shares issued (5,760,000)
-----------
Cash consideration, net of cash acquired $ 250,000
===========
Proforma financial information has not been provided due to the limited
operations of Scofima. Revenue and net income were approximately $3,000 and
$100, respectively, for the ten months ended October 31, 2000 and were
approximately $6,000 and $800, respectively for the year ended December 31,
1999. Total assets were approximately $120,000 at both October 31, 2000 and
December 31, 1999.
NOTE 8. RECENT ACCOUNTING PRONOUNCEMENTS.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133, as amended by SFAS
138, is effective for all fiscal quarters of fiscal years beginning after June
15, 2000. SFAS 133 establishes accounting and reporting standards for derivative
instruments including derivative instruments embedded in other contracts and for
hedging activities. Adoption of SFAS 133 did not have a material impact on the
Company's consolidated financial position, results of operations or liquidity.
In December 1999, the United States Securities and Exchange Commission
issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in
Financial Statements," as amended, which for the Company is effective no later
than the fourth quarter of fiscal 2001. SAB No. 101 summarizes certain of the
SEC staff's views regarding the appropriate recognition of revenue in financial
statements. Adoption of SAB No. 101 is not expected to have a material impact on
the Company's consolidated financial position or results of operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Procom develops, manufacturers and markets network attached storage
(NAS) appliances and other storage devices for a wide range of computer networks
and operating systems. Our NAS appliances, which consist of our DataFORCE and
NetFORCE product lines, provide end-users with faster access to data at lower
overall cost than other storage alternatives. We refer to these products
collectively as our NAS appliances. In addition, we sell disk drive storage
upgrade systems, CD/DVD-ROM servers and arrays and tape backup products, which
we refer to collectively as our non-NAS products. In the last two years, we have
significantly increased our focus on the development and sale of NAS appliances.
We continue to develop more advanced NAS appliances and expect this business to
be our principal business in the future. We are currently analyzing the market
demands and opportunities for all of our non-NAS products, and hope to
transition users of these products to our growing line of more complex,
generally higher margin NAS solutions.
In December 1999, we executed an agreement with Hewlett-Packard, under
which we supply a customized version of our mid-range NAS appliance hardware and
software for Hewlett-Packard for resale. Under the agreement, which has a
five-year term, and which has no minimum quantity commitments, we
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expect that Hewlett-Packard will market and support the NAS appliances through
their distribution channels. We commenced shipments under the agreement in
limited quantities in April 2000. In early February 2001, Hewlett-Packard
notified us that they do not anticipate they will purchase additional NAS
products from us in the future. While neither they nor we have formally
terminated the agreement, we do not anticipate that future sales to
Hewlett-Packard will be significant.
Changing Business Mix. In recent periods, we have experienced
significantly reduced demand, revenues and gross margins for our non-NAS
products, and we have discontinued some non-NAS products. The demand for our CD
servers and arrays has declined, and we have experienced increased pricing
pressures on our disk drive storage upgrade systems, resulting in lower overall
revenues and gross profits. Our gross margins vary significantly by product
line, and, therefore, our overall gross margin varies with the mix of products
we sell. For example, our sales of CD servers and arrays have historically
generated higher gross margins than those of our tape back-up and disk drive
products. Because recently we have sold, and expect to continue to sell, fewer
CD server and arrays, we expect our overall gross margins to be negatively
affected. In recent quarters, sales of our higher margin NAS appliances have
increased as a percentage of total sales, which has offset the impact of the
decline in sales of servers and arrays and resulted in higher overall gross
margins. No assurance can be given that overall gross margins will not decline
in future periods.
In recent periods, we have experienced significant declines in net sales
and gross profit, and we have incurred operating losses. We expect to incur
operating losses through at least the fourth quarter of fiscal 2001. See "Risk
Factors -- We may not be able to achieve of sustain profitability, and our
failure to do so could require us to seek additional financing, which may not be
available to us on favorable or any terms."
Our revenues and gross margins have been and may continue to be affected
by a variety of factors including:
- new product introductions and enhancements;
- competition;
- direct versus indirect sales;
- the mix and average selling prices of products; and
- the cost of labor and components.
Revenue and Revenue Recognition. We generally record sales upon product
shipment. In the case of sales to most of our distributors, we record sales when
the distributor receives the products. We recognize our product service and
support revenues over the terms of their respective contractual periods. Our
agreements with many of our VARs, system integrators and distributors allow
limited product returns, including stock balancing, and price protection
privileges. We maintain reserves, which are adjusted at each financial reporting
date, to state fairly the anticipated returns, including stock balancing, and
price protection claims relating to each reporting period. We calculate the
reserves based on historical rates of sales and returns, including price
protection and stock balancing claims, our experience with our customers, our
contracts with them, and current information as to the level of our inventory
held by our customers.
In addition, under a product evaluation program established by us, our
indirect channel partners and end users generally are able to purchase
appliances on a trial basis and return the appliances within a specified period,
generally 30-60 days, if they are not satisfied. The period may be extended if
the customer needs additional time to evaluate the product within the customer's
particular operating environment. The values of evaluation units at customer
sites on financial reporting dates are included in inventory as finished goods.
At April 30, 2001 and July 31, 2000, inventory related to evaluation units was
approximately $2.3 million and $1.5 million, respectively.
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Costs and Expenses. Our cost of sales consists primarily of the cost of
components produced by our suppliers, such as disk drives, cabinets, power
supplies, controllers and CPUs, our direct and indirect labor expenses and
related overhead costs such as rent, utilities and manufacturing supplies and
other expenses. In addition, cost of sales includes third-party license fees,
warranty expenses and reserves for obsolete inventory.
Selling, General and Administrative Expenses. These expenses include
costs directly associated with the selling process such as salaries and
commissions of sales personnel, marketing, direct and cooperative advertising
and travel expenses. General and administrative expenses include our general
corporate expenses, such as salaries and benefits, rent, utilities, bad debt
expense, legal and other professional fees and expenses, depreciation, and
amortization of goodwill. Amortization of goodwill is expected to approximate
$120,000 per quarter. These costs are expensed as incurred.
Our research and development expenses consist of the costs associated
with software and hardware development. Specifically, these costs include
employee salaries and benefits, consulting fees for contract programmers, test
supplies, employee training for programmers and support staff and other related
expenses. The cost of developing new appliances and substantial enhancements to
existing appliances are expensed as incurred.
The following table sets forth consolidated statement of operations data as a
percentage of net sales for each of the periods indicated:
Three Months Ended Nine Months Ended
-------------------------- --------------------------
April 30, April 30, April 30, April 30,
2001 2000 2001 2000
--------- --------- --------- ---------
(unaudited) (unaudited) (unaudited) (unaudited)
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 60.3 75.9 61.6 74.8
--------- --------- --------- ---------
Gross profit 39.7 24.1 38.4 25.2
Selling, general and administrative expenses 54.8 37.2 40.5 35.5
Research and development expenses 18.4 13.2 14.9 10.6
Acquired research and development expenses -- -- 12.9 --
--------- --------- --------- ---------
Operating loss (33.5) (26.3) (29.9) (20.9)
Interest income and (expense), net (3.7) 1.8 (1.2) 1.7
--------- --------- --------- ---------
Loss before income taxes (37.2) (24.5) (31.1) (19.2)
Provision (benefit) for income taxes .8 (6.5) (.8) (5.5)
--------- --------- --------- ---------
Net loss (38.0%) (18.0%) (30.3%) (13.7%)
========= ========= ========= =========
COMPARISON OF THREE MONTHS AND NINE MONTHS ENDED APRIL 30, 2001 AND 2000
Net Sales. Net sales decreased by 42.1% to $8.0 million for the three
months ended April 30, 2001, from $13.8 million for the three months ended April
30, 2000. This decrease resulted from a significant decrease in unit sales of CD
servers and arrays and disk drive storage upgrade systems, combined with the
effect of significant price erosion of the average selling price of these
products. In addition, sales were reduced due to lower sales of non-NAS products
by our German subsidiary. Net sales for the nine months ended April 30, 2001
decreased 32.7% from sales for the same period in fiscal 2000. This decline was
caused by the same factors noted above, as well as our relocation to our new
corporate headquarters during the first three months of fiscal 2001, which we
believe caused us to lose sales during that period. We expect to see continued
weakness in the demand for our disk drive storage upgrade systems and CD servers
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and arrays and non-NAS product sales throughout fiscal 2001, and we may
accelerate the discontinuance of our non-NAS products.
Net sales related to our disk based NAS appliances increased 18.4% to
$5.8 million for the three months ended April 30, 2001, from $4.9 million for
the three months ended April 30, 2000. This increase was primarily the result of
increased unit sales of our NetFORCE NAS appliances, offset by decreased sales
of our DataFORCE appliances. Net sales related to our disk based NAS appliances
increased to $22.1 million for the nine months ended April 30, 2001, from $10.6
million for the nine months ended April 30, 2000.
International sales were $4.0 million, or 50.0% of our net sales for the
three months ended April 30, 2001, compared to $6.2 million, or 44.5% of our net
sales in the comparable period of fiscal 2000. The decrease in international
sales in absolute dollars is due primarily to reduced sales of non-NAS products
by our German subsidiary, while the increase as a percentage of our net sales
was due primarily to sales of our NAS products to customers in Europe and Asia.
International sales were $19.0 million, about 57.7% of our net sales for the
nine months ended April 30, 2001, compared to $21.6 million, or 44.1% of our net
sales in the nine months ended April 30, 2000. The decrease in international
sales in absolute dollars is due primarily to reduced sales of non-NAS products
by our German subsidiary. The increase as a percentage of our net sales was due
primarily to sales of our NAS products to customers in Europe and Asia,
including sales of approximately $5.2 million to a European storage service
provider, other sales of NAS appliances by our German and Swiss subsidiaries,
and reduced U.S. sales of our CD servers and arrays. There can be no assurance
that our revenues of our NAS products will continue to increase in any
particular quarter or period, or that any specific customers will continue to
purchase our products in such period.
Gross Profit. Gross profit decreased to $3.2 million, for the three
months ended April 30, 2001, from $3.3 million for the three months ended April
30, 2000. Gross margin increased to 39.7% of net sales for the three months
ended April 30, 2001, from 24.1% of net sales for the comparable period of
fiscal 2000. Gross margin increased from 25.2% for the nine months ended April
30, 2000 to 38.4% for the first nine months of fiscal 2001. The increase in
gross margin for both periods was primarily the result of the higher percentage
of NAS revenues, offset to a lesser extent by a reduction in sales of CD servers
and arrays, which have historically experienced higher margins. In addition, we
realized reduced margins on lower sales of disk drive upgrade systems due to
competition and price erosion in the disk drive upgrade industry. We expect that
gross margins may be impacted by continuing reductions in sales of some of our
higher margin non-NAS product lines, such as CD servers and arrays, until sales
of our NAS appliances significantly increase both in absolute dollars and as a
percentage of our total sales.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased to $4.4 million in the three months ended
April 30, 2001, from $5.1 million in the three months ended April 30, 2000, and
increased as a percentage of net sales to 54.8% from 37.2%. Selling, general and
administrative expenses decreased to $13.4 million in the first nine months of
fiscal 2001, from $17.4 million in the same period of fiscal 2000. The dollar
decrease in selling, general and administrative expenses was primarily the
result of reduced sales and administrative salaries and commissions, reduced
cooperative advertising costs and reduced expenses of our German subsidiary. In
addition, we incurred reduced advertising, marketing and travel costs, offset
somewhat by increased legal fees and increases in the cost of personnel
necessary to support our NAS sales and marketing efforts. During the three
months ended April 30, 2001, we continued to identify and eliminate certain
positions and functions not related to our core NAS activities. As a result, we
experienced some reductions in selling, general and administrative expenses in
the past quarter. However, we expect overall selling, general and administrative
expenses to increase in future periods as we plan to substantially increase
spending on efforts to market our NAS appliances and we expect increased
facilities costs, such as utilities, taxes and maintenance, as we utilize our
recently completed corporate headquarters.
Research and Development Expenses. Research and development expenses
decreased slightly from $1.8 million, or 13.2% of net sales in the third quarter
of fiscal 2000 to $1.5 million, or 18.4% of net sales, for the three months
ended April 30, 2001. The decrease in the third quarter of fiscal 2001 is due
primarily to reduced tools, evaluation units, test supplies and expenses for
outside programmers. Research and
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development expenses decreased from $5.2 million, or 10.6% of net sales, in the
nine months ended April 30, 2000 to $4.9 million, or 14.9% of net sales, for the
comparable period of fiscal 2001. This decrease was due primarily to reduced
costs for evaluation units and test supplies offset slightly by increases in
compensation expense for additional NAS software programmers and hardware
developers. We anticipate that our research and development expenses will
increase, both in absolute dollars and as a percentage of net sales, with the
expected addition of dedicated NAS engineering resources.
Acquired Research and Development Expenses. As discussed above in Note 7
to the Condensed Consolidated Financial Statements, in December 2000 we acquired
the outstanding shares of Scofima, an Italian company engaged in software
development. We employed an appraiser to value the assets of Scofima, and the
appraiser assigned a value of approximately $4.3 million to in-process research
and development relating to software being developed by Scofima which has not
yet reached technological feasibility, and for which no alternative future use
is available. We incurred this charge in the second quarter of fiscal 2001.
Interest Income (Expense). Interest income decreased 43.5% to $139,000
for the three months ended April 30, 2001, from $246,000 for the three months
ended April 30, 2000. We historically have invested the majority of our
available cash in investment-grade commercial paper with maturities of less than
90 days. As a result of a decrease in our investable cash position, interest
income decreased in fiscal 2001. During the first quarter of fiscal 2001, our
new corporate headquarters was placed into service, and we began to incur
interest expense on the amount we have financed for our building. Previously,
interest expense had been capitalized as part of the developmental cost of our
headquarters. In addition, on October 31, 2000, we issued a $15.0 million 6%
convertible debenture, and interest expense in future periods will include
interest charges on the amount outstanding under the debenture agreement.
Interest expense of $434,000 and $1,005,000 was incurred in the three and nine
months ended April 30, 2001, respectively, as we borrowed under the convertible
debenture, utilized our CIT term loan and expensed a pro-rata share of prepaid
loan costs.
Benefit for Income Taxes. Our effective tax provision rate for the three
months ended April 30, 2001 was (2.0%), compared to an effective tax benefit
rate of 26.7% for the same period in fiscal 2000. The fiscal 2001 provision is
necessary due to a provision for earnings of our Italian and Swiss subsidiaries,
while we have taken no current benefit for our U.S. and German losses. The
corresponding fiscal 2000 effective tax rate reflects the statutory rates and
unusable foreign losses, partially offset by research and development tax
credits. The net deferred tax asset recorded on the balance sheet as of April
30, 2001 is based on the expectation that we will more likely than not have
future taxable income against which we may apply certain tax attributes,
including our net operating loss deduction. We have considered other tax
planning strategies that if implemented would enable us to recover a portion of
the value of our deferred tax asset. We believe we can return to profitability,
and that it is more likely than not that future profitability will be sufficient
to recover the value of our net deferred tax asset at April 30, 2001.
LIQUIDITY AND CAPITAL RESOURCES
As of April 30, 2001, we had cash and short-term marketable securities
totaling $7.7 million.
Net cash used in operating activities was $14.7 million in the nine
months ended April 30, 2001 compared to $4.3 million in the nine months of
fiscal 2000. Net cash used in operating activities relates primarily to our net
loss, and increases in our accounts receivable as we granted extended terms to
our foreign customers. In addition, our inventories increased, including an
increase of approximately $0.8 million in evaluation inventory, and accounts
payable decreased, as we paid off nearly all of the costs of our corporate
headquarters, which was completed in September 2000, and we utilized our IBM
Credit flooring line, which requires payments at certain required dates. These
uses of cash were offset by a reduction of approximately $2.7 million in our
income tax refund receivable, which we received in the first nine months of
fiscal 2001.
Net cash used in investing activities was $2.1 million in the nine
months ended April 30, 2001, while net cash used in investing activities was
$3.6 million in the comparable period of fiscal 2000. Net cash
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used in investing activities in the first nine months of fiscal 2001 was the
result of purchases of $1.5 million to complete our corporate headquarters and
$0.4 million of other property and equipment. Net cash used in investing
activities in the first nine months of fiscal 2000 resulted from the purchase of
$3.6 million of property and equipment, primarily costs to complete our
corporate headquarters.
Net cash provided by financing activities was $9.0 million in the nine
months ended April 30, 2001, and $1.6 million in the comparable period of fiscal
2000. Net cash provided by financing activities in the first nine months of
fiscal 2001 resulted primarily from the issuance of a $15.0 million convertible
debenture, the closing and funding of a term loan/line of credit agreement with
CIT Business Credit (see below) and approximately $0.8 million in stock option
exercises and employee stock purchases, reduced by the repayment of
approximately $10.8 million in loans previously secured by the Company's
commercial paper portfolio.
On July 31, 2000, we had established a revolving line of credit with
Finova Capital Corporation. The line had been based on a percentage of our
eligible accounts receivable and inventory, up to a maximum of $10,000,000. We
paid off all amounts outstanding under the Finova flooring line in early October
2000.
On October 10, 2000, we entered into a term loan agreement and a
three-year working capital line of credit with CIT Business Credit. A term loan
of $4.0 million is due and payable upon our finalization of a long-term mortgage
of our corporate headquarters, or it will be repaid in 12 monthly installments
commencing April 1, 2001. An initial term loan of $1.0 million, which was due
and payable in 90 days, was repaid on November 1, 2000. The term loans bear
interest at the lender's prime rate (8.0% at April 30, 2001), plus .5%, with
increases if the loan is not reduced according to a fixed amortization. The
working capital line of credit allows for us to borrow, on a revolving basis,
for a period of three years, a specified percentage of its eligible accounts
receivable and inventories (approximately $2.8 million at April 30, 2001), up to
a limit of $5.0 million. Amounts outstanding under the working capital line bear
interest at the lender's prime rate plus .25%. At April 30, 2001, $4.3 million
was outstanding under the various credit arrangements. The lender charged
approximately $130,000 for the credit facilities, which is being amortized as
interest expense over the term of the loan. The lines accrue various monthly
maintenance, minimum usage and early termination fees. The lines require certain
financial and other covenants, including the maintenance of a minimum EBITDA
requirement for each fiscal quarter beginning in the quarter ending January 31,
2001. We were in compliance with all covenants of the lines at April 30, 2001.
The combined lines of credit are collateralized by all the assets of the
Company. In May 2001, the Company paid down the $4.3 million outstanding under
the various credit arrangements.
In addition to the two lines noted above, we replaced the Finova
flooring line of credit with a flooring line with IBM Credit who has committed
to make $2.5 million in flooring inventory commitments available to us. The
flooring line is collateralized by the specific inventory purchased pursuant to
the flooring commitments, and the two lenders have entered into an intercreditor
agreement which determines the level of priority of either lender's security
interest. The flooring line requires the maintenance of a minimum net worth of
$16.0 million. The Company was in compliance with the terms of the flooring line
at April 30, 2001.
On October 31, 2000, we issued a $15.0 million convertible unsecured
debenture to a private investor. The debenture bears interest at 6.0% per annum,
and is repayable in full on October 31, 2003, unless otherwise converted into
our common stock. The debenture is convertible into our common stock at the
investor's option at an initial conversion price of $22.79 per share, subject to
antidilution adjustments and at our option if our common stock trades at more
than 135% of the conversion price then in effect for at least 20 consecutive
trading days. The conversion price under the debenture automatically re-sets
periodically. During these re-set periods, the conversion price will, for five
consecutive trading days, adjust to 90% of the average closing price of our
stock during the 10 trading days preceding each re-set period if this amount is
less than the conversion price that would otherwise apply. The first re-set
period began on May 15,2001 and ended May 21, 2001. The next re-set period
begins on October 31, 2001 and additional re-set periods will occur every six
months thereafter. During the first re-set period the investor elected to
convert $5.0 million of the debenture at a re-set conversion price of
approximately $9.71 per share. We elected to pay the investor in cash the $5.0
million principal amount of the debenture that the investor elected to convert
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during the first re-set period. Up to an additional $5.0 million of the
debenture, plus any unpaid interest on that amount, may be converted at the
re-set conversion price beginning on October 31,2001, and any remaining portion
of the debenture, plus any unpaid interest, may be converted at the re-set
conversion price during any subsequent re-set period. We have the right to pay
the investor in cash the principal amount of any portion of the debenture the
investor elects to convert during a re-set period. If we were to issue shares at
90% of the trading price of our common stock upon conversion of the debenture
during a re-set conversion period, we would incur a charge to our income
statement, which could be significant, based on the difference between the
issuance price of our common stock and the value of the common stock at October
31, 2000. In connection with the issuance of the debenture, we issued to the
investor a 5-year warrant to purchase up to 32,916 shares of our common stock at
an initial exercise price of $32.55 per share, with the number of shares for
which the warrant is exercisable and the exercise price subject to antidilution
adjustments. We have has valued the warrant using a Black-Scholes model, with
the following assumptions: Expected life -- 5 years, Risk free interest rate --
6%, and Volatility, 1.20. These factors yield a value of $562,000, which will be
amortized over the life of the debt, or if conversion of the debenture occurs,
we will reclassify the remaining value to interest expense.
The principal amount of the debentures is classified as a current
liability, net of the remaining unamortized warrant value. At April 30, 2001,
the debenture amount repayable was $15,000,000 and the unamortized warrant value
was $467,000, for a net debenture value of $14,533,000 on the balance sheet. In
addition to the warrant cost, costs of approximately $700,000 were incurred in
the debt transactions noted above, and the amounts will be classified as prepaid
expenses, and amortized as interest expense over the life of the debt
instruments.
In addition to the lines of credit, our foreign subsidiaries in Germany,
Italy and Switzerland have lines of credit with banks in their respective
countries that are utilized primarily for overdraft and short-term cash needs.
At April 30, 2001, approximately $325,000 was outstanding under these lines.
In March 1999, we purchased an 8.3 acre parcel of land for $7.3 million
in Irvine, California, for development as our corporate headquarters facility.
Construction commenced in late 1999 and was completed in September 2000. The
cost of the land together with the cost of constructing the facility, including
capitalized interest and other carrying costs, is approximately $15.9 million,
including $0.7 million in capitalized interest costs. In addition, we may need
to spend approximately $0.8 million to build out the remaining portion of the
building if we sublease it. We have attempted to lease 47,000 square feet of the
building and we are currently considering a variety of other financing options.
On September 14, 1998, our board of directors approved an open market
stock repurchase program. We were authorized to effect repurchases of up to $2.0
million in shares of our common stock. We have repurchased a total of 77,845
shares at an average cost of $5.15 per share. No repurchases were made in the
nine months ended April 30, 2001, and we do not intend to make additional
repurchases. In September 2000, our Board terminated the repurchase program.
As is customary in the computer reseller industry, we are contingently
liable at April 30, 2001 under the terms of repurchase agreements with several
financial institutions providing inventory financing for dealers of our
appliances. Under these agreements, dealers purchase our appliances, and the
financial institutions agree to pay us for those purchases, less a pre-set
financing charge, within an agreed payment term. Two of these institutions,
Finova and IBM Credit Corporation, have also provided us with vendor inventory
financing. The contingent liability under these agreements approximates the
amount financed, reduced by the resale value of any appliances that may be
repurchased, and the risk of loss is spread over several dealers and financial
institutions. At July 31, 2000, and April 30, 2001, we were contingently liable
for purchases made under these agreements of approximately $560,000 and
$192,000, respectively. During the three years ended July 31, 2000, and through
the nine months ended April 30, 2001, we were not required to repurchase any
previously sold inventory pursuant to the flooring agreements.
At April 30, 2001, we had recorded a net deferred tax asset of
approximately $2.1 million, comprised of gross deferred tax assets of
approximately $4.8 million, less a valuation allowance of approximately $2.7
million. The realization of the benefit of the net deferred tax asset will be
dependent on
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our returning to profitability, thereby allowing us to utilize our net operating
loss carryforward and other tax attributes, such as the difference between the
book and tax basis of our reserves or depreciation against future taxable
income. We believe that our current losses are primarily the result of our
determination to transition from our CD-Tower and disk drive upgrade subsystems
product lines (driven in part by reducing demand for those products) to more
complex network attached storage products, which have required significant
research and development and a longer market acceptance period. We have
considered other tax planning strategies that, if implemented, would enable us
to recover the value of our deferred tax asset. We believe we can return to
profitability, and that it is more likely than not that future profitability
will be sufficient to recover the value of our net deferred tax asset at April
30, 2001.
On December 28, 2000, we acquired all of the issued and outstanding
capital stock of Scofima Software S.r.l., a company organized under the laws of
Italy ("Scofima"), in exchange for 480,000 shares of our common stock. Under our
agreement with the former shareholders of Scofima, we registered for resale by
those shareholders the shares issued to them in the acquisition. Scofima had an
option to acquire a software system designed as a caching and content
distribution solution. Immediately prior to our acquisition of Scofima, Scofima
exercised its option, and acquired the software system. The purpose of the
software is to provide functionalities that are necessary for the content
delivery market of the internet. The software had been in development for
approximately 2-3 years, involving 5 programmers and system developers. The
software was not complete at the date of acquisition, and has yet to be
determined to be technologically feasible. We are currently completing the
software, but final release is not expected for several months. We issued
480,000 shares valued at $12 per share and incurred approximately $250,000 in
acquisition costs in exchange for the outstanding shares of Scofima. Scofima had
net assets of approximately $500,000 at the date of acquisition. The transaction
was accounted for as a purchase of assets. We have employed an appraiser to
identify the values of the assets acquired, including, among other assets,
certain in process research and development costs. The amount of purchase price
allocated to in-process research and development was determined by estimating
the stage of development of the software, estimating future cash flows from
projected revenues, and discounting those cash flows to present value. The
discount rate applied was 25%. The incremental product sales resulting from the
products incorporating the software are estimated to be $44 million over the
initial four years of sales with sales growing from approximately $1.5 million
in the initial year to $13.4 million in the fourth year. The appraiser
concluded, and we have determined that approximately $4.3 million of the
purchase price was related to our research and development efforts that had not
attained technological feasibility and for which no future alternative use was
expected. We have expensed the value of the research and development as of the
date of the acquisition of Scofima and capitalized the fair value of the other
assets acquired as determined and allocated by the appraiser, including the
value of the assembled workforce of approximately $0.2 million and developer
relationships valued at $0.1 million which will be amortized over 4 years, with
the remainder of $1.4 million assigned to goodwill, which will amortized over 4
years.
We transact business in various foreign countries, but we only have
significant assets deployed outside the United States in Germany, Italy and
Switzerland. We have effected intercompany advances and sold goods to our German
subsidiary as well as our subsidiaries in Italy and Switzerland denominated in
U.S. dollars, and those amounts are subject to currency fluctuation, and require
constant revaluation on our financial statements. While a significant reduction
in valuation of various currencies such as the Euro (to which the value of the
German mark and the Italian lira are pegged) and the Swiss franc could lead to
lower sales as our products then become more expensive for foreign customers, we
do not believe that the currency fluctuations have had a material impact on our
liquidity. Our reported sales can be affected by changes in the currency rates
in effect in any particular period. For example, in the quarter ended October
31, 2000, the Euro, and two currencies whose values are pegged to the Euro,
declined in value significantly and was volatile throughout the nine months of
fiscal 2001. As a result, we incurred a foreign currency loss of $160,000 in the
quarter ended October 31, 2000, a foreign currency gain of $219,000 in the
quarter ended January 31, 2001 and a foreign currency loss of $97,000 in the
quarter ended April 30, 2001. Also, these foreign currency fluctuations can
cause us to report more or less in sales by virtue of the translation of the
subsidiary's sales into U.S. dollars at an average rate in effect throughout the
quarter. Also, we have funded operational losses of our subsidiaries of
approximately $2.1 million since we purchased them, and if our subsidiaries
continue to incur operational losses, our cash and liquidity would be negatively
impacted.
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Subsequent to April 30, 2001, we completed the sale of 3,800,000 shares
of our common stock raising gross proceeds of approximately $34.2 million. As a
result of this offering, the conversion price of our outstanding debenture was
adjusted pursuant to a weighted average adjustment under the terms of the
debenture. The adjusted conversion price is $19.57.
We expect to have sufficient cash generated from operations, from our
recently completed common stock offering, and through availability under lines
of credit to meet our anticipated cash requirements for the next twelve months.
RISK FACTORS
Before investing in our common stock, you should be aware that there are risks
inherent in our business, including those indicated below. Additional risks and
uncertainties not presently known to us or that we currently deem immaterial may
also impair our business operations. If any of the following risks actually
occurs, our business could be harmed. In that case, the trading price of our
common stock could decline, and you might lose part or all of your investment.
You should carefully consider the following risk factors as well as the other
information in this Report on Form 10-Q.
COMPETING DATA STORAGE TECHNOLOGIES MAY EMERGE AS A STANDARD FOR DATA STORAGE
SOLUTIONS, WHICH COULD CAUSE GROWTH IN THE NAS MARKET NOT TO MEET OUR
EXPECTATIONS AND DEPRESS OUR STOCK PRICE.
The market for data storage is rapidly evolving. There are other storage
technologies in use, including storage area network technology, which provide an
alternative to network attached storage. We are not able to predict how the data
storage market will evolve. For example, it is not clear whether usage of a
number of different solutions will grow and co-exist in the marketplace or
whether one or a small number of solutions will be dominant and displace the
others. It is also not clear whether network attached storage technology will
emerge as a dominant or even prevalent solution. Whether NAS becomes an accepted
standard will be due to factors outside our control. If a solution other than
network attached storage emerges as the standard in the data storage market,
growth in the network attached storage market may not meet our expectations. In
such event, our growth and the price of our stock would suffer.
IF GROWTH IN THE NAS MARKET DOES NOT MEET OUR EXPECTATIONS, OUR FUTURE FINANCIAL
PERFORMANCE COULD SUFFER.
We believe our future financial performance will depend in large part
upon the continued growth in the NAS market and on emerging standards in this
market. We intend for NAS products to be our primary business. The market for
NAS products, however, may not continue to grow. Long-term trends in storage
technology remain unclear and some analysts have questioned whether competing
technologies, such as storage area networks, may emerge as the preferred storage
solution. If the NAS market grows more slowly than anticipated, or if NAS
products based on emerging standards other than those adopted by us become
increasingly accepted by the market, our operating results could be harmed.
THE REVENUE AND PROFIT POTENTIAL OF NAS PRODUCTS IS UNPROVEN, AND WE MAY BE
UNABLE TO ATTAIN REVENUE GROWTH OR PROFITABILITY FOR OUR NAS PRODUCT LINES.
NAS technology is relatively recent, and our ability to be successful in
the NAS market may be negatively affected by not only a lack of growth of the
NAS market but also the lack of market acceptance of our NAS products.
Additionally, we may be unable to achieve profitability as we transition to a
greater emphasis on NAS products.
IF WE FAIL TO SUCCESSFULLY MANAGE OUR TRANSITION TO A FOCUS ON NAS PRODUCTS, OUR
BUSINESS AND PROSPECTS WOULD BE HARMED.
We began developing NAS products in 1997. Since then, we have focused
our efforts and resources on our NAS business, and we intend to continue to do
so. We expect to continue to wind down our non-NAS product development and
marketing efforts. In the interim, we expect to continue to rely in part upon
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sales of our non-NAS products to fund operating and development expenses. Net
sales of our non-NAS products have been declining in amount and as a percentage
of our overall net sales, and we expect these declines to continue. If the
decline in net sales of our non-NAS products varies significantly from our
expectations, or the decline in net sales of our non-NAS products is not
substantially offset by increases in sales of our NAS products, we may not be
able to generate sufficient cash flow to fund our operations or to develop our
NAS business.
We also expect our transition to a NAS-focused business to require us to
continue:
- engaging in significant marketing and sales efforts to achieve
market awareness as a NAS vendor;
- reallocating resources in product development and service and
support of our NAS appliances;
- modifying existing and entering into new channel partner
relationships to include sales of our NAS appliances; and
- expanding and reconfiguring manufacturing operations.
In addition, we may face unanticipated challenges in implementing our
transition to a NAS-focused company. We may not be successful in managing any
anticipated or unanticipated challenges associated with this transition.
Moreover, we expect to continue to incur costs in addressing these challenges,
and there is no assurance that we will be able to generate sufficient revenues
to cover these costs. If we fail to successfully implement our transition to a
NAS-focused company, our business and prospects would be harmed.
THE CALIFORNIA ENERGY CRISIS IS CAUSING US TO EXPERIENCE SIGNIFICANTLY HIGHER
ENERGY COSTS AND PERIODIC INTERRUPTIONS IN OUR SUPPLY OF ELECTRICAL POWER, WHICH
COULD DISRUPT OUR BUSINESS, HARM OUR OPERATING RESULTS AND DEPRESS THE PRICE OF
OUR COMMON STOCK.
California is currently experiencing a shortage of electrical power and
other energy sources. This shortage has resulted in significantly higher
electricity and other energy costs and has periodically resulted in rolling
brown-outs, or the temporary and generally unannounced loss of the primary
electrical power source. The computer and manufacturing equipment and other
systems in our headquarters in Irvine, California, are powered by electricity.
Currently, we do not have secondary electrical power sources to mitigate the
impacts of temporary or longer-term electrical outages. It is not anticipated
that the energy shortages will abate soon; therefore, we expect to continue to
experience higher costs for electricity and other energy sources, as well as
brown-outs and black-outs. We may also become subject to usage restrictions or
other energy consumption regulations that could adversely impact or disrupt our
manufacturing and other activities. Continued higher energy costs could
materially harm our profitability and depress the price of our common stock. In
addition, if we experience interruptions in our supply of electricity, our
manufacturing and other operations would be disrupted, which could materially
adversely affect our results of operations and depress the price of our common
stock.
IF U.S. OR WORLD ECONOMIC CONDITIONS WORSEN, INFORMATION TECHNOLOGY SPENDING ON
DATA STORAGE AND OTHER CAPITAL EQUIPMENT COULD DECLINE. IF TECHNOLOGY SPENDING
IS REDUCED, OUR SALES AND OPERATING RESULTS COULD BE HARMED.
Many of our customers are affected by economic conditions in the United
States and throughout the world. Many companies have recently announced that
they will reduce their spending on data storage and other capital equipment. If
spending on data storage technology products is reduced by customers and
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potential customers, our sales could be harmed, and we may experience greater
pressures on our gross margins. If economic conditions do not improve, or if our
customers reduce their overall information technology purchases, our sales,
gross profits and operating results may be reduced.
OUR AGREEMENT WITH HEWLETT-PACKARD COMPANY IS UNLIKELY TO GENERATE SIGNIFICANT
NET SALES.
We believe our relationship with Hewlett-Packard Company helped us
accomplish our strategy to increase penetration in the NAS market. There is no
minimum purchase commitment under our agreement with Hewlett-Packard. We do not
currently, and are unlikely ever to, generate significant net sales under this
agreement. The Hewlett-Packard agreement has a five-year term, and there is no
assurance that the agreement can or will be renewed. We commenced limited
shipments under the agreement in April 2000 and sales to Hewlett-Packard have
not been significant. In February 2001, Hewlett-Packard notified us that they
do not anticipate they will purchase additional NAS products from us in the
future. While neither they nor we have formally terminated the agreement, we do
not anticipate that future sales to Hewlett-Packard will be significant.
IF WE FAIL TO INCREASE THE NUMBER OF DIRECT AND INDIRECT SALES CHANNELS FOR OUR
NAS PRODUCTS, OUR ABILITY TO INCREASE NET SALES MAY BE LIMITED.
In order to grow our business, we will need to increase market awareness
and sales of our NAS appliances. To achieve these objectives, we believe it will
be necessary to increase the number of our direct and indirect sales channels.
We plan to significantly increase the number of our direct sales personnel.
However, there is intense competition for these professionals, and we may not be
able to attract and retain sufficient new sales personnel.
We also plan to expand revenues from our indirect sales channels,
including distributors, VARs, OEMs and systems integrators. To do this, we will
need to modify and expand our existing relationships with these indirect channel
partners, as well as enter into new indirect sales channel relationships. We may
not be successful in accomplishing these objectives. If we are unable to expand
our direct or indirect sales channels, our ability to increase revenues may be
limited.
BECAUSE WE DO NOT HAVE EXCLUSIVE RELATIONSHIPS WITH OUR DISTRIBUTORS OR
RESELLERS, SUCH AS INGRAM MICRO, TECH DATA, COMPUCOM AND CUSTOM EDGE, THESE
CUSTOMERS MAY GIVE HIGHER PRIORITY TO PRODUCTS OF COMPETITORS, WHICH COULD HARM
OUR OPERATING RESULTS.
Our distributors and resellers generally offer products of several
different companies, including products of our competitors. Accordingly, these
distributors and resellers, such as Ingram Micro, Tech Data and Compucom , may
give higher priority to products of our competitors, which could harm our
operating results. In addition, our distributors and resellers often demand
additional significant selling concessions and inventory rights, such as limited
return rights and price protection. We cannot assure you that sales to our
distributors or resellers will continue, or that these sales will be profitable.
BECAUSE WE HAVE ONLY APPROXIMATELY THREE YEARS OF OPERATING HISTORY IN THE NAS
MARKET, WHICH IS NEW AND RAPIDLY EVOLVING, OUR HISTORICAL FINANCIAL INFORMATION
IS OF LIMITED VALUE IN PROJECTING OUR FUTURE OPERATING RESULTS OR PROSPECTS.
We have been manufacturing and selling our NAS products for only
approximately three years. For the year ended July 31, 2000 and the first nine
months of the current fiscal year 2001, these products accounted for less than
41% and 73%, respectively, of our total net sales. We expect sales of our NAS
products to represent an increasing percentage of our net sales in the future.
Because our operating history in the NAS product market is only approximately
three years, as well as the rapidly evolving nature of the NAS market, it is
difficult to evaluate our business or our prospects. In particular, our
historical financial information is of limited value in projecting our future
operating results.
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MARKETS FOR BOTH OUR NAS APPLIANCES AND OUR NON-NAS PRODUCTS ARE INTENSELY
COMPETITIVE, AND IF WE ARE UNABLE TO COMPETE EFFECTIVELY, WE MAY LOSE MARKET
SHARE OR BE REQUIRED TO REDUCE PRICES.
The markets in which we operate are intensely competitive and
characterized by rapidly changing technology. Increased competition could result
in price reductions, reduced gross margins or loss of market share, any of which
could harm our operating results. We compete with other NAS companies,
direct-selling storage providers and smaller vendors that provide storage
solutions to end-users. In our non-NAS markets, we compete with computer
manufacturers that provide storage upgrades for their own products, as well as
with manufacturers of hard drives, CD servers and arrays and storage upgrade
products. Many of our current and potential competitors have longer operating
histories, greater name recognition, larger customer bases and greater
financial, technical, marketing and other resources than we do. As a result,
they may be able to respond more quickly to new or emerging technologies and
changes in customer requirements, devote greater resources to the development,
promotion, sale and support of their products, and reduce prices to increase
market share. In addition, current and potential competitors have established or
may establish cooperative relationships among themselves or with third parties.
Accordingly, it is possible that new competitors or alliances among competitors
may emerge and rapidly acquire significant market share. We may not be able to
compete successfully against current or future competitors. In addition, new
technologies may increase competitive pressures.
WE DEPEND ON A FEW CUSTOMERS, INCLUDING DISTRIBUTORS SUCH AS INGRAM MICRO AND
TECH DATA AND SPECIALIZED END-USERS, FOR A SUBSTANTIAL PORTION OF OUR NET SALES
AND ACCOUNTS RECEIVABLE, AND CHANGES IN THE TIMING AND SIZE OF THESE CUSTOMERS'
ORDERS MAY CAUSE OUR OPERATING RESULTS TO FLUCTUATE.
Three customers accounted for approximately 42% and 45% of our total
accounts receivable at July 31, 1999 and July 31, 2000, respectively, and one
individual customer accounted for approximately 9% and 7% of our net sales for
fiscal 1999 and 2000. One customer, Storway, a European storage service
provider, accounted for approximately 16% of our net sales for the first nine
months of the current fiscal year 2001, and three customers, Storway, Mount 10
and J-Dot Technology, accounted for approximately 54% of our total accounts
receivable at April 30, 2001. In fiscal 1999 and 2000, we sold our non-NAS
products principally to distributors and master resellers such as Ingram Micro,
Tech Data, Custom Edge (previously Inacom) and Compucom. Unless and until we
diversify and expand our customer base for NAS products, our future success will
depend to a large extent on the timing and size of future purchase orders, if
any, from these customers. In addition, we expect that single site purchasers of
large installations of our NAS products will purchase large volumes of our NAS
products over relatively short periods of time. This will cause both our sales
and our accounts receivable to be highly concentrated and significantly
dependent on one or only a few customers, as has occurred during the first nine
months of the current fiscal year 2001. If we lose a major customer, or if one
of our customers significantly reduces its purchasing volume or experiences
financial difficulties and is unable to or does not pay amounts owed to us, our
results of operations would be adversely affected. We cannot be certain that
customers that have accounted for significant revenues in past periods will
continue to purchase our products in future periods.
OUR GROSS MARGINS OF OUR VARIOUS PRODUCT LINES HAVE FLUCTUATED SIGNIFICANTLY IN
THE PAST AND MAY CONTINUE TO FLUCTUATE SIGNIFICANTLY. FOR EXAMPLE, WE MAY SEE
REDUCED SALES OF HIGHER-MARGIN CD SERVICES OR NOTEBOOK UPGRADE PRODUCTS AND WE
MAY NOT SEE INCREASED SALES OF OUR NAS APPLIANCES.
Historically, our gross margins have fluctuated significantly. Our gross
margins vary significantly by product line and distribution channel, and,
therefore, our overall gross margin varies with the mix of products we sell. Our
markets are characterized by intense competition and declining average unit
selling prices over the course of the relatively short life cycles of individual
products. For example, we derive a significant portion of our sales from disk
drives, CD servers and arrays, and storage upgrade products. The
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market for these products is highly competitive and subject to intense pricing
pressures. Some of these products, such as CD servers and arrays and some laptop
storage upgrade systems, have historically generated high gross margins,
although we have experienced significant declines in sales of these products.
Sales of disk drive upgrade systems generally generate lower gross margins than
those of our NAS products. If we fail to increase sales of our NAS appliances,
or if demand, sales or gross margins for CD servers and arrays and our laptop
storage upgrade systems decline rapidly, we believe our overall gross margins
will continue to decline.
Our gross margins have been and may continue to be affected by a variety
of other factors, including:
- new product introductions and enhancements;
- competition;
- changes in the distribution channels we use;
- the mix and average selling prices of products; and
- the cost and availability of components and manufacturing labor.
IF WE ARE UNABLE TO TIMELY INTRODUCE COST-EFFECTIVE HARDWARE OR SOFTWARE
SOLUTIONS FOR NAS ENVIRONMENTS, OR IF OUR PRODUCTS FAIL TO KEEP PACE WITH
TECHNOLOGICAL CHANGES IN THE MARKETS WE SERVE, OUR OPERATING RESULTS COULD BE
MATERIALLY ADVERSELY AFFECTED.
Our future growth will depend in large part upon our ability to
successfully develop and introduce new hardware and software for the NAS market.
Due to the complexity of products such as ours, and the difficulty in estimating
the engineering effort required to produce new products, we face significant
challenges in developing and introducing new products. We may be unable to
introduce new products on a timely basis or at all. If we are unable to
introduce new products in a timely manner, our operating results could be
harmed.
Even if we are successful in introducing new products, we may be unable
to keep pace with technological changes in our markets and our products may not
gain any meaningful market acceptance. The markets we serve are characterized by
rapid technological change, evolving industry standards, and frequent new
product introductions and enhancements that could render our products obsolete
and less competitive. As a result, our position in these markets could erode
rapidly due to changes in features and functions of competing products or price
reductions by our competitors. In order to avoid product obsolescence, we will
have to keep pace with rapid technological developments and emerging industry
standards. We may not be successful in doing so, and if we fail in this regard,
our operating results could be harmed.
WE RELY UPON A LIMITED NUMBER OF SUPPLIERS FOR SEVERAL KEY COMPONENTS USED IN
OUR PRODUCTS, INCLUDING DISK DRIVES, COMPUTER BOARDS, POWER SUPPLIES,
MICROPROCESSORS AND OTHER COMPONENTS, AND ANY DISRUPTION OR TERMINATION OF THESE
SUPPLY ARRANGEMENTS COULD DELAY SHIPMENT OF OUR PRODUCTS AND HARM OUR OPERATING
RESULTS.
We rely upon a limited number of suppliers of several key components
used in our products, including disk drives, computer boards, power supplies and
microprocessors. In the past, we have experienced periodic shortages, selective
supply allocations and increased prices for these and other components. We may
experience similar supply issues in the future. Even if we are able to obtain
component supplies, the quality of these components may not meet our
requirements. For example, in order to meet our product performance
requirements, we must obtain disk drives of extremely high quality and capacity.
Even a small deviation from our requirements could render any of the disk drives
we receive unusable by us. In the event of a reduction or interruption in the
supply or a degradation in quality of any of our components, we may
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not be able to complete the assembly of our products on a timely basis or at
all, which could force us to delay or reduce shipments of our products. If we
were forced to delay or reduce product shipments, our operating results could be
harmed. In addition, product shipment delays could adversely affect our
relationships with our channel partners and current or future end-users.
UNDETECTED DEFECTS OR ERRORS FOUND IN OUR PRODUCTS, OR THE FAILURE OF OUR
PRODUCTS TO PROPERLY INTERFACE WITH THE PRODUCTS OF OTHER VENDORS, MAY RESULT IN
DELAYS, INCREASED COSTS OR FAILURE TO ACHIEVE MARKET ACCEPTANCE, WHICH COULD
MATERIALLY ADVERSELY AFFECT OUR OPERATING RESULTS.
Complex products such as those we develop and offer may contain defects
or errors, or may fail to properly interface with the products of other vendors,
when first introduced or as new versions are released. Despite internal testing
and testing by our customers or potential customers, we do, from time to time,
and may in the future encounter these problems in our existing or future
products. Any of these problems may:
- cause delays in product introductions and shipments;
- result in increased costs and diversion of development resources;
- require design modifications; or
- decrease market acceptance or customer satisfaction with these
products, which could result in product returns.
In addition, we may not find errors or failures in our products until
after commencement of commercial shipments, resulting in loss of or delay in
market acceptance, which could significantly harm our operating results. Our
current or potential customers might seek or succeed in recovering from us any
losses resulting from errors or failures in our products.
IF WE ARE UNABLE TO MANAGE OUR INTERNATIONAL OPERATIONS EFFECTIVELY, OUR
OPERATING RESULTS COULD BE MATERIALLY ADVERSELY AFFECTED.
Net sales to our international customers, including export sales from
the United States, accounted for approximately 58% of our net sales for the
first nine months of current fiscal year 2001 as compared to 44% of our net
sales for the first nine months of fiscal year 2000, 41% of our net sales for
the year ended July 31, 2000 and approximately 33% of our net sales for the year
ended July 31, 1999. We believe that our growth and profitability will require
successful expansion of our international operations to which we have committed
significant resources. Our international operations will expose us to
operational challenges that we would not otherwise face if we conducted our
operations only in the United States. These include:
- currency exchange rate fluctuations, particularly when we sell our
products in denominations other than U.S. dollars;
- difficulties in collecting accounts receivable and longer accounts
receivable payment cycles;
- reduced protection for intellectual property rights in some
countries, particularly in Asia;
- legal uncertainties regarding tariffs, export controls and other
trade barriers;
- the burdens of complying with a wide variety of foreign laws and
regulations; and
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- seasonal fluctuations in purchasing patterns in other countries,
particularly in Europe.
Any of these factors could have an adverse impact on our existing
international operations and business or impair our ability to continue
expanding into international markets. For example, our reported sales can be
affected by changes in the currency rates in effect during any particular
period. The effects of currency fluctuations were evident in our results of
operations for the first nine months of the current fiscal year 2001. During
this period, the Euro and two currencies whose values are pegged to the Euro,
were significantly volatile, as they decreased, increased, and then decreased
again in value against the US dollar. As a result, in the quarter ended October
31, 2000, we incurred a foreign currency loss of approximately $160,000 while,
in the quarter ended January 31, 2001, we realized a foreign currency gain of
$219,000, and then in the quarter ended April 30, 2001, we realized a foreign
currency loss of $97,000. Also, these currency fluctuations can cause us to
report higher or lower sales by virtue of the translation of the subsidiary's
sales into U.S. dollars at an average rate in effect throughout the quarter. In
addition, we have funded operational losses of our subsidiaries of approximately
$2.1 million between the date of purchase and April 30, 2001, and if our
subsidiaries continue to incur operational losses, our cash and liquidity would
be negatively impacted.
In order to successfully expand our international sales, we must
strengthen foreign operations, hire additional personnel and recruit additional
international distributors and resellers. Expanding internationally and managing
the financial and business operations of our foreign subsidiaries will also
require significant management attention and financial resources. For example,
our foreign subsidiaries in Europe have incurred operational losses. To the
extent that we are unable to address these concerns in a timely manner, our
growth, if any, in international sales will be limited, and our operating
results could be materially adversely affected. In addition, we may not be able
to maintain or increase international market demand for our products.
OUR PROPRIETARY SOFTWARE RELIES ON OUR INTELLECTUAL PROPERTY, AND ANY FAILURE BY
US TO PROTECT OUR INTELLECTUAL PROPERTY COULD ENABLE OUR COMPETITORS TO MARKET
PRODUCTS WITH SIMILAR FEATURES THAT MAY REDUCE DEMAND FOR OUR PRODUCTS, WHICH
WOULD ADVERSELY AFFECT OUR NET SALES.
Despite our efforts to protect our proprietary rights, unauthorized
parties may attempt to copy or otherwise obtain and use our proprietary software
or technology. We believe the protection of our proprietary technology is
important to our business. If we are unable to protect our intellectual property
rights, our business could be materially adversely affected. We currently rely
on a combination of copyright and trademark laws and trade secrets to protect
our proprietary rights. In addition, we generally enter into confidentiality
agreements with our employees and license agreements with end-users and control
access to our source code and other intellectual property. We have applied for
the registration of some, but not all, of our trademarks. We have applied for
U.S. patents with respect to the design and operation of our NetFORCE product,
and we anticipate that we may apply for additional patents. It is possible that
no patents will issue from our currently pending applications. New patent
applications may not result in issued patents and may not provide us with any
competitive advantages over, or may be challenged by, third parties. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to
copy aspects of our products or to obtain and use information that we regard as
proprietary. In addition, the laws of some foreign countries, and the
enforcement of those laws, do not protect proprietary rights to as great an
extent as do the laws of the United States. We cannot assure you that our means
of protecting our proprietary rights will be adequate or that our competitors
will not independently develop similar technology, duplicate our products or
design around any patent issued to us or other intellectual property rights of
ours.
In addition, we may initiate claims or litigation against third parties
for infringement of our proprietary rights to establish the validity of our
proprietary rights. This litigation, whether or not it is resolved in our favor,
could result in significant expense to us and divert the efforts of our
technical and management personnel.
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WE MAY FROM TIME TO TIME BE SUBJECT TO CLAIMS OF INFRINGEMENT OF OTHER PARTIES'
PROPRIETARY RIGHTS OR CLAIMS THAT OUR OWN TRADEMARKS, PATENTS OR OTHER
INTELLECTUAL PROPERTY RIGHTS ARE INVALID, AND IF WE WERE TO SUBSEQUENTLY LOSE
OUR INTELLECTUAL PROPERTY RIGHTS, OUR BUSINESS WOULD BE MATERIALLY ADVERSELY
AFFECTED.
We may from time to time receive claims that we are infringing third
parties' intellectual property rights or claims that our own trademarks, patents
or other intellectual property rights are invalid. For example, we have been
recently notified by Intel Corporation that our products may infringe some of
the intellectual property rights of Intel. In its notification, Intel offered us
a non-exclusive license for patents in their portfolio. We are investigating
whether our products infringe the patents of Intel, and we have had discussions
with Intel regarding this matter. We do not believe that we infringe the patents
of Intel, but our discussions and our investigation are preliminary, and we
expect we will continue discussions with Intel. We cannot assure you that Intel
would not be successful in asserting a successful claim of infringement, or if
we were to seek a license from Intel regarding its patents, that Intel would
continue to offer us a non-exclusive license on any terms. We expect that
companies in our markets will increasingly be subject to infringement claims as
the number of products and competitors in our industry segment grows and the
functionality of products in different industry segments overlaps. The
resolution of any claims of this nature, with or without merit, could be
time-consuming, result in costly litigation, cause product shipment delays,
require us to redesign our products or require us to enter into royalty or
licensing agreements, any of which could harm our operating results. Royalty or
licensing agreements, if required, might not be available on terms acceptable to
us or at all. The loss of access to any key intellectual property right could
harm our business.
OUR NET SALES AND OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY, AND ANY
FLUCTUATIONS COULD CAUSE THE MARKET PRICE OF OUR COMMON STOCK TO DECLINE.
In recent periods, we have experienced significant declines in net sales
and gross profit and incurred operating losses, causing our quarterly operating
results to vary significantly. If we fail to meet the expectations of investors
or securities analysts, as well as our internal operating goals, as a result of
any future fluctuations in our quarterly operating results, the market price of
our common stock could decline significantly. Our net sales and quarterly
operating results are likely to fluctuate significantly in the future due to a
number of factors. These factors include:
- market acceptance of our new products and product enhancements or
those of our competitors;
- the level of competition in our target product markets;
- delays in our introduction of new products;
- changes in sales volumes through our distribution channels, which
have varying commission and sales discount structures;
- changing technological needs within our target product markets;
- the impact of price competition on the selling prices for our
non-NAS products, which continue to represent a majority of our net
sales;
- the availability and pricing of our product components;
- our expenditures on research and development and the cost to expand
our sales and marketing programs; and
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- the volume, mix and timing of orders received.
Due to these factors, we believe that period-to-period comparisons of
our results of operations are not necessarily meaningful and should not be
relied upon as indicators of future performance. In addition, it is difficult
for us to forecast accurately our future net sales. This difficulty results from
our limited operating history in the emerging NAS market, as well as the fact
that product sales in any quarter are generally booked and shipped in that
quarter. Because we incur expenses, many of which are fixed, based in part on
our expectations of future sales, our operating results may be
disproportionately affected if sales levels are below our expectations.
Our revenues in any quarter may also be affected by product returns and
any warranty obligations in that quarter. Many of our distribution and reseller
customers have limited return rights. In addition, we generally extend
warranties to our customers that correspond to the warranties provided by our
suppliers. If returns exceed applicable reserves or if a supplier were to fail
to meet its warranty obligations, we could incur significant losses. In fiscal
2000, we experienced a 14% product return rate. This rate may vary significantly
in the future, and we cannot assure you that our reserves for product returns
will be adequate in any future period.
IF WE ARE UNABLE TO ATTRACT QUALIFIED PERSONNEL OR RETAIN OUR EXECUTIVE OFFICERS
AND OTHER KEY PERSONNEL, WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY.
Our continued success depends, in part, on our ability to identify, attract,
motivate and retain qualified technical and sales personnel. Competition for
qualified engineers and sales personnel, particularly in Orange County,
California, is intense, and we may not be able to compete effectively to retain
and attract qualified, experienced employees. Should we lose the services of a
significant number of our engineers or sales people, we may not be able to
compete successfully in our targeted markets and our business would be harmed.
We believe that our success will depend on the continued services of our
executive officers and other key employees. In particular, we rely on the
services of our four founders, Messrs. Razmjoo, Alaghband, Aydin and
Shahrestany. We maintain employment agreements with each of our founders. We do
not maintain key-person life insurance policies on these individuals. The loss
of any of these executive officers or other key employees could harm our
business.
WE MAY NOT BE ABLE TO ACHIEVE OR SUSTAIN PROFITABILITY, AND OUR FAILURE TO DO SO
COULD REQUIRE US TO SEEK ADDITIONAL FINANCING, WHICH MAY NOT BE AVAILABLE TO US
ON FAVORABLE OR ANY TERMS.
In recent periods, we have experienced significant declines in net sales
and gross profit, and we have incurred operating losses. We incurred operating
losses of $5.2 million for fiscal 1999, $12.1 million for fiscal 2000 and $10.0
million (including a charge for in-process research and development) for the
first nine months of the current fiscal year 2001. We expect to continue to
incur operating losses through at least the fourth quarter of fiscal 2001. As
part of our strategy to focus on the NAS market, we plan to significantly
increase our direct sales force and to increase our investment in research and
development and marketing efforts. We will need to significantly increase our
revenues from our NAS products to achieve and maintain profitability. The
revenue and profit potential of these products is unproven. We may not be able
to generate significant or any revenues from our NAS products or achieve or
sustain profitability in the future. In addition, we have invested substantial
cash in our new corporate headquarters. If we are unable to achieve or sustain
profitability in the future, we will have to seek additional financing in the
future, which may not be available to us on favorable or any terms.
CONTROL BY OUR EXISTING SHAREHOLDERS COULD DISCOURAGE POTENTIAL ACQUISITIONS OF
OUR BUSINESS THAT OTHER SHAREHOLDERS MAY CONSIDER FAVORABLE.
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As of May 15, 2001, our executive officers and directors beneficially
owned approximately 5,900,000 shares, or approximately 37% of the outstanding
shares of common stock. Acting together, these shareholders would be able to
exert substantial influence on matters requiring approval by shareholders,
including the election of directors. This concentration of ownership could have
the effect of delaying or preventing a change in our control or otherwise
discouraging a potential acquirer from attempting to obtain control of us, which
could in turn have an adverse effect on the market price of our common stock or
prevent our shareholders from realizing a premium over the market price for
their shares of common stock.
THE MARKET PRICE FOR OUR COMMON STOCK HAS FLUCTUATED SIGNIFICANTLY IN THE PAST
AND WILL LIKELY CONTINUE TO DO SO IN THE FUTURE, WHICH COULD RESULT IN A DECLINE
IN YOUR INVESTMENT'S VALUE.
The market price for our common stock has been volatile in the past, and
particularly volatile in the last twelve months, and may continue to fluctuate
substantially in the future. The value of your investment in our common stock
could decline due to the impact of any of the above or of the following factors
upon the market price of our common stock:
- fluctuations in our operating results;
- fluctuations in the valuation of companies perceived by investors to
be comparable to us;
- a shortfall in net sales or operating results compared to securities
analysts' expectations;
- changes in analysts' recommendations or projections;
- announcements of new products, applications or product enhancements
by us or our competitors; and
- changes in our relationships with our suppliers or customers,
including failures by customers to pay amounts owed to us.
WE HAVE ISSUED CONVERTIBLE DEBENTURES, AND THE OBLIGATIONS OF THE DEBENTURES
POSE RISKS TO THE PRICE OF OUR COMMON STOCK AND OUR OPERATIONS.
On October 31, 2000, we issued 3-year $15 million convertible debentures
to a private investor. The debentures provide that, in certain circumstances,
the holder of the debentures may convert its position into our stock, or demand
that we repay outstanding amounts with cash. The terms and conditions of the
debentures pose unique and special risks to our operations and the price of our
common stock. Some of those risks are discussed in more detail below.
OUR ISSUANCE OF STOCK UPON THE CONVERSION OF THE DEBENTURES AND THE EXERCISE OF
THE WARRANTS, AS WELL AS ADDITIONAL SALES OF OUR COMMON STOCK BY THE INVESTOR,
MAY DEPRESS THE PRICE OF OUR COMMON STOCK AND SUBSTANTIALLY DILUTE YOUR SHARES.
We have registered for resale by the investor in our debentures a total
of 2,322,149 shares of our common stock. This number represents approximately
235% of the number of shares of our common stock issuable if our debentures were
to remain outstanding until their stated maturity on October 31, 2003 and all
interest on the debentures were to be paid in shares of our stock valued at
$8.55 per share, the closing
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price of our stock on April 18, 2001, plus the number of shares of our common
stock issuable if the investor's warrant were to be exercised in full. As is
noted in the risk factor immediately below, if the investor were to convert the
debentures during a period when the re-set conversion price is in effect, we
could be required to issue a substantially greater number of our shares to the
investor. The issuance of all or any significant portion of the shares of our
common stock that we have registered for resale, together with any additional
shares that we may be required to register for resale if the debentures are
converted during a period when the re-set conversion price is in effect, could
result in substantial dilution to the interests of our other shareholders and a
decrease in the price of our stock. A decline in the price of our common stock
could encourage short sales of our stock, which could place further downward
pressure on the price of our stock.
THE CONVERSION PRICE UNDER THE DEBENTURES WILL AUTOMATICALLY RE-SET
PERIODICALLY. IF THE INVESTOR CONVERTS SOME OR ALL OF THE DEBENTURES DURING THE
RESET PERIODS AND WE DO NOT REPAY IN CASH THE DEBENTURES THAT THE INVESTOR THEN
DESIRES TO CONVERT, WE WILL HAVE TO ISSUE SHARES SUBSTANTIALLY IN EXCESS OF
THOSE ORIGINALLY CONTEMPLATED, AND THOSE ADDITIONAL SHARES WILL DILUTE YOUR
SHARES.
The conversion price under the debentures will automatically re-set
periodically. During these re-set periods, the conversion price will, for five
consecutive trading days, adjust to 90% of the average closing price of our
stock during the 10 trading days preceding each re-set period if this amount is
less than the conversion price that would otherwise apply. The first re-set
period began on May 15, 2001 and ended on May 21, 2001. The next re-set period
begins on October 31, 2001 and additional re-set periods will occur every six
months thereafter. During the first re-set period, the investor elected to
convert $5.0 million of the debentures at a re-set conversion price of
approximately $9.71 per share. We have paid the investor in cash the $5.0
million principal amount of the debentures that the investor elected to convert
during the first re-set period. Up to an additional $5.0 million of the
debentures, plus any unpaid interest on that amount, may be converted at the
re-set conversion price beginning on October 31, 2001, and any remaining
debentures, plus any unpaid interest, may be converted at the re-set conversion
price during any subsequent re-set period.
We have the right to pay the investor in cash the principal amount of
any portion of the debentures the investor elects to convert during a re-set
period. If we do not elect to pay cash to satisfy any future conversions of the
remaining portion of the debentures during subsequent re-set periods, the number
of shares of our common stock that we would be required to issue upon conversion
of the remaining portion of the debentures at the re-set conversion price could
be substantial. For example, if the 10-trading day average of our shares
preceding a re-set period were to be $1.30 per share, which is 75% lower than
the lowest closing price reached by our shares since the date the debentures
were issued, the re-set conversion price would be approximately $1.17 per share.
If the remaining $10.0 million principal amount of the debentures were to be
converted at this price, we would be required to issue the investor
approximately 8,547,008 shares, which would result in the investor owning 34.9%
of our outstanding stock after giving effect to such issuance to the investor.
WE WILL RECORD A CHARGE IF THE DEBENTURES ARE CONVERTED AT A CONVERSION PRICE
THAT IS LESS THAN $22.79.
If we issue shares of our common stock at a conversion price that is
less than $22.79 per share, we will record a charge to our statement of
operations in an amount equal to the intrinsic value of the beneficial
conversion feature. This value would be determined by subtracting the number of
shares of our common stock issuable upon conversion of the applicable portion of
the debentures at a conversion price of $22.79 from the number of shares
issuable upon conversion of that portion of the debentures at the lower
conversion price, and multiplying the difference by $22.79, the closing price of
our common stock on the date we issued the debentures. Any such charge, if
recorded, would be a non-cash charge and would not affect our net shareholders'
equity.
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IF OUR SHARES ARE ISSUED TO THE INVESTOR, THOSE SHARES MAY BE SOLD INTO THE
MARKET, WHICH COULD DEPRESS THE PRICE OF OUR STOCK AND ENCOURAGE SHORT SALES OF
OUR STOCK.
To the extent the debentures are converted or interest on the debentures
is paid in shares of our common stock rather than cash, a significant number of
these shares of our common stock may be sold into the market, which could
decrease the price of our common stock and encourage short sales. Short sales
could place further downward pressure on the price of our common stock. In that
case, we could be required to issue an increasingly greater number of shares of
our common stock upon future conversions of the debentures as a result of the
adjustments described above, sales of which could further depress the price of
our common stock.
THE DEBENTURES PROVIDE FOR VARIOUS EVENTS OF DEFAULT THAT WOULD ENTITLE THE
INVESTOR TO REQUIRE THE COMPANY TO REPAY THE ENTIRE AMOUNT OWED IN CASH WITHIN
THREE DAYS. IF AN EVENT OF DEFAULT OCCURS, WE MAY BE UNABLE TO IMMEDIATELY REPAY
THE AMOUNT OWED, AND ANY REPAYMENT MAY LEAVE US WITH LITTLE OR NO WORKING
CAPITAL IN OUR BUSINESS.
The debentures provide for various events of default, including the
following:
- the occurrence of an event of default under our loan agreements with
The CIT Group;
- our failure to pay the principal, interest or any liquidated damages
due under the debentures;
- our failure to make any payment on any indebtedness of $1 million or
more to any third party if that failure results in the acceleration
of the maturity of that indebtedness;
- an acquisition after October 31, 2000 by any individual or entity,
other than the investor and its affiliates, of more than 40% of our
voting or equity securities;
- the replacement of more than 50% of the persons serving as our
directors as of October 31, 2000, unless the replacement director or
directors are approved by our directors as of October 31, 2000 or by
successors whose nominations they have approved;
- a merger or consolidation of our company or a sale of more than 50%
of its assets unless the holders of our securities immediately prior
to such transaction continue to hold at least a majority of the
voting rights and equity interests of the surviving entity or the
acquirer of our assets;
- our entry into bankruptcy;
- our common stock fails to be listed or quoted for trading on the New
York Stock Exchange, the American Stock Exchange, the Nasdaq
National Market or the Nasdaq SmallCap Market;
- our completion of a "going private" transaction under SEC Rule
13e-3;
- a holder of shares issuable under the debentures or the warrant is
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not permitted to sell those securities under our registration
statement covering those shares for a period of five or more trading
days;
- after the effective date of the registration statement covering the
resale of the shares issuable pursuant to the debentures and the
investor's warrant, the investor is not permitted, for five or more
trading days, to sell our shares under that registration statement
or any replacement registration statement we may file;
- our failure to deliver certificates evidencing shares of our common
stock underlying the debentures or the warrant within five days
after the deadline specified in our transaction documents with the
investor;
- our failure to have a sufficient number of authorized but unissued
and otherwise unreserved shares of our common stock available to
issue such stock upon any exercise or conversion of the warrant and
the debentures;
- the exercise or conversion rights of the investor under the warrant
or the debentures are suspended for any reason, except as provided
in the applicable transaction documents;
- our default on specified obligations under our registration rights
agreement with the investor and failure to cure that default within
60 days; and
- other than the specified defaults under the registration rights
agreement referred to above, our default in the timely performance
of any obligation under the transaction documents with the investor
and failure to cure that default for 20 days after we are notified
of the default.
If an event of default occurs, the investor can require us to repurchase
all or any portion of the principal amount of any outstanding debentures at a
repurchase price equal to the greater of 110% of such outstanding principal
amount, plus all accrued but unpaid interest on such outstanding debentures
through the date of payment, or the total value of all of our shares issuable
upon conversion of such outstanding debentures, valued based on the average
closing price of our common stock for the preceding five trading days, plus any
accrued but unpaid interest on such outstanding debentures. In addition, upon an
event of default under the debentures, the investor could also require us to
repurchase from the investor any of our shares of common stock issued to the
investor upon conversion of the debentures within the preceding 30 days, which
would be valued at the average closing price of our common stock over the
preceding five trading days. We would be required to complete these repurchases
no later than the third trading day following the date an event of default
notice is delivered to us.
If we were required to make a default payment at a time when all of the
remaining $10.0 million principal amount of the debentures were outstanding, the
payment required would be a minimum of $11.0 million and could be substantially
greater depending upon the market price of our common stock at the time. In
addition, if we default in the timely performance of specified obligations under
our registration rights agreement with the investor, we would also be obligated
to pay as liquidated damages to the investor an amount equal to $300,000 each
month until any such default is cured.
Some of the events of default include matters over which we may have
some, little or no control, such as various corporate transactions in which the
control of our company changes, or if our common stock ceases to be listed on a
trading market. If an event of default occurs, we may be unable to repay any
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part or all of the entire amount in cash. Any such repayment could leave us with
little or no working capital for our business.
THE PAYMENT TO BRIGHTON CAPITAL, LTD. IN CONNECTION WITH OUR SALE OF OUR
CONVERTIBLE DEBENTURES MAY BE INCONSISTENT WITH THE PROVISIONS OF SECTION 15 OF
THE SECURITIES EXCHANGE ACT AND MAY ENABLE THE INVESTOR TO RESCIND ITS
INVESTMENT.
We paid Brighton Capital, Ltd. $375,000 for its introduction to us of
the purchaser of our 6% convertible debentures. The Staff of the Securities and
Exchange Commission has informed us that the receipt by Brighton Capital of this
payment may be inconsistent with the registration provisions of Section 15 of
the Securities Exchange Act of 1934, as amended. If this payment were determined
to be inconsistent with Section 15, then, under Section 29 of the Securities
Exchange Act:
- Montrose Investments L.P., the purchaser of our debentures, might
have the right to rescind its purchase of these securities, which
would require us to repay to Montrose Investments L.P. the $15.0
million that it invested in us;
- We might be subject to regulatory action; and
- We might be able to recover the $375,000 fee that we paid to
Brighton Capital in connection with the transaction.
THE DEBENTURES RESTRICT OUR ABILITY TO RAISE ADDITIONAL EQUITY WITHOUT THE
CONSENT OF THE INVESTOR, WHICH COULD HINDER OUR EFFORTS TO OBTAIN ADDITIONAL
NECESSARY FINANCING TO OPERATE OUR BUSINESS OR TO REPAY THE DEBENTURE HOLDERS.
The agreements we executed when we issued these debentures prohibit us
from obtaining additional equity or equity equivalent financing for a period of
90 trading days after the effective date (May 11, 2001) of the registration
statement covering the resale of the shares issuable upon conversion of the
debentures. We also agreed that for a period of 180 trading days after the
effective date of the registration statement covering the resale of the shares
issuable upon conversion of the debentures, we would not, without the investor's
consent, obtain additional equity or equity equivalent financing unless we first
offer the investor the opportunity to provide such financing upon the terms and
conditions proposed. These restrictions have several exceptions, such as
issuances of options to employees and directors, strategic transactions and
acquisitions and bona fide public offerings with gross proceeds exceeding $20
million. The restrictions described in this paragraph may make it extremely
difficult to raise additional equity capital during the 90-day and 180-day
periods. We may need to raise such additional capital, and if we are unable to
do so, we may have little or no working capital for our business, and the market
price of our stock may decline.
WE MAY BE REQUIRED TO PAY LIQUIDATED DAMAGES IF WE DO NOT OBTAIN SHAREHOLDER
APPROVAL FOR ISSUANCE OF OUR COMMON STOCK, OR IF WE ARE UNABLE TO TIMELY
REGISTER THESE SHARES.
We are subject to National Association of Securities Dealers Rule 4350,
which generally requires shareholder approval of any transaction that would
result in the issuance of securities representing 20% or more of an issuer's
outstanding listed securities. Upon conversion or the payment of interest on
debentures we are not able to issue more than 2,322,150 shares, or 19.99% of our
outstanding common stock on October 30, 2000, the day prior to the date of
issuance of the debentures. The terms of the convertible debentures purchase
agreement also provide that the shareholder desiring to convert has the option
of requiring us either to seek shareholder approval within 75 days of the
request or to pay the converting holder the monetary value of the debentures
that cannot be converted, at a premium to the converting
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holder. If the shareholder requires that we convert the debentures into shares
and we have not obtained the requisite shareholder approval within 75 days, we
would be obligated to pay the monetary value to the purchaser as liquidated
damages. Also, under the terms of the Registration Rights Agreement, we will
incur liquidated damages of approximately $300,000 per month if the investor is
not permitted, for five or more trading days, to sell our shares under our
registration statement covering the resale of those shares or under any
replacement registration statement that we may file.
EVEN IF WE NEVER ISSUE OUR STOCK UPON THE CONVERSION OF THE DEBENTURES OR UPON
EXERCISE OF THE INVESTOR'S WARRANTS, WE MAY ISSUE ADDITIONAL SHARES, WHICH WOULD
REDUCE YOUR OWNERSHIP PERCENTAGE AND DILUTE THE VALUE OF YOUR SHARES.
Other events over which you have no control could result in the issuance
of additional shares of our common stock, which would dilute your ownership
percentage in Procom. Our issuance of 480,000 shares in connection with the
acquisition of Scofima Software S.r.l. is an example of an issuance of
additional shares to finance an acquisition that may dilute your ownership.
Also, subsequent to April 30, 2001,, we sold 3.8 million shares of our common
stock in an offering. In the future, we may issue additional shares of common
stock or preferred stock: to raise additional capital or finance acquisitions,
upon the exercise or conversion of outstanding options, warrants and shares of
convertible preferred stock, or in lieu of cash payment of dividends. Our
issuance of additional shares would dilute your shares.
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS.
This Report on Form 10-Q contains "forward-looking" statements,
including, without limitation, the statements under the captions "Risk Factors,"
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations," You can identify these statements by the use of words like "may,"
"will," "could," "should," "project," "believe," "anticipate," "expect," "plan,"
"estimate," "forecast," "potential," "intend," "continue," and variations of
these words or comparable words. In addition, all of the non-historical
information in this Report on Form 10-Q is forward-looking. Forward-looking
statements do not guarantee future performance and involve risks and
uncertainties. Actual results may and probably will differ substantially from
the results that the forward-looking statements suggest for various reasons,
including those discussed under "Risk Factors". These forward-looking statements
are made only as of the date of this Report on Form 10-Q. We do not undertake to
update or revise the forward-looking statements, whether as a result of new
information, future events or otherwise.
NEW ACCOUNTING STANDARDS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended, which defines derivatives,
requires that all derivatives be carried at fair value, and provides for hedge
accounting when certain conditions are met. This statement is effective for the
first fiscal quarter of fiscal years beginning after June 15, 2000. Adoption of
this statement did not have a material impact on our consolidated financial
position, results of operations or cash flows.
In December 1999, the United States Securities and Exchange Commission
issued Staff Accounting Bulleting (SAB) No. 101, "Revenue Recognition in
Financial Statements," as amended, which for the Company is effective no later
than the fourth quarter of fiscal 2001. SAB No. 101 summarizes certain of the
SEC staff's views regarding the appropriate recognition of revenue in financial
statements. Adoption of SAB No. 101 is not expected to have a material impact on
the Company's consolidated financial position or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
INTEREST RATE RISK
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Our exposure to market risk for changes in interest rates relates
primarily to the increase or decrease in the amount of interest income we can
earn on our investment portfolio as well as the fluctuation in interest rates on
our various borrowing arrangements. We do not use derivative financial
instruments in our investment portfolio. We invest in high-credit quality
issuers and, by policy, we limit the amount of credit exposure to any one
issuer. As stated in our policy, we ensure the safety and preservation of our
invested principal funds by limiting default risk, market risk and reinvestment
risk. We mitigate default risk by investing in safe and high-credit quality
securities and by constantly positioning our portfolio to respond appropriately
to a significant reduction in a credit rating of any investment issuer,
guarantor or depository. The portfolio includes only marketable securities with
active secondary or resale markets to help ensure reasonable portfolio
liquidity.
As discussed elsewhere in this Report on Form 10-Q, we have developed
our headquarters in Irvine, California and we have spent approximately $15.9
million and we expect to spend a total of $16.7 million to complete the
facility. We may be seeking long-term mortgage financing for all or some of the
facility cost during the next fiscal year. We have not "locked" in a commitment,
and may therefore find such financing to be much more expensive as a result.
Since July 31, 2000, we have entered into a line of credit and term loan
agreements pursuant to which amounts outstanding bear interest at the lender's
prime rate plus .50%. Accordingly, since we anticipate that we will be borrowing
funds under such agreements, we expect that we will experience interest rate
risk on our debt.
FOREIGN CURRENCY EXCHANGE RISK
We transact business in various foreign countries, but we only have
significant assets deployed outside the United States in Germany. We have
effected intercompany advances and sold goods to our German subsidiary, as well
as our subsidiaries in Italy and Switzerland, denominated in U.S. dollars, and
those amounts are subject to currency fluctuation and require constant
revaluation on our financial statements. During the nine months ended April 30,
2001 and 2000, we incurred approximately $37,000 and $202,000, respectively, in
foreign currency losses which are included in our selling, general and
administrative costs. We do not operate a hedging program to mitigate the effect
of a significant rapid change in the value of the Euro, the German mark, or the
Italian lira compared to the U.S. dollar. If such a change did occur, we would
have to take into account a currency exchange gain or loss in the amount of the
change in the U.S. dollar denominated balance of the amounts outstanding at the
time of such change. For example, after being weak for some months, the Euro
strengthened, and we recorded a currency gain of $219,000 in the quarter ended
January 31, 2001 after recording a foreign currency loss of $160,000 in the
quarter ending October 31, 2000. In the third quarter ended April 30, 2001, we
recorded a currency loss of $97,000. Our net sales can also be effected by a
change in the exchange rate because we translate sales of our subsidiaries at
the average rate in effect during a financial reporting period. At April 30,
2001, approximately $8.6 million in current intercompany advances and accounts
receivable from our foreign subsidiaries were outstanding. We can not assure you
that we will not sustain a significant loss if a rapid or unpredicted change in
value of the Euro or related European currencies should occur. We can not assure
you that such a loss would not have an adverse material effect on our results of
operations or financial condition.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is from time to time involved in litigation related to its
ordinary operations, such as collection actions and vendor disputes. The Company
does not believe that the resolution of any existing claim or lawsuit will have
a material adverse effect on the Company's business, results of operations or
financial condition.
Item 2. Changes in Securities and Use of Proceeds.
Not applicable.
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Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 5. Other Information.
Not applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) See Exhibit Index. No Statement re Computation of Per Share Earnings
is included, because the computation can be clearly determined from
material contained in this Report. See the Consolidated Statements
of Operations, and the Notes thereto.
(b) Reports on Form 8-K. On March 28, 2001, we filed an amendment to a
Report on Form 8-K that we originally filed on January 12, 2001
reporting an acquisition under Item 2. On May 17, 2001, we filed a
Report on Form 8-K under Item 5.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized, in the City of Irvine, County of
Orange, State of California, on the 14th of June, 2001.
PROCOM TECHNOLOGY, INC.
By: /s/ Alex Razmjoo
-------------------------------
Alex Razmjoo
Chairman, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Report on Form 10-Q has been signed below by the following persons
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Alex Razmjoo Chairman of the Board, President June 14, 2001
- -------------------------- and Chief Executive Officer
Alex Razmjoo (Principal Executive Officer)
/s/ Alex Aydin Executive Vice President, Finance June 14, 2001
- -------------------------- and Administration (Principal
Alex Aydin Financial and Accounting Officer)
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INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
3.1 Amended and Restated Articles of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 in the Form S-1A filed
November 14, 1996)
3.2 Amended and Restated Bylaws of the Company (incorporated by
reference to Exhibit 3.2 in the Form S-1A filed November 14, 1996)
4.1 Form of Convertible Debenture dated October 31, 2000 (incorporated
by reference to Exhibit 4.1 in the Registration Statement on Form
S-3 of Procom filed on November 22, 2000)
4.1.1 Amendment to Convertible Debenture (incorporated by reference to
Exhibit 4.1.1 in the Form S-3 filed on April 25, 2001)
4.2 Form of Common Stock Purchase Warrant dated October 31, 2000
(incorporated by reference to Exhibit 4.2 in the Report on Form 8-K
filed on November 3, 2000)
4.3 Securities Purchase Agreement dated October 31, 2000 (incorporated
by reference to Exhibit 4.3 in the Report on Form 8-K filed on
November 3, 2000)
4.4 Registration Rights Agreement dated October 31, 2000 by and between
the Registrant and Montrose Investments, Ltd. (incorporated by
reference to Exhibit 4.4 in the Report on Form 8-K filed on November
3, 2000)
4.5 Subordination Agreement dated October 31, 2000 by and between the
Registrant, Montrose Investments, Ltd. and CIT Group/Business
Credit, Inc. (incorporated by reference to Exhibit 4.5 in the Report
on Form 8-K filed on November 3, 2000)
10.1 Form of Indemnity Agreement between the Company and each of its
executive officers and directors (incorporated by reference to
Exhibit 3.2 in the Form S-1A filed November 14, 1996)
10.2 Form of Amended and Restated Procom Technology, Inc. 1995 Stock
Option Plan (incorporated by reference to Exhibit 10.2 in the Form
S-1A filed November 14, 1996)
10.2.1 Form of Procom Technology, Inc. 1999 Employee Stock Purchase Plan
(incorporated by reference to Exhibit 4 in the Form S-8 filed on
July 2, 1999)
10.3 Amended and Restated Executive Employment Agreement, dated as of
October 28, 1996, between the Company and Alex Razmjoo (incorporated
by reference to Exhibit 10.3 in the Form S-1 filed October 30, 1996)
10.4 Amended and Restated Executive Employment Agreement, dated as of
October 28, 1996, between the Company and Frank Alaghband
(incorporated by reference to Exhibit 10.4 in the Form S-1 filed
October 30, 1996)
10.5 Amended and Restated Executive Employment Agreement, dated as of
October 28, 1996, between the Company and Alex Aydin (incorporated
by reference to Exhibit 10.5 in the Form S-1 filed October 30, 1996)
10.6 Amended and Restated Executive Employment Agreement, dated as of
October 28, 1996, between the Company and Nick Shahrestany
(incorporated by reference to Exhibit 10.6 in the Form S-1 filed
October 30, 1996)
10.7 Form of Registration Rights Agreement (incorporated by reference to
Exhibit 10.7 in the Form S-1 filed October 30, 1996)
10.8 Asset Purchase Agreement, dated June 24, 1998, among Invincible
Technologies Acquisition Corporation, Invincible Technologies
Corporation, and certain stockholders of Invincible Technologies
Corporation named therein (incorporated by reference to Exhibit
10.10 in the Report on Form 8-K filed October 29, 1998)
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10.9 Agreement for Wholesale Financing (Security Agreement) between
Procom Technology, Inc. and IBM Credit Corporation (incorporated by
reference to Exhibit 10.1 to the Form S-3/A filed on January 16,
2001)