SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
----------------
FORM 10-K/A
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED JULY 31, 2001
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)
HTTP://WWW.PROCOM.COM
(Registrant's Web Site)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None.
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of October 10, 2001 the aggregate market value of the voting stock of the
Registrant held by non-affiliates of the Registrant was approximately $20.2
million.
The number of shares of Common Stock, $.01 par value, outstanding on October
10, 2001, was 15,998,064.
DOCUMENTS INCORPORATED BY REFERENCE
Information required by Part III is incorporated by reference to portions of
the Registrant's Proxy Statement for the 2002 Annual Meeting of Shareholders,
which will be filed with the Securities and Exchange Commission within 120 days
after the close of the 2001 fiscal year.
PROCOM TECHNOLOGY, INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED JULY 31, 2001
PART I
Item 1. Business ............................................................................ 3
Item 2. Facilities .......................................................................... 11
Item 3. Legal Proceedings ................................................................... 12
Item 4. Submission of Matters to a Vote of Security Holders ................................. 12
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters ................ 12
Item 6. Selected Financial Data ............................................................. 13
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk .......................... 34
Item 8. Financial Statements and Supplementary Data ......................................... 35
Item 9. Changes and Disagreements with Accountants on Accounting and Financial Disclosures .. 53
PART III
Item 10. Directors and Executive Officers of the Registrant .................................. 54
Item 11. Executive Compensation .............................................................. 55
Item 12. Security Ownership of Certain Beneficial Owners and Management ...................... 55
Item 13. Certain Relationships and Related Transactions ...................................... 55
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K ..................... 55
THE INFORMATION CONTAINED IN THIS REPORT ON FORM 10-K INCLUDES FORWARD-LOOKING
STATEMENTS. WHEN USED IN THIS REPORT, THE WORDS "ANTICIPATES," "BELIEVES,"
"EXPECTS," "INTENDS," "FORECASTS," "PLANS," "FUTURE," "STRATEGY" OR WORDS OF
SIMILAR IMPORT ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. OTHER
STATEMENTS OF THE COMPANY'S PLANS AND OBJECTIVES MAY ALSO BE CONSIDERED TO BE
FORWARD LOOKING STATEMENTS. SUCH STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND
UNCERTAINTIES, WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
EXPRESSED IN THE FORWARD-LOOKING STATEMENTS. READERS ARE CAUTIONED NOT TO PLACE
UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE
DATE HEREOF. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLISH REVISED
FORWARD-LOOKING STATEMENTS TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS OR
CIRCUMSTANCES AFTER THE DATE HEREOF OR TO REFLECT THE OCCURRENCE OF
UNANTICIPATED EVENTS. READERS ARE URGED TO CAREFULLY REVIEW AND CONSIDER THE
VARIOUS DISCLOSURES MADE BY THE COMPANY TO ADVISE INTERESTED PARTIES OF CERTAIN
RISKS AND OTHER FACTORS THAT MAY AFFECT THE COMPANY'S BUSINESS AND OPERATING
RESULTS, INCLUDING THE DISCLOSURES MADE UNDER THE CAPTION "RISK FACTORS" IN
THIS REPORT, AS WELL AS THE COMPANY'S OTHER PERIODIC REPORTS ON FORM 10-K, 10-Q
AND 8-K FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.
Historically, the Company's fiscal year was a 52 or 53 week year ending on
the Saturday nearest July 31. During the fiscal year ended July 31, 1997, the
Company modified its accounting period so that each quarter and yearly
accounting period would end on the last day of each month. Accordingly, the
fiscal year ended July 31, 1997 contains four additional days. Unless otherwise
indicated, references herein to specific years and quarters are to the Company's
fiscal years and fiscal quarters.
The Company's principal executive offices are located at 58 Discovery,
Irvine, CA 92618; its telephone number is (949) 852-1000 and its web site is
HTTP://WWW.PROCOM.COM.
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PART I
ITEM 1. BUSINESS
GENERAL
We are a designer and provider of network data storage and access
appliances. Appliances are specialized devices that perform a specific function
within the computer network. Data storage appliances are emerging as the
solution of choice to manage the rapidly growing data storage requirements of
computer networks. These appliances provide superior performance at a lower cost
than general-purpose computers used as file servers. We have developed network
attached storage, or NAS, appliances that we believe are faster, more reliable
and easier to install and operate than similarly configured and comparably
priced appliances. We achieve these advantages by integrating into our
appliances proprietary, specialized operating system software optimized for data
storage and retrieval.
Industry Overview
Large and Growing Need for Data Storage
Companies increasingly view data as a strategic asset that creates a
competitive advantage. Continuous and rapid access to this data is critical to
managing a business effectively. The volume of data produced and stored by
businesses is growing rapidly. According to IDC research, data storage needs
triple every two years. The factors contributing to the growth in network
storage requirements include:
- proliferation of e-commerce;
- new communication media such as e-mail, digital imaging and video
storage;
- widespread use of enterprise applications, including enterprise resource
planning, sales force automation, supply chain and customer relationship
management systems; and
- increasing personalization of consumer marketing and product
development.
As a result of these factors, expenditures for data storage are growing
rapidly and consuming an increasing percentage of total information technology
expenditures. Specifically, networked storage is rapidly becoming the dominant
method for data management and sharing. According to a recent IDC study,
networked storage will increase from 29% of the total storage market in 2001 to
62% of the total storage market in 2004. We are focused on delivering solutions
to meet the requirements of the networked storage market.
Common Solutions to Network Storage Requirements
There are several approaches to providing network data storage capacity.
These approaches include:
- General Purpose Servers. Companies can increase their data storage
capacity by adding general purpose computers as data file servers or by
attaching external storage devices directly to existing servers. General
purpose servers are designed to execute computer applications and
perform a wide variety of functions, including providing database,
electronic mail, network management, file management and application
services. They are not specifically designed to store and retrieve
files. As a result, general purpose computers used as file servers often
provide unsatisfactory file input/output, or I/O, performance, do not
support computing platforms other than that of the server itself, and
require significant maintenance and support. Moreover, because of their
complexity, general purpose servers often cost more to purchase and
operate than other alternatives and therefore represent a poor long-term
value when used principally as storage devices.
- Storage Area Networks. A storage area network, or SAN, is a
self-contained fiber-optic network of high-speed storage devices. While
SANs may be the preferred storage solution in very large computing
environments with particular data access characteristics, they also have
a number of disadvantages. SAN installations require significant upfront
costs, and SAN systems
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are expensive to maintain. Moreover, they require the implementation and
maintenance of a separate and proprietary fibre channel network, which
is not compatible with the fibre channel networks of other SAN vendors.
- Network Attached Storage. NAS appliances have been developed to offload
basic file I/O tasks from general purpose servers. NAS appliances are
designed to store and retrieve larger amounts of data more quickly than
general purpose servers. Freed of all hardware and operating system
elements unrelated to file I/O tasks, NAS appliances provide greater
file throughput, usually for less cost. Unlike SAN devices, NAS
appliances can be easily connected to an existing computer network, with
additional appliances added over time as storage needs grow. NAS
appliances can also complement a SAN deployment. These characteristics
make NAS appliances a scalable, versatile and cost-effective data
storage solution.
The advantages of NAS have been acknowledged in the marketplace. Because
storage appliances are designed to perform specific dedicated functions, NAS
appliances are ideal for companies seeking a storage solution that:
- is easy to install, use and administer;
- is easy to integrate with existing infrastructure components;
- provides immediate return on investment through server consolidation;
- has a low acquisition price and low total cost of ownership; and
- provides high speed data access, high capacity and scalability.
Specific Challenges in Data Management
In general, enterprises using networked computing environments face
challenges in managing rapidly growing volumes of distributed data. These
challenges include:
- Poor Data Access Performance. Data access performance across networks
has historically been improved by increasing processor performance or by
increasing network bandwidth. However, this approach has its limits. The
remaining bottleneck in data access performance is caused by the file
server's operating system, which must also perform many additional tasks
unrelated to data access. These unrelated tasks slow the server's
ability to respond to file I/O requests.
- Difficulties Accessing Shared Data. Organizations require solutions that
provide access to shared data. These organizations often install
applications that run on differing and incompatible computing operating
systems. However, many of these operating systems are incapable of
accessing or sharing data created or stored on other systems without the
assistance of additional software.
- Unavailable Data. Unavailable data can result in costly business
interruptions. Data availability is critical to worker productivity,
making it imperative that network data storage devices have low failure
rates, rapid recovery times and the ability to provide uninterrupted
data service. Data unavailability can be caused by hardware and/or
software failure.
- Data Administration Challenges. Network data administration, including
the backup and expansion of data storage capacity, requires the
management of both hardware and software systems. This becomes more
complex with large volumes of data, increasing numbers of users
accessing data and wide distribution of data stored across the network.
Storage devices that cannot be managed remotely place an added burden on
technical personnel and resources.
- Solutions That Are Not Easily Scalable. Given the continuing increase in
data storage needs, effective storage solutions will provide a simple
and economical means to increase capacity over time. Preferred solutions
allow enterprises to modify their existing infrastructure and incur only
incremental costs as they grow rather than to make extensive and
expensive modifications to their computing networks.
- High Total Cost of Ownership. The total cost of ownership for a storage
solution includes not only the initial system purchase price, but also
the costs associated with ongoing maintenance and support. Systems that
require frequent service can have total ownership costs significantly
greater than their initial purchase price.
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The Procom Solution
Our NAS appliances are well suited to address the growth in data storage as
well as the specific challenges of data management. A key element of our
solution is our proprietary operating system software, which we integrate with
high-performance, industry-standard hardware components to provide our customers
with the following benefits:
- Fast File Service Response Times. Our NAS appliances are designed to
achieve rapid I/O response times. We have developed proprietary
operating system software optimized for data access and storage. This
software enables our NAS appliances to execute user read and write
requests significantly faster than general purpose computers used as
file servers.
- Cross-Platform Compatibility. Our NAS appliances provide native support
and enable simultaneous shared file services for environments using
UNIX, including Linux, and Windows NT operating systems. As a result,
users can share data across multiple operating systems, eliminating the
need to duplicate data or have separate storage devices for each
computing environment. This functionality allows organizations to
consolidate their data storage onto fewer devices, providing performance
efficiencies and lower total cost of ownership.
- High Levels of Data Availability and Product Reliability. Our appliances
are designed to provide high levels of data availability with minimal
incremental cost. Data journaling and hardware redundancies help ensure
the protection and availability of data in the event of hardware
component failure. Moving basic storage functions from a server to a NAS
appliance improves the server's reliability and its ability to process
non-storage functions.
- Ease of Installation, Administration and Maintenance. Our appliances are
easier to install and operate than both general purpose computers and
NAS appliances from other vendors. Our NAS appliances are specifically
designed to be installed easily and quickly, some in just minutes.
Moreover, our appliances' management software is accessible via a Web
browser, making remote initiation of diagnosis and management utilities
possible. In general, our appliances simplify system administration and
permit more efficient use of technical personnel.
- Scalable Solution. Our appliances are designed so that storage capacity
can grow on an incremental and cost-effective basis while maintaining
high throughput levels. A system administrator can incrementally
increase storage capacity by adding disk drives to an existing
appliance, or by adding additional NAS appliances to the existing
network infrastructure without an interruption in access to stored data.
Adding one of our NAS appliances to a network takes less time than
adding a general purpose file server. This capability allows customers
to expand their storage capacity incrementally without significant
changes to their network infrastructure.
- File and Block access to data. Through our available DUET option, our
NetFORCE 3000 series of products can be configured to deliver both file
and block level access to data. This capability positions Procom to
uniquely deliver targeted solutions to those applications that require
block level access to data, including most of the Microsoft line of
enterprise servers such as Exchange and SQL Server.
- Low Total Cost of Ownership. We reduce the initial cost of ownership by
taking advantage of the price and performance of commercial
off-the-shelf hardware components. Our products are easy to install,
which also helps to reduce the initial cost of ownership. We reduce the
ongoing cost of ownership by providing products with exceptional
reliability and low maintenance costs.
Strategy
Our objective is to become the leading provider of network data storage and
access appliances for the midrange market by employing the following strategies:
- Seek NAS Market Leadership by Building On Our Storage Experience. Over
the past several years, we have designed, developed and distributed NAS
appliances. We plan to expand our NAS market presence by continuing to
develop our NAS technology and expanding our NetFORCE product line and
NAS related software. As part of this strategy, we will seek to build on
our data storage experience and existing customer relationships.
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- Make high end networked storage technology available to middle market
companies. We intend to leverage our deep technical knowledge of the
networked storage market and make features that are in the domain of
high-end servers available at prices that are acceptable to the midrange
of the market.
- Expand our Field Sales Force and Target Data-Intensive Markets. We
intend to increase the size of our field sales force over the next 12
months. We believe that a strong field sales force presence is important
in penetrating data-intensive markets, including e-business, networking,
and enterprises using applications such as Web and e-mail hosting, data
warehousing, imaging, multimedia and digital video production. We intend
to use our field sales force to complement and support our channel
partners through joint sales calls, market education and development and
post-sales support.
- Increase Indirect Sales. We plan to expand our relationships with our
existing channel partners, especially UNIX networking and storage
resellers that have access to our targeted markets. We also intend to
engage new channel partners to enhance our ability to penetrate targeted
markets. We intend to continue the expansion of our distribution
capabilities by entering into additional agreements with selected
distributors, VARs and system integrators.
- Focus on Software Differentiation. We will continue to differentiate our
appliances by developing additional features and functionality within
our proprietary operating system software. We believe this approach
provides us with a competitive advantage and allows us to design systems
with advanced features that provide an exceptional level of system
speed, availability and reliability. We also intend to work closely with
industry leading software providers to enable our NAS appliances to be
integrated with their software architectures.
Products
We were formed in 1987 to develop and market computer storage-related
products. We began developing NAS appliances in 1997 as a natural evolution of
our market-leading position in CD/DVD-ROM server and array appliances. We
continue to sell these products, as well as storage upgrade products, such as
higher capacity disk drive upgrade kits for notebook computers. Sales of these
non-NAS products accounted for $13.5 million, or 32.2%, of net sales for fiscal
2001 and $45.8 million, or 72.4%, of our net sales for fiscal 2000. 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 revenue in fiscal 2001. We believe that sales and gross margins on these
products will continue to decline as demand for CD servers is reduced because
internet solutions can provide access to large amounts of discrete data
previously contained on CD-ROMs. We also believe demand for third party storage
upgrade products will continue to decline as computer manufacturers ship new
desktop and laptop computers with disk drives containing increasingly greater
storage capacity. As a result, we expect to reduce our emphasis and reliance on
sales of these products in the future. We provide a line of high-performance NAS
appliances that allows us to address the price and performance needs of our
customers.
We currently offer two broad categories of products: NAS appliances and
other data storage products. During fiscal 2001, sales of NAS and related
technologies represented a majority of our overall business. Our NAS appliances
represented 7.9%, 27.6% and 67.8% of our net sales in fiscal 1999, 2000 and
2001, respectively.
Network Attached Storage Products
NetFORCE. Our NetFORCE appliances are disk-based, read and write NAS storage
appliances with optimized software providing faster I/O performance than
stand-alone file servers and direct attached storage products. Our NetFORCE
product line ranges from an entry level, plug and play, 75 gigabyte device
designed for remote offices and small-sized computer workgroups to our highest
performance, fault tolerant network data server that provides up to 17 terabytes
of storage capacity. The list prices for our NetFORCE product line range from
approximately $12,000 to $540,000, depending primarily on the model purchased
and the product configuration specified by the customer. The table below
describes the key features and target markets for each of these appliances.
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DataFORCE. Our DataFORCE appliances are CD/DVD-ROM-based, read only NAS
storage devices. Our product line consists of devices that provide a high-speed
economical means to distribute data to user workstations from as many as 250
CD-ROM disks. In 1999, DataFORCE was awarded "Editor's Choice Award" by Network
Computing magazine and "Product of the Year" by Imaging and Documents Solutions
magazine. The table below also describes the key features and target markets for
each of these products we currently offer.
PRODUCT KEY FEATURES TARGET MARKETS
------- ------------ --------------
NetFORCE 3100HA - High performance, high availability filers, Businesses requiring the highest level of
NetFORCE 3200C with Fibre Channel backend data availability and integrity, including
NetFORCE 3500/3600 - 3200C and 3600C feature active-active cluster storage intensive enterprises using Windows
failover capability, with no single point of NT, UNIX and Linux-based systems.
failure
- Files accessed and shared by both Windows NT
and UNIX-based systems
- Full support for Microsoft Windows NT and Windows
2000, including ADS and ACL
- Dynamic volume expansion
- Snap shot capability provides multiple points in
time copies of data
- Full NDMP support for improved backup capability
- Web-based remote device management
- Fully supports Microsoft ADS and domain
architecture and ACLs
DUET - Integrates NAS and SAN functionality in a Installations requiring both file access and
pre-tested, pre-configured solution block access to data. This includes most
- File and Block access to data Microsoft server applications such as
- Successfully completed Microsoft HCL testing Exchange and SQL Server.
- Integrated management, monitoring and
failover capabilities
- Fully supports Microsoft Cluster Servers
ProMirror - Highly reliable, Safe-Asynchronous Mirroring Businesses requiring uninterrupted flow of
(SAM) architecture data. As an integrated part of a disaster
- Highly cost effective, using existing IP recovery solution. ProMirror delivers highly
infrastructure advanced capabilities very cost effectively.
- Near real-time reflection of data between
source and target servers
- Continuous replication of data, with fast
reversion from source to target in case of
primary site failure
- Software features are available on all
NetFORCE filers
- Web-based, easy to use management tools
NetFORCE 1700 - High performance, high capacity mid-range Workgroups using Windows NT, UNIX and
filer Linux-based systems, especially mid-sized
- Highest storage density in class, over 1.8TB e-businesses and engineering intensive
in 5U of rack space environments.
- Highest performance in its class, 4054 IOPS
- Full support for Microsoft Windows NT and Windows
2000, including ADS and ACL
- Dynamic volume expansion
- Snap shot capability provides multiple points in
time copies of data
- Full NDMP support for improved backup capability
- Simple, 15 minutes plug and play installation
DataFORCE 1000R - 250 CD-ROM capacity Organizations that use document imaging and
Rack-mountable - Web-based remote device management and firms with extensive data access needs,
modular fault tolerant design including libraries, law firms, accounting
- Supports Windows NT, UNIX, Novell and firms, educational and other institutions.
Macintosh environments
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PRODUCT KEY FEATURES TARGET MARKETS
------- ------------ --------------
DataFORCE 200/300 - Up to 115 CD-ROM capacity with web-based Organizations that use document imaging
remote device management technologies. Also, libraries, law firms,
- Easy to install public accounting firms, educational and
- Supports Windows NT, UNIX, Novell and other institutions.
Macintosh environments
We are currently in the process of developing our next generation NetFORCE
appliances. These new appliances are expected to provide even greater
performance and capacity at the high end, and deliver even greater value and
capabilities at the low end of our product spectrum. We continue to invest in
research and development to deliver solutions that are easily integrated within
our customers' information technology infrastructure and leverage upcoming
technologies such as iSCSI.
Other Data Storage Products
We also develop and market a number of other data storage products,
including disk drive upgrades, standalone and networked CD/DVD-ROM servers and
arrays, as well as tape backup products. Our disk drive upgrades allow users to
increase the storage capacity of their laptop and desktop computers, which
extends the life of their initial hardware investment. Our CD/DVD-ROM servers
and arrays allow users to access software and data stored on these media. Our
tape backup products provide reliable backup storage for large amounts of data.
We offer these products in a variety of configurations depending on the price
and performance requirements of our customers.
Together, these products constituted 32.2% of our total net sales in fiscal
2001, and 72.4% for fiscal 2000. We expect our sales of these products to
decline over time, especially as a percentage of total net sales, as we continue
to transition to the growth opportunity presented by the NAS market. We plan to
provide continued technical and customer support for these products to our
customers and channel partners. However, we have determined that demand for
these products will likely decline and we have decided to reduce our emphasis on
sales of these product lines in the future.
Technology
Our NAS operating system and the associated software and hardware components
are designed to achieve the following objectives:
- providing high-speed access to data by optimizing network, computer
processor and hard drive features and interfaces;
- allowing files created in both the UNIX and Windows NT environments to
be shared simultaneously and across multiple operating systems, while
protecting the integrity of the underlying data;
- supporting the native security features of both UNIX and Windows NT;
- supporting remote management and monitoring of the NAS device via
Web-based software;
- supporting the backup and restoring functionality of commonly used
storage management software applications;
- providing both file and block level access to data through DUET;
- providing disaster recovery capabilities through ProMirror; and
- enabling ease of installation by the user.
Although our core technical competence is in the development of software, we
also possess hardware engineering expertise. We use this expertise to integrate
our software with best-of-breed hardware components. A key element of our design
philosophy is to utilize hardware components from third-party vendors to the
extent possible. This approach allows us to benefit from the technological
advances of numerous competing hardware vendors, while benefiting from the
constant price erosion in several hardware sectors. Moreover, this philosophy
reduces our dependence on any one supplier. We intend to improve the performance
of our software,
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incorporate anticipated advances in disk drive and computer processor hardware,
and support the complementary storage technologies and software applications of
other vendors.
Customers
The customers that use our NAS appliances and our other data storage
products represent a broad array of enterprises within diverse industry sectors,
including e-businesses, financial services, communications, healthcare and
governmental agencies. Generally, NAS customers are organizations that require
highly reliable, readily accessible, and easily managed storage. These
organizations are typically in highly competitive markets and rely on
data-intensive applications, such as Web servers, search engines, data
warehousing and data mining, multimedia, engineering, digital video production,
and ERP. Our NAS appliances and other data storage products are currently sold
primarily through distributors, VARs and system integrators under the Procom
brand.
Sales and Marketing
We have an international marketing and distribution strategy. We distribute
our products through a number of channels including distributors, VARs, system
integrators and field sales. As of July 31, 2001, we employed a total of 100
individuals in sales and marketing, composed of 66 in field sales, 21 in
customer service and technical support, and 13 in marketing.
Sales
We use a variety of selling channels, which are selected based on the needs
and characteristics of our markets and products. For example, we sell our
entry-level NAS and non-NAS products principally through VARs and distributors.
We sell our high-end NAS appliances through VARs and system integrators
supported by our own field sales force. We believe this hybrid approach is the
most efficient and cost-effective strategy for distributing these high-end
appliances, which often require custom configuration and typically involve
significant customer contact and a longer sales cycle.
Field Sales. As of July 31, 2001, our field sales force consisted of 48
domestic and 18 international sales professionals and technical sales support
specialists. Many of these employees are based at our headquarters office. We
also have field sales employees based elsewhere in the U.S. and abroad. Our
field sales force focuses on generating and supporting sales opportunities with
our channel partners, which enables cooperation between our channel partners and
our field sales force.
Indirect Sales. Our indirect channel partners consist of system integrators,
VARs and distributors. Our indirect channel partners market, sell, implement and
support our products. We intend to enhance our existing relationships with these
partners and develop relationships with additional indirect channel partners -
especially those that we expect to enhance our ability to penetrate target
markets.
Marketing
Our marketing organization consists of a product management group and
marketing communications group. Our product management group is responsible for
product direction, market opportunity identification and strategic positioning,
as well as industry research and education. Our product management activities
also include development of relationships with indirect channel partners,
participation in tradeshows to promote and launch our products and coordination
of our involvement in various industry standards organizations. One of our
employees currently chairs the NAS committee of the Storage Networking Industry
Association (SNIA), a committee whose purpose is to define and promote NAS
standardization.
Our marketing communications group is responsible for increasing awareness
of our company and our products. These efforts include brand promotion, public
relations, advertising, industry trade show participation, speaking engagements,
seminars, direct mail and Web site content development. Our marketing
communications professionals also produce data sheets, presentations, and
product demonstrations.
Customer Service and Support
We are committed to providing our customers with timely and effective service
and support. Our engineers and technicians work closely with our sales personnel
to provide system integrators, VARs and distributors with pre- and post-sales
support, technical support, education, training and consulting services. We
provide these services by telephone and facsimile, as well as through online
bulletin board services and Web sites. As of July 31, 2001, our customer service
and support team consisted of 21 people, including 14
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in our headquarters in California and seven in the field. We also rely on our
system integrators, VARs, and distributors to provide technical support and
service.
Research and Development
We believe that a substantial commitment to research and development is
essential to our ability to introduce new and enhanced products that address
emerging market opportunities. As of July 31, 2001, our engineering and product
development staff consisted of 49 employees, which includes 35 software
engineers and 14 hardware engineers. Before we develop a new product, our
research and development engineers work with marketing managers and customers to
develop specifications for product requirements. Our engineers then design the
new product around those specifications. After we commercially release a new
product, our engineers continue to work with customers to refine the
specifications for future generations and upgrades of our products.
In order to respond to the short product life cycle inherent in the
industry, our research and development team monitors industry trends to aid in
selecting new technologies and features for potential development and
incorporation into our appliances. We have devoted substantial resources to the
development of our proprietary operating system software.
Our total expenses for research and development were $5.5 million in fiscal
1999, $7.2 million for fiscal 2000 and $6.4 million for fiscal 2001. As we
continue to support the growth of our NAS business, we do anticipate a decrease
in our research and development expenses in the next fiscal year as we undertake
cost saving initiatives in fiscal 2002. We intend to devote a decreasing amount
of resources toward the support and further development of our other data
storage products.
Manufacturing and Assembly
We conduct our primary manufacturing and assembly activities at our
headquarters in Irvine, California. These activities consist of testing,
assembly and component integration. We have historically operated without a
significant backlog and generally purchase the major components of our products
based on historical requirements and forecast needs. Some of our products
require printed circuit boards, special metal or plastic housings, software,
manuals, additional hardware components and certain custom components
manufactured to our specifications. We subcontract with third-party vendors for
the manufacture of these items. Our strategy has been to develop cooperative
relationships with our most important suppliers, which involves exchanging
critical information and implementing joint quality training programs. This
strategy helps to minimize supply disruptions and maintain component quality. We
test and evaluate the components used in our products. In addition, we perform
quality assurance testing on our completed products. We use just-in-time
manufacturing techniques and believe we have sufficient manufacturing capacity
to meet foreseeable production needs. In December 1999 we were awarded ISO 9001
certification.
Competition
The market for NAS appliances is rapidly evolving and competitive. We
believe we compete with the following companies:
- other NAS companies, such as Network Appliance, EMC and Auspex;
- companies which provide entry level NAS filers such as Quantum and
Maxtor; and
- computer manufacturers which also provide NAS solutions along with other
data storage products, such as Compaq, Sun Microsystems and Dell.
Our overall success depends to a great extent on our ability to continue to
develop appliances that incorporate new and rapidly evolving technologies to
provide users with cost-effective data storage and information access solutions.
In our NAS business, we compete principally on the basis of:
- product features and performance;
- ease of installation, administration and maintenance;
- cross-platform compatibility and scalability;
- total cost of ownership;
10
- engineering, technical expertise and development of proprietary
software;
- time to market with new features and appliances; and
- technical support and customer service.
We believe that we compete effectively in each of these areas. Additionally,
we believe that our accumulated expertise in developing operating system
software differentiates our NAS appliances from those of our competitors and
poses a barrier to entry for current and potential competitors. We believe that
our channel relationships with system integrators, computer resellers, VARs and
distributors as well as the price and performance characteristics of our NAS
appliances provide us with a competitive advantage.
The market for our other data storage appliances is mature and intensely
competitive. Within our non-NAS product businesses, we believe we compete with
the following companies in the following categories:
- computer manufacturers which provide storage upgrades for their
appliances, such as IBM, Compaq and Dell; and
- hard drive, CD server/array and tape backup manufacturers, such as
Maxtor and Quantum.
We believe we compete effectively with these competitors by offering a broad
range of reasonably priced appliances, by maintaining relationships with
computer resellers and VARs that possess key relationships with decision makers
at end users, and at the same time developing brand name identity through
marketing and advertisements.
INTELLECTUAL PROPERTY
Our success and ability to compete is dependent on our ability to develop
and maintain the proprietary aspects of our technology and operate without
infringing on the proprietary rights of others. We rely primarily on a
combination of copyright and trade secret protections and confidentiality
agreements to establish and protect our intellectual property rights. We seek to
protect our software, documentation and other written materials under trade
secret, copyright and patent laws, which afford only limited protection. We have
registered our "Procom" name and logo. We will continue to evaluate the
registration of additional trademarks as appropriate. We generally enter into
confidentiality agreements with our employees, resellers and customers. We have
exclusive rights to our domain name, "www.procom.com."
EMPLOYEES
As of July 31, 2001, we had 211 full-time employees. Of the total, 100 are
in sales and marketing (including 66 in field sales, 21 in customer service and
technical support and 13 in marketing), 33 in manufacturing (including testing,
quality assurance, warehousing and materials functions), 49 in engineering and
product development (including 35 in software development and 14 in hardware
development) and 29 in finance and administration. We have 177 employees in the
United States, 12 in Germany, 14 in Italy and eight in other countries in
Europe. None of our employees is represented by any collective bargaining
agreement. We have never experienced a work stoppage and consider relations with
our employees to be good.
ITEM 2. FACILITIES
Our principal administrative, sales, marketing, manufacturing and research
and development facility had been located in approximately 62,000 square feet of
leased office space in Santa Ana, California. The lease for this office space
expired on August 31, 2000.
In September 2000, we moved into our new headquarters in Irvine, California.
This facility is approximately 127,000 square feet, of which we occupy
approximately 80,000 square feet. In August 2001, we subleased approximately
5,400 square feet of this facility for a lease term of four years. We anticipate
leasing the remaining 41,600 square feet of our new facility and have initiated
discussions with interested parties. However, no assurance can be given that we
will be successful in completing such a lease.
We also lease space aggregating 37,919 square feet to house operations of
our subsidiaries and sales offices located outside the United States in Germany,
Italy, Switzerland, Canada, France and Great Britain.
11
ITEM 3. LEGAL PROCEEDINGS.
We are not a party to any material legal proceedings. We are from time to
time involved in litigation related to our ordinary operations, such as
collection actions and vendor disputes. We do not believe that the resolution of
any such other existing claim or lawsuit will have a material adverse affect on
our business, results of operations or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 2001.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(1) Our common stock is listed on the Nasdaq National Market System under
the symbol "PRCM". The approximate number of holders of record of our common
stock as of September 30, 2001 was 98 and the number of beneficial owners is
believed to be in excess of 6,500. Our common stock was first listed on the date
of our public offering of shares on December 18, 1996.
(2) We have never paid cash dividends on our common stock. We currently
anticipate retaining future earnings, if any, to internally finance growth and
product development. Payment of dividends in the future will depend upon our
earnings and financial condition and various other factors our directors may
deem appropriate at the time. Our line of credit agreement restricts the payment
of cash dividends.
(3) The range of high and low sales prices of our common stock, as reported
by the Nasdaq National Market System, for each quarter of fiscal 1999, 2000 and
2001:
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
------------------ ------------------ ------------------ ------------------
HIGH LOW HIGH LOW HIGH LOW HIGH LOW
------ ------ ------ ------ ------ ------ ------ ------
Fiscal 2001 $50.00 $21.06 $26.44 $11.25 $20.38 $ 5.20 $13.50 $ 6.75
Fiscal 2000 $10.13 $ 5.63 $38.25 $ 8.63 $89.75 $15.50 $74.00 $21.19
Fiscal 1999 $ 6.50 $ 4.25 $12.63 $ 5.94 $ 9.56 $ 4.00 $ 9.75 $ 3.81
12
ITEM 6. SELECTED FINANCIAL DATA.
FINANCIAL HIGHLIGHTS
YEAR ENDED JULY 31,
-----------------------------------------------------------------------
1997 1998 1999 2000 2001
--------- --------- --------- --------- ---------
STATEMENT OF OPERATIONS DATA:
(in `000s except per share data)
Net sales $ 109,332 $ 111,886 $ 101,290 $ 63,210 $ 41,882
Cost of sales 72,684 75,527 73,003 46,189 26,625
--------- --------- --------- --------- ---------
Gross profit 36,648 36,359 28,287 17,021 15,257
Selling, general and administrative expenses 19,155 22,257 26,314 21,930 21,235
Research and development expenses 3,922 4,788 5,502 7,187 6,403
Acquired in-process research and development -- 1,693 -- -- 4,262
Impairment and restructuring charge -- -- 1,626 -- --
--------- --------- --------- --------- ---------
Total operating expenses 23,077 28,738 33,442 29,117 31,900
--------- --------- --------- --------- ---------
Operating income (loss) 13,571 7,621 (5,155) (12,096) (16,643)
Interest income (expense), net 328 1,229 1,222 1,048 (907)
--------- --------- --------- --------- ---------
Income (loss) before income taxes 13,899 8,850 (3,933) (11,048) (17,550)
Provision (benefit) for income taxes 5,452 3,474 (1,058) (3,064) 1,800
--------- --------- --------- --------- ---------
Net income (loss) $ 8,447 $ 5,376 $ (2,875) $ (7,984) $ (19,350)
========= ========= ========= ========= =========
Net income (loss) per share:
Basic $ 0.83 $ 0.48 $ (0.26) $ (0.70) $ (1.54)
========= ========= ========= ========= =========
Diluted $ 0.81 $ 0.48 $ (0.26) $ (0.70) $ (1.54)
========= ========= ========= ========= =========
Weighted average number of shares
Basic 10,205 11,114 11,241 11,351 12,533
========= ========= ========= ========= =========
Diluted 10,374 11,252 11,241 11,351 12,533
========= ========= ========= ========= =========
CONSOLIDATED BALANCE SHEET DATA (in `000s):
Cash and short-term marketable securities $ 18,777 $ 23,362 $ 22,433 $ 15,515 $ 25,419
Working capital 29,220 32,873 31,245 10,604 27,041
Total assets 43,274 54,439 57,088 52,796 65,227
Lines of credit -- 210 254 610 8
Loan payable -- -- 7,500 10,750 --
Convertible debenture -- -- -- -- 9,726
Total shareholders' equity $ 30,067 $ 36,732 $ 34,286 $ 27,556 $ 47,066
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
We develop, manufacture and market 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 a 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. Over the last four 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 we hope to transition users of these products to
our growing line of more complex, generally higher margin NAS solutions.
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 margins.
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. In future periods, as
sales of our higher margin NAS appliances continue to increase as a percentage
of total sales, we expect our overall gross margins to be positively affected.
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 value of evaluation units at customer
sites at a financial reporting date are included in inventory as finished goods.
At July 31, 2000 and 2001, inventory related to evaluation units was
approximately $1.5 million and $2.2 million, respectively. We do not record
evaluation units as sales until the customer has notified us of acceptance of
these units.
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 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
14
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. 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 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:
YEAR ENDED JULY 31,
--------------------------------
STATEMENT OF OPERATIONS 1999 2000 2001
----- ----- -----
Net sales 100.0% 100.0% 100.0%
Cost of sales 72.1 73.1 63.6
----- ----- -----
Gross profit 27.9 26.9 36.4
Operating expenses:
Selling, general and administrative 26.0 34.7 50.7
Research and development 5.4 11.4 15.3
Acquired in-process research and development -- -- 10.2
Impairment and restructuring charge 1.6 -- --
----- ----- -----
Total operating expenses 33.0 46.1 76.2
----- ----- -----
Operating loss (5.1) (19.2) (39.8)
----- ----- -----
Interest income (expense), net 1.2 1.7 (2.2)
----- ----- -----
Loss before income taxes (3.9) (17.5) (42.0)
Provision (benefit) for income taxes (1.1) (4.8) 4.3
----- ----- -----
Net loss (2.8)% (12.7)% (46.3)%
===== ===== =====
FISCAL YEAR ENDED JULY 31, 2001 COMPARED TO FISCAL YEAR ENDED JULY 31, 2000
Net sales decreased by 33.7% to $41.9 million in fiscal 2001, from $63.2
million in fiscal 2000. This decrease resulted from a significant decrease in
unit sales of our legacy products, which include CD servers and arrays and disk
drive storage upgrade systems, and the effect of the strategic discontinuance of
specific product lines. We expect to see continued weakness in the demand for
our disk drive storage upgrade systems, CD servers and arrays and non-NAS
product sales throughout fiscal 2002, and we may accelerate the discontinuance
of our non-NAS products.
Net sales related to our NAS appliances increased 62.7% to $28.4 million in
fiscal 2001, from $17.4 million in fiscal 2000. This increase was primarily the
result of increased unit sales of our NetFORCE NAS appliances offset by
decreased sales of our DataFORCE NAS appliances.
International sales were $23.3 million, or 55.7% of our net sales, for
fiscal 2001 compared to $26.2 million, or 41.4% of our net sales, in fiscal
2000. The decrease in international sales is due primarily to reduced sales of
non-NAS products by our German subsidiary. As a percentage of overall sales,
international sales improved over fiscal 2000 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 decreased to $15.3 million for fiscal 2001 from $17.0 million
for fiscal 2000. Gross margin increased to 36.4% for the year ended July 31,
2001, from 26.9% for the comparable period in fiscal 2000. The increase in gross
margin 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, and an increase in our inventory
reserves associated with the discontinuation of specific product lines in the
fourth quarter of fiscal 2001. In addition, we realized reduced margins on lower
sales of disk drive upgrade systems due to 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.
15
Selling, general and administrative expenses decreased 3.2% to $21.2 million
in fiscal 2001, from $21.9 million in fiscal 2000, and increased as a percentage
of net sales to 50.7% from 34.7%. 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 offset by increased selling and
administrative costs of our Italian subsidiary and a $3.3 million increase in
our accounts receivables reserves due primarily to the weak economic conditions
and their impact on the financial stability of several of our customers. 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 fiscal 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 year. We expect overall
selling, general and administrative expenses in the next fiscal year to continue
to decrease as we continue our cost saving initiatives undertaken in fiscal
2001.
Research and development expenses decreased 10.9% to $6.4 million, or 15.3%
of net sales, in fiscal 2001, from $7.2 million, or 11.4% of net sales, in
fiscal 2000. The dollar 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. As we
continue to support the growth of our NAS business, we do anticipate a decrease
in our research and development expenses in the next fiscal year as we undertake
cost saving initiatives in fiscal 2002.
Acquired in-process research and development. 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. The
appraiser assigned a value of approximately $4.3 million to in-process research
and development relating to software being developed by Scofima which had not
yet reached technological feasibility and for which no alternative future use
was available. As a result, we incurred a one-time charge of $4.3 million in the
second quarter of fiscal 2001. See discussion of assumptions used by appraiser
in Note 12 to the Consolidated Financial Statements.
Interest income decreased 23.3% to $0.8 million in fiscal 2001, from $1.1
million in fiscal 2000. This decrease is due primarily to a decline in our
average investable cash position, which we had historically invested in
investment-grade commercial paper with maturities of less than 90 days, during
fiscal 2001. This decrease was partially offset by interest earned on net
proceeds received from the sale of our common stock in the fourth quarter of
fiscal 2001.
Interest expense increased to $1.7 million for the year ended July 31, 2001
compared to the comparable period in fiscal 2000. The increase is attributable
to the issuance of a $15.0 million 6% convertible debenture, borrowings under
our CIT term loan agreement and amortization of prepaid loan costs, which
included a write-off of $0.3 million in debt issuance costs associated with the
$5.0 million convertible debenture repayment. In addition, in 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 development
cost of our headquarters.
Provision (Benefit) for Income Taxes. The fiscal 2001 provision of $1.8
million represents primarily an increase in our deferred tax asset valuation
allowance. At July 31, 2001, we recorded a valuation allowance equal to the
net deferred tax asset. As to our ability to successfully transition to and grow
our NAS product sales, the realization of the tax benefits relating to our net
deferred tax asset will be dependent on our ability to return to profitability,
which management believes will occur in fiscal 2002.
FISCAL YEAR ENDED JULY 31, 2000 COMPARED TO FISCAL YEAR ENDED JULY 31, 1999
Net sales decreased by 37.6% to $63.2 million for the year ended July 31,
2000, from $101.3 million for the year ended July 31, 1999. 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. We expect to see
continued weakness in the demand for our disk drive storage upgrade systems and
CD servers 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 118.3% to $17.4
million for the year ended July 31, 2000, from $8.0 million for the year ended
July 31, 1999. This increase was primarily the result of increased unit sales of
our NetFORCE NAS appliances including approximately $3.0 million in sales to
Hewlett-Packard under our five-year agreement with them and, to a lesser extent,
increased sales of our DataFORCE NAS appliances.
International sales fell to $26.2 million, or 41.4% of our net sales, for
the year ended July 31, 2000, compared to $33.7 million, or 33.3% of our net
sales, in the year ended July 31, 1999. While the decrease in absolute dollars
was the result of reduced sales of
16
commodity disk drive and tape backup systems internationally, the increase in
international sales as a percentage of our net sales was due primarily to
reduced U.S. sales of our CD servers and arrays.
Gross profit decreased 39.8% to $17.0 million, for the year ended July 31,
2000, from $28.3 million, for the year ended July 31, 1999. Gross margin
decreased to 26.9% of net sales for the year ended July 31, 2000, from 27.9% of
net sales for the year ended July 31, 1999. The decrease in gross margin was
primarily the result of the higher percentage of total revenues of our European
subsidiaries, which have historically experienced lower margins, and to a lesser
extent, 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 further reductions in gross margins due
to decreases 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 as a percentage of our total sales.
Selling, general and administrative expenses decreased 16.7% to $21.9
million in the year ended July 31, 2000, from $26.3 million in the year ended
July 31, 1999, and increased as a percentage of net sales to 34.7% from 26.0%.
The dollar decrease in selling, general and administrative expenses was
primarily the result of reduced sales commissions, occasioned by lower gross
profit. In addition, we incurred reduced advertising and marketing costs, and
reduced legal fees, offset by increases in the cost of personnel necessary to
support our NAS sales and marketing efforts. During the year ended July 31,
2000, we identified and eliminated certain positions and functions not related
to our core NAS activities. As a result, we experienced a slight reduction in
selling, general and administrative expenses in the third and fourth quarters of
fiscal 2000. However, we expect overall selling, general and administrative
expense 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 increased 30.6% to $7.2 million, or 11.4%
of net sales, for the year ended July 31, 2000, from $5.5 million, or 5.4% of
net sales, for the year ended July 31, 1999. These increases were primarily due
to compensation expense for additional NAS software programmers and hardware
developers. We anticipate that our research and development expenses will
continue to increase, both in absolute dollars and as a percentage of net sales,
with the expected addition of dedicated NAS engineering resources.
Interest Income (Expense). Net interest income decreased 14.2% to $1.0
million for the year ended July 31, 2000, from $1.2 million for the year ended
July 31, 1999. During fiscal year 2000, we 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, partially
offset by slightly increased interest rates, net interest income decreased in
fiscal 2000. Interest expense for each of the applicable periods includes
relatively minor amounts of interest paid on lines of credit maintained by our
foreign subsidiaries. We expect that interest income will be reduced in the
future and that interest expense will increase significantly due to the
financing of our corporate headquarters, and our need to borrow additional
amounts to finance our operations.
Provision (Benefit) for Income Taxes. Our effective tax benefit rate for the
year ended July 31, 2000 was (27.7%), compared to an effective tax benefit rate
of (26.9%) for the same period in fiscal 1999. The fiscal 2000 benefit
approximates the federal and state statutory rates applied to our U.S. operating
losses, reduced by unusable foreign operating losses, and adjusted for research
and development credits. The corresponding fiscal 1999 effective tax rate
reflects the statutory rates and unusable foreign losses, partially offset by
research and development tax credits.
17
LIQUIDITY AND CAPITAL RESOURCES
As of July 31, 2001, we had cash and cash equivalents totaling $25.4
million.
Net cash used in operating activities was $18.2 million in fiscal 2001 and
$4.4 million in fiscal 2000. Net cash provided by operating activities was $1.3
million in fiscal 1999. Net cash used in operating activities in fiscal 2001
relates primarily to our net loss, net of a $4.3 million one-time charge
relating to acquired in-process research and development, increases in our
accounts receivable as we granted extended terms to our foreign customers offset
by an increase in reserves of $3.3 million relating to weak global economic
conditions and their impact on the financial stability of several of our
customers, and a decrease in accounts payable, as we paid off nearly all of the
costs of our corporate headquarters which was completed in September 2000. These
uses of cash were slightly offset by decreases in our inventories, which
included an increase in reserves of $1.2 million primarily associated with the
discontinuation of specific product lines and the receipt of approximately $2.7
million of our income tax refund receivable. Net cash used in operating
activities in fiscal 2000 resulted from a net loss before non-cash charges of
$8.0 million offset in part by a decrease in working capital. Net cash provided
by operating activities in fiscal 1999 was entirely the result of a decrease in
working capital as our net loss adjusted for non-cash charges was negligible.
Net cash used in investing activities was $3.0 million in fiscal 2001, while
net cash provided by investing activities was $1.7 million in fiscal 2000 and
$18.0 million in fiscal 1999. Net cash used in investing activities in fiscal
2001 was the result of expenditures of $1.5 million to complete our corporate
headquarters and purchases of $1.3 million of other property and equipment. Net
cash provided by investing activities in fiscal 2000 was a result of the
redemption of $9.0 million of short-term marketable securities partially offset
by purchases of $1.7 million of property and equipment and $5.6 million in costs
to construct our corporate headquarters. Net cash used in investing activities
in 1999 resulted from the purchases of $9.1 million of property and equipment
and $9.0 million of investments in short-term marketable securities.
Net cash provided by financing activities was $31.2 million in fiscal 2001
compared to $5.0 million and $6.8 million in fiscal 2000 and fiscal 1999,
respectively. Net cash provided by financing activities in fiscal 2001 resulted
primarily from the sale of 3,800,000 shares of our common stock, the issuance of
a $15.0 million convertible debenture, and approximately $1.1 million in stock
option exercises and employee stock purchases, reduced by the repayment of
approximately $10.8 million in loans previously secured by our commercial paper
portfolio and $5.0 million in convertible debentures. Net cash provided by
financing activities in fiscal 2000 resulted primarily from a $3.3 million
increase in a loan payable and $1.4 million in stock option exercises and
employee stock purchases. Net cash provided by financing activities in fiscal
1999 was primarily the result of borrowings of $7.5 million under a loan
partially offset by net payments on our lines of credit and repurchases of
common stock.
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. In early
October 2000, we paid off all amounts outstanding under the Finova line of
credit and replaced it with the line of credit with CIT Business Credit (see
below).
18
On October 10, 2000, we entered into a term loan agreement and a three-year
working capital line of credit with CIT Business Credit ("CIT"). A term loan of
$4.0 million, due and payable upon the finalization of a long-term mortgage on
our corporate headquarters or paid in 12 monthly installments commencing April
1, 2001, was repaid in May 2001. An initial term loan of $1.0 million, due and
payable in 90 days, was repaid on November 1, 2000. The term loans under the
agreement incurred interest at the lender's prime rate (6.75% per annum at July
31, 2001), plus .5%, with increases if the loan was not reduced according to a
fixed amortization. The working capital line of credit allows us to borrow, on a
revolving basis, for a period of three years, a specified percentage of our
eligible accounts receivable and inventories (approximately $2.9 million at July
31, 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 July 31,
2001, no amounts were outstanding under the various credit arrangements. The
lender charged approximately $130,000 for the credit facility, which is being
amortized as interest expense over the term of the credit agreement. The line of
credit accrues various monthly maintenance, minimum usage and early termination
fees. The line of credit requires certain financial and other covenants,
including the maintenance of a minimum EBITDA requirement for each fiscal
quarter beginning in the quarter ended January 31, 2001. At July 31, 2001, we
were not in compliance with the minimum EBITDA requirement. Although we have
repaid all amounts outstanding under the credit facility and do not intend to
borrow against the line of credit in fiscal 2002, CIT may elect to decline
making any advances under the line of credit or may terminate the line. In
addition, if advances are made while we are out of compliance with the financial
or other covenants, CIT may charge us the default rate of interest (currently
9.0% per annum) on those advances. We have initiated discussions with various
other potential financing sources regarding an alternate short-term working
capital financing arrangement. However, no assurance can be given that we will
be successful in obtaining any such financing arrangement on favorable or any
terms. The line of credit is collateralized by all of our assets.
In addition to the CIT line of credit noted above, we replaced the Finova
flooring line of credit with a flooring line with IBM Credit, which has
committed to make $2.5 million in flooring inventory commitments available to
us. As of July 31, 2001, we owed $531,000 under the flooring line. The flooring
line is collateralized by the specific inventory purchased pursuant to the
flooring commitments. CIT and IBM Credit 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, and we were in compliance with this covenant at July 31, 2001.
The flooring line also requires us to represent, at the time we request advances
under the line, that we are in compliance with the terms of our other loan
agreements. Because of our default of the financial covenant of the CIT credit
line, we were out of compliance with this provision of the flooring line at July
31, 2001. We have received a waiver from IBM with respect to our non-compliance
with this covenant of the IBM line resulting from our default of the financial
covenant of the CIT credit line for the year ended July 31, 2001. If we were to
be out of compliance with the EBITDA covenant, or any other covenant, under the
CIT line for any quarterly period subsequent to July 31, 2001, IBM could
declare an event of default under its flooring line and decline to make future
advances under the line and or terminate the line.
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 then in effect for at least 20 consecutive trading
days. The conversion price can be adjusted if we sell shares of our common stock
at a price less than $22.79 per share while the debentures are outstanding. The
conversion price under the debenture also 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 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. 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 period, we would
incur a material charge to our statement of operations, based on the difference
between the 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 valued the warrant using the 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 through May 2002, the last re-set period.
The principal amount of the debenture, net of the remaining unamortized
warrant value, is classified as a current liability. At July 31, 2001, the
debenture amount repayable was $10,000,000 and the unamortized warrant value was
$274,000, for a net debenture value of $9,726,000. In addition to the warrant
cost, approximately $700,000 of debt issuance costs were incurred in the debt
transactions noted above. The unamortized cost of approximately $529,000 is
included in prepaid expenses and will be amortized as interest expense through
May 2002, the last re-set period. At July 31, 2001, we were in default under
the financial covenant of the CIT loan agreement. The investor has advised us
informally that they will not declare an event of default under the debenture
as long as there is no amount outstanding under the CIT loan agreement.
19
In June 2001, we completed the sale of 3,800,000 shares of common stock
raising gross proceeds of approximately $34.2 million before issuance costs of
$2.7 million. We intend to use the offering proceeds in the future to pay any
remaining indebtedness under the debenture. As a result of this offering, the
conversion price of our outstanding debenture was adjusted to $19.57 pursuant to
a weighted average adjustment under the terms of the debenture. In addition, the
completion of the offering resulted in an adjustment to the exercise price of
the warrant and to the number of our shares issuable upon exercise of the
warrant pursuant to anti-dilution provisions of the warrant. As so adjusted, the
warrant exercise price is $27.95 and the number of shares issuable upon exercise
of the warrant is 38,333.
In addition to the line 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 July 31, 2001, approximately $8,000 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 of 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 $0.8 million in capitalized interest costs. We have leased
approximately 5,400 square feet of the facility to a tenant for a four year
lease term. We are attempting to lease 41,600 square feet of the building, and
we are currently considering a variety of other financing options. There can be
no assurance that we will be able to lease the space on favorable or any terms,
or that we will be able to obtain any other financing.
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
year ended July 31, 2001, and we do not intend to make additional repurchases.
In September 2000, our Board terminated the repurchase program. We are
prohibited from repurchasing our stock under the terms of our outstanding
debentures.
As is customary in the computer reseller industry, we are contingently
liable at July 31, 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 2001, we were contingently liable for
purchases made under these agreements of approximately $560,000 and $62,000,
respectively. During the three years ended July 31, 2001, we were not required
to repurchase any previously sold inventory pursuant to the flooring agreements.
At July 31, 2001, we recorded a valuation allowance equal to the net
deferred tax asset totaling approximately $9.0 million.
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 their 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 was not yet determined
to be technologically feasible. We are currently completing the software and
expect to release it in the third quarter of fiscal 2002. 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 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
research and development
20
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 be 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 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. 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
year. Also, we have funded operational losses of our subsidiaries of
approximately $3.2 million since we purchased them, and if our subsidiaries
continue to incur operational losses, our cash and liquidity would be negatively
impacted.
We expect to have sufficient cash generated from operations and from our
recently completed common stock offering to meet our anticipated cash
requirements for the next twelve months.
NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards (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 Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," as
amended, ("SAB 101") which was effective for us in the fourth quarter of fiscal
2001. Adoption of SAB101 did not have a material effect on our consolidated
financial position or results of operations.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations," and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001 as well as all purchase method business combinations
completed after June 30, 2001. SFAS 141 also specifies criteria intangible
assets acquired in a purchase method business combination must meet to be
recognized and reported apart from goodwill, noting that any purchase price
allocable to an assembled workforce may not be accounted for separately. SFAS
142 will require that goodwill and intangible assets with indefinite useful
lives no longer be amortized, but instead tested for impairment at least
annually in accordance with the provisions of SFAS 142. SFAS 142 will also
require that intangible assets with definite useful lives be amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets."
The Company is required to adopt the provisions of SFAS 141 immediately,
except with regard to business combinations initiated prior to July 1, 2001,
which it expects to account for using the pooling-of-interests method, and SFAS
142 is effective August 1, 2002. Furthermore, any goodwill and any intangible
asset determined to have an indefinite useful life that are acquired in a
purchase business combination completed after June 30, 2001 will not be
amortized, but will continue to be evaluated for impairment in accordance with
the appropriate pre-SFAS 142 accounting literature. Goodwill and intangible
assets acquired in business combinations completed before July 1, 2001 will
continue to be amortized prior to the adoption of SFAS 142.
SFAS 141 will require upon adoption of SFAS 142, that the Company evaluate
its existing intangible assets and goodwill that were acquired in a prior
purchase business combination, and to make any necessary reclassifications in
order to conform with the new criteria in SFAS 141 for recognition apart from
goodwill. Upon adoption of SFAS 142, the Company will be required to reassess
the useful lives and residual values of all intangible assets acquired in
purchase business combinations, and make any necessary amortization period
adjustments by the end of the first interim period after adoption. In addition,
to the extent an intangible asset is identified as having an indefinite useful
life, the Company will be required to test the intangible asset for impairment
in accordance
21
with the provisions of SFAS 142 within the first interim period. Any impairment
loss will be measured as of the date of adoption and recognized as the
cumulative effect of a change in accounting principle in the first interim
period.
In connection with the transitional goodwill impairment evaluation, SFAS 142
will require the Company to perform an assessment of whether there is an
indication that goodwill is impaired as of the date of adoption. To accomplish
this, the Company must identify its reporting units and determine the carrying
value of each reporting unit by assigning the assets and liabilities, including
the existing goodwill and intangible assets, to those reporting units as of the
date of adoption. The Company will then have up to six months from the date of
adoption to determine the fair value of each reporting unit and compare it to
the reporting unit's carrying amount. To the extent a reporting unit's carrying
amount exceeds its fair value, an indication exists that the reporting unit's
goodwill may be impaired and the Company must perform the second step of the
transitional impairment test. In the second step, the Company must compare the
implied fair value of the reporting unit's goodwill, determined by allocating
the reporting unit's fair value to all of it assets (recognized and
unrecognized) and liabilities in a manner similar to a purchase price allocation
in accordance with SFAS 141, to its carrying amount, both of which would be
measured as of the date of adoption. This second step is required to be
completed as soon as possible, but no later than the end of the year of
adoption. Any transitional impairment loss will be recognized as the cumulative
effect of a change in accounting principle in the Company's statement of
earnings.
And finally, any unamortized negative goodwill existing at the date SFAS 142
is adopted must be written off as the cumulative effect of a change in
accounting principle.
As of the date of adoption, the Company expects to have unamortized goodwill
in the amount of $1,140,000, and unamortized identifiable intangible assets in
the amount of $630,000, all of which will be subject to the transition
provisions of SFAS 141 and 142. Amortization expense related to goodwill was
$142,000, $167,000 and $340,000 for the years ended July 31, 1999, 2000 and
2001, respectively. Because of the extensive effort needed to comply with
adopting SFAS 141 and 142, it is not practicable to reasonably estimate the
impact of adopting these statements on the Company's financial statements at the
date of this report, including whether any transitional impairment losses will
be required to be recognized as the cumulative effect of a change in accounting
principle.
In October 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets." SFAS 144 supersedes SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of," and addresses financial accounting and reporting for the impairment or
disposal of long-lived assets. This statement is effective for fiscal years
beginning after December 15, 2001. Adoption of this statement will not have a
material impact on our consolidated financial position or results of operations.
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-K.
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.
22
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 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 RECENT TERRORIST ATTACKS MAY HAVE AN ADVERSE EFFECT ON OUR BUSINESS.
The terrorist attacks in New York and Washington, D.C. on September 11, 2001
appear to be having an adverse effect on business, financial and general
economic conditions. These effects may, in turn, have an adverse effect on our
business and results and operations. At this time, however, we are not able to
predict the nature, extent and duration of these effects on overall economic
conditions or on our business and operating results.
THE CALIFORNIA ENERGY CRISIS IS CAUSING US TO EXPERIENCE SIGNIFICANTLY HIGHER
ENERGY COSTS AND OCCASIONAL 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 occasionally 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;
23
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.
DUE TO DETERIORATING U.S. AND WORLD ECONOMIC CONDITIONS, 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 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 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.
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 increase the number of our field 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, 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, Compucom, and
Custom Edge 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 FOUR 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 four years. For the years ended July 31, 1999, 2000 and 2001,
these products accounted for approximately 8%, 28% and 68% of our total net
sales, respectively. 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 four 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.
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
24
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 45% and 54% of our total
accounts receivable at July 31, 2000 and July 31, 2001, respectively, and one
customer accounted for approximately 9% and 7% of our sales in fiscal 1999 and
2000, respectively, while another customer, Storway, a European storage service
provider, accounted for 12% of our net sales in fiscal 2001. In fiscal 1999,
2000, and 2001, 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 in 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. During the fourth quarter of fiscal
2001, we increased our reserves for accounts receivable by $3.3 million. We
cannot be certain that customers that have accounted for significant revenues in
past periods will continue to purchase our products or fully pay for products
they purchase 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 SERVERS 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 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.
25
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 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.
26
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 33%, 41% and 56% of our net sales for
the years ended July 31, 1999, 2000, 2001, respectively. 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
- 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 fiscal year 2001. During this period, the Euro and two
currencies whose values are pegged to the Euro, fluctuated significantly against
the U.S. dollar. As a result, we incurred a foreign currency loss of
approximately $160,000 in the first quarter of fiscal 2001, a foreign currency
gain of $219,000 in the second quarter of fiscal 2001, and foreign currency
losses of $97,000 and $16,000 in the third and fourth quarters of fiscal 2001,
respectively. 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 fiscal year. In addition, we
have funded operational losses of our subsidiaries of approximately $3.2 million
between the date of purchase and July 31, 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
27
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.
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
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 ongoing, 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
- the volume, mix and timing of orders received.
28
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 and 2001, we experienced product return rates of approximately 14% and 12%,
respectively. 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 $16.6
million (including a charge for in-process research and development) in fiscal
year 2001. We expect to continue to incur operating losses through at least the
third quarter of fiscal 2002. As part of our strategy to focus on the NAS
market, we plan to increase our field sales force. We will need to 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. 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.
As of October 10, 2001, our executive officers and directors beneficially
owned approximately 5,800,000 shares, or approximately 36% 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.
29
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 their 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 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
30
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
received a notice that the investor intends to seek payment or conversion of the
payment, due on October 31, 2001. We intend to make a payment in cash to satisfy
any investor demand.
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 $.50 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 $.45 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 22,400,000 shares, which would result in the investor owning 58.4%
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, OR IF WE SATISFY AN INVESTOR DEMAND FOR REPAYMENT OR
CONVERSION.
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 material
non-cash charge and would not affect our net shareholders' equity. In June 2001,
we completed the sale of 3,800,000 shares of common stock raising gross proceeds
of approximately $34.2 million before issuance costs of $2.7 million. As a
result of this offering, the conversion price of our outstanding debenture was
adjusted to $19.57 pursuant to a weighted average adjustment under the terms of
the debenture. In addition, the completion of the offering resulted in an
adjustment to the exercise price of the warrant and to the number of our shares
issuable upon exercise of the warrant pursuant to anti-dilution provisions of
the warrant. As so adjusted, the warrant exercise price is $27.95 and the number
of shares issuable upon exercise of the warrant is 38,333.
Also, we are amortizing certain debt issuance costs and the cost of the
warrant we issued to the investor. These costs will be amortized as interest
expense through May 2002, the last re-set period. At July 31, 2001, the amount
relating to unamortized debt issuance costs and warrant costs was approximately
$529,000.
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 US 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;
31
- 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 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.
At July 31, 2001, we are in default under a financial covenant of the
CIT loan agreement, although there is no amount outstanding under this loan
agreement. The investor has informally advised us that it will not declare an
event of default under the debenture as long as there is no amount outstanding
under the CIT loan agreement.
32
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
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. In March 2001, the Staff of the
Securities and Exchange Commission 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 180
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 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 this 180-day period. 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 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.
33
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. 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 in June 2001, we
completed the sale of 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-K 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-K 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-K. We do not undertake
to update or revise the forward-looking statements, whether as a result of new
information, future events or otherwise.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
INTEREST RATE RISK
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-K, construction of our
headquarters in Irvine, California was completed in September 2000. Total costs
for the headquarters facility, including land costs, were approximately $15.9
million. 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 up to .50%. Accordingly, if we were to borrow 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. In fiscal 1999, 2000 and 2001, we
incurred approximately $29,000, $213,000 and $54,000, 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. Our net sales can also be affected 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 July 31, 2001, approximately
$9.6 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.
34
ITEM 8. FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Independent Auditors' Report .......................... 36
Consolidated Balance Sheets ........................... 37
Consolidated Statements of Operations ................. 38
Consolidated Statements of Shareholders' Equity ....... 39
Consolidated Statements of Cash Flows ................. 40
Notes to Consolidated Financial Statements ............ 41
35
INDEPENDENT AUDITORS' REPORT
The Board of Directors of Procom Technology, Inc.:
We have audited the accompanying consolidated balance sheets of Procom
Technology, Inc. and subsidiaries as of July 31, 2000 and 2001, and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the years in the three-year period ended July 31, 2001. In connection
with our audits of the consolidated financial statements, we have also audited
the consolidated financial statement schedule as of and for each of the years in
the three-year period ended July 31, 2001. These consolidated financial
statements and the financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Procom Technology,
Inc. and subsidiaries as of July 31, 2000 and 2001, and the results of their
operations and their cash flows for each of the years in the three-year period
ended July 31, 2001, in conformity with accounting principles generally accepted
in the United States of America. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
KPMG LLP
Orange County, California
September 26, 2001
36
PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JULY 31,
-------------------------------
2000 2001
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents ........................ $ 1,450,000 $ 25,419,000
Short-term marketable securities, held to maturity 14,065,000 --
Accounts receivable, less allowance for doubtful
accounts and sales returns of $2,752,000 and
$6,412,000, respectively ....................... 6,699,000 11,979,000
Inventories, net ................................. 8,430,000 6,292,000
Income tax receivable ............................ 2,699,000 18,000
Deferred income taxes ............................ 1,833,000 --
Prepaid expenses ................................. 372,000 1,184,000
Other current assets ............................. 296,000 310,000
------------ ------------
Total current assets ......................... 35,844,000 45,202,000
Property and equipment, net ........................ 16,034,000 17,766,000
Other assets ....................................... 918,000 2,259,000
------------ ------------
Total assets ................................. $ 52,796,000 $ 65,227,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Lines of credit .................................. $ 610,000 $ 8,000
Loan payable ..................................... 10,750,000 --
Accounts payable ................................. 8,888,000 4,151,000
Flooring line obligation ......................... 1,511,000 531,000
Accrued expenses and other current liabilities ... 1,837,000 2,052,000
Accrued compensation ............................. 1,213,000 1,194,000
Deferred service revenues ........................ 431,000 447,000
Income taxes payable ............................. -- 51,000
Convertible debenture ............................ -- 9,726,000
------------ ------------
Total current liabilities .................... 25,240,000 18,160,000
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, 11,531,357 and 15,993,564 shares
issued and outstanding, respectively ........... 115,000 160,000
Additional paid-in capital ....................... 19,685,000 58,575,000
Retained earnings (accumulated deficit) .......... 8,007,000 (11,343,000)
Accumulated other comprehensive loss ............. (251,000) (325,000)
------------ ------------
Total shareholders' equity ................... 27,556,000 47,067,000
------------ ------------
Total liabilities and shareholders' equity ... $ 52,796,000 $ 65,227,000
============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
37
PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE YEARS ENDED JULY 31,
-----------------------------------------------------
1999 2000 2001
------------- ------------- -------------
Net sales .................................. $ 101,290,000 $ 63,210,000 $ 41,882,000
Cost of sales .............................. 73,003,000 46,189,000 26,625,000
------------- ------------- -------------
Gross profit ........................... 28,287,000 17,021,000 15,257,000
Selling, general and administrative expenses 26,314,000 21,930,000 21,235,000
Research and development expenses .......... 5,502,000 7,187,000 6,403,000
Acquired in-process research and development -- -- 4,262,000
Impairment and restructuring charge ........ 1,626,000 -- --
------------- ------------- -------------
Total operating expenses ............... 33,442,000 29,117,000 31,900,000
------------- ------------- -------------
Operating loss ......................... (5,155,000) (12,096,000) (16,643,000)
Interest income ............................ 1,248,000 1,055,000 809,000
Interest expense ........................... (26,000) (7,000) (1,716,000)
------------- ------------- -------------
Loss before income taxes ................. (3,933,000) (11,048,000) (17,550,000)
Provision (benefit) for income taxes ..... (1,058,000) (3,064,000) 1,800,000
------------- ------------- -------------
Net loss ................................... $ (2,875,000) $ (7,984,000) $ (19,350,000)
============= ============= =============
Net loss per common share:
Basic and diluted ..................... $ (0.26) $ (0.70) $ (1.54)
============= ============= =============
Weighted average number of common shares:
Basic and diluted ..................... 11,241,000 11,351,000 12,533,000
============= ============= =============
The accompanying notes are an integral part of these
consolidated financial statements.
38
PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK ACC. OTHER
------------------------ ADDITIONAL RETAINED COMPREHENSIVE
SHARES AMOUNT PAID IN CAPITAL EARNINGS INCOME (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)
Acquisition of businesses ................ 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 ................................. -- -- -- (19,350,000) -- (19,350,000)
Foreign currency translation adjustment .. -- -- -- -- (74,000) (74,000)
------------
Comprehensive loss ..................... (19,424,000)
Issuance of common stock through public
offering, net of issuance costs of
$2.7 million ......................... 3,800,000 38,000 31,453,000 -- -- 31,491,000
Acquisition of business .................. 480,000 5,000 5,755,000 -- -- 5,760,000
Compensatory stock options ............... -- -- 41,000 -- -- 41,000
Exercise of employee stock options ...... 157,401 2,000 845,000 -- -- 847,000
Issuance of stock to employees ........... 24,806 -- 234,000 -- -- 234,000
Issuance of stock warrant to investor .... -- -- 562,000 -- -- 562,000
----------- --------- ------------ ------------ --------- ------------
BALANCE AT JULY 31, 2001 ............... 15,993,564 $ 160,000 $ 58,575,000 $(11,343,000) $(325,000) $ 47,067,000
=========== ========= ============ ============ ========= ============
The accompanying notes are an integral part of these
consolidated financial statements.
39
PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JULY 31,
--------------------------------------------------
1999 2000 2001
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ................................................... $ (2,875,000) $ (7,984,000) $(19,350,000)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:
Depreciation and amortization .............................. 1,506,000 895,000 1,506,000
Amortization of debt issuance costs related to stock warrant -- -- 288,000
Compensatory stock options ................................. -- 62,000 41,000
Acquired in-process research and development ............... -- -- 4,262,000
Impairment and restructuring charge ........................ 1,408,000 -- --
Deferred income taxes ...................................... 19,000 -- 1,833,000
Changes in operating accounts:
Accounts receivable ..................................... 7,883,000 1,949,000 (5,269,000)
Inventories ............................................. (530,000) 1,543,000 2,138,000
Income tax receivable ................................... (2,859,000) 160,000 2,681,000
Prepaid expenses ........................................ 289,000 143,000 (812,000)
Other current assets .................................... (54,000) (10,000) (14,000)
Other assets ............................................ 187,000 (17,000) 61,000
Accounts payable ........................................ (1,872,000) (413,000) (4,847,000)
Accrued expenses and compensation ....................... (1,041,000) (324,000) 196,000
Tax benefits from stock option exercises ................ 71,000 -- --
Deferred service revenues ............................... (87,000) (413,000) 16,000
Income taxes payable .................................... (768,000) (18,000) 51,000
------------ ------------ ------------
Net cash provided by (used in) operating activities ........ 1,277,000 (4,427,000) (17,219,000)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ......................... (9,055,000) (7,289,000) (2,793,000)
Purchases (redemptions) of short-term marketable securities (9,008,000) 9,008,000 --
Acquisitions, net of cash acquired ......................... 30,000 -- (250,000)
------------ ------------ ------------
Net cash provided by (used in) investing activities ..... (18,033,000) 1,719,000 (3,043,000)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance (repayment) of loan payable ....................... 7,500,000 3,250,000 (10,750,000)
Issuance of convertible debenture .......................... -- -- 15,000,000
Repayment of convertible debenture ......................... -- -- (5,000,000)
Borrowings (repayments) under lines of credit .............. (453,000) 356,000 (602,000)
Flooring line obligation ................................... -- -- (980,000)
Proceeds from employee stock purchases ..................... 39,000 313,000 234,000
Repurchase of common stock ................................. (401,000) -- --
Proceeds from exercise of stock options .................... 152,000 1,115,000 847,000
Net proceeds from issuance of common stock ................. -- -- 31,491,000
------------ ------------ ------------
Net cash provided by financing activities ............... 6,837,000 5,034,000 30,240,000
Effect of exchange rate changes ................................ (18,000) (236,000) (74,000)
------------ ------------ ------------
Increase (decrease) in cash .................................... (9,937,000) 2,090,000 9,904,000
Cash and cash equivalents at beginning of period ............... 23,362,000 13,425,000 15,515,000
------------ ------------ ------------
Cash and cash equivalents at end of period ..................... $ 13,425,000 $ 15,515,000 $ 25,419,000
============ ============ ============
Supplemental disclosures of cash flow information:
CASH PAID (RECEIVED) DURING THE YEAR FOR:
Interest ................................................... $ 25,000 $ 7,000 $ 845,000
Income taxes ............................................... $ 2,275,000 $ (2,754,000) $ (2,765,000)
SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING ACTIVITIES:
Common stock warrant issued to convertible debenture investor $ -- $ -- $ 562,000
Common stock issued for acquisition of business ............. $ -- $ -- $ 5,760,000
The accompanying notes are an integral part of these
consolidated financial statements.
40
PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Procom Technology, Inc. (the "Company") was incorporated in California in
1987. The Company designs, manufactures and markets enterprise-wide data storage
and information access solutions that are compatible with all major hardware
platforms, network protocols and operating systems.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Procom
Technology, Inc. and its wholly-owned subsidiaries. All significant intercompany
transactions have been eliminated in consolidation. The functional currencies of
the European subsidiaries are those of their respective countries. The Company
incurred foreign currency losses of approximately $29,000, $213,000 and $54,000
for the years ended July 31, 1999, 2000 and 2001, respectively. The Company did
not engage in hedging activities for any of these periods. The Company follows
the provisions of Statement of Financial Accounting Standards ("SFAS") 52 when
translating assets and liabilities and results of operations for each period
presented.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS - CASH AND SHORT-TERM MARKETABLE DEBT
SECURITIES, HELD TO MATURITY
For statement of cash flow purposes, short term marketable securities with
original maturities less than 90 days are considered cash equivalents. The
carrying amount of cash and cash equivalents approximates fair value for all
periods presented due to the short-term maturities (less than 90 days) of these
financial instruments. At July 31, 2000, approximately $11,900,000 of the
short-term marketable securities were pledged as collateral for a repayment of a
loan which was repaid in fiscal 2001.
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 the Company's consolidated
financial position, results of operations or cash flows.
ACCOUNTS RECEIVABLE
The allowance for doubtful accounts represents management's estimate of the
amount expected to be lost on specific accounts and on other as yet unidentified
accounts included in accounts receivable. In estimating the potential losses on
specific accounts, management relies on analyses prepared in-house and review of
other available information. The allowance for sales returns represents
management's estimates of anticipated sales returns relating to each reporting
period. In estimating the allowance for sales returns, management relies on
historical experience. Although the Company believes it has the continued
ability to reasonably estimate the allowance for doubtful accounts and sales
returns, the amounts the Company will ultimately incur could differ materially
in the near term from the amounts assumed in arriving at the allowance for
doubtful accounts and sales returns in the accompanying consolidated financial
statements.
INVENTORIES
Inventories are valued at the lower of cost (on a first-in, first-out (FIFO)
basis) or market. Allowances for obsolete inventory are based on management's
estimate of the amount considered obsolete based on specific reviews of
inventory items. In estimating the
41
allowance, management relies on its knowledge of the industry (including
technological and design changes) as well as its current inventory levels. The
amounts the Company will ultimately realize could differ materially in the near
term from amounts estimated by management.
LONG-LIVED ASSETS
Property and equipment are stated at cost. Depreciation is calculated using
the straight-line method over the respective estimated useful lives of the
assets, which range from three to seven years. Leasehold improvements are
amortized using the straight-line method over the lesser of the lease term or
the estimated useful life of the assets.
Expenditures for major renewals and betterments are capitalized, while minor
replacements, maintenance and repairs that do not extend the assets' lives are
charged to operations as incurred. Upon sale or disposition, the cost and
related accumulated depreciation are removed from the Company's accounts and any
gain or loss is included in the statement of operations. Interest of
approximately $208,000, $489,000 and $142,000 has been capitalized during fiscal
years 1999, 2000 and 2001, respectively, and included in the cost of the
Company's headquarters.
Long-lived assets, goodwill and certain identifiable intangibles are
reviewed for impairment in value based upon undiscounted future operating cash
flows, and appropriate losses are recognized and reflected in current earnings,
to the extent the carrying amount of an asset exceeds its estimated fair value
determined by the use of appraisals, discounted cash flow analyses or comparable
fair values of similar assets.
INCOME TAXES
The Company reports certain expenses differently for financial and tax
reporting purposes and, accordingly, provides for the related deferred income
taxes. Income taxes are accounted for under the asset and liability method in
accordance with SFAS No. 109, "Accounting for Income Taxes."
REVENUE RECOGNITION
The Company generally records sales upon product shipment. In the case of
sales to most of the distributors with whom the Company has contracts, the
Company records sales when the distributor receives the products. The Company
recognizes product service and support revenues over the terms of their
respective contractual periods. The Company's agreements with many of its VARs,
system integrators and distributors allow limited product returns, including
stock balancing, and price protection privileges. The Company maintains
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. The Company calculates the reserves based on
historical rates of sales and returns, including price protection and stock
balancing claims, past experiences with its customers, the terms of its
agreements with its customers, and current information as to the level of
inventory held by the customer. The amounts the Company will ultimately realize
could differ materially in the near term from the amounts estimated. In
addition, under a product evaluation program established by the Company, its
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 value of the evaluation units are included
in inventory as finished goods. At July 31, 2000 and 2001, inventory related to
evaluation units was approximately $1.5 million and $2.2 million, respectively.
The Company does not record evaluation units as sales until notification of
acceptance for these units is received from the customer.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," as
amended, ("SAB 101") which was effective for us in the fourth quarter of fiscal
2001. Adoption of SAB101 did not have a material effect on the Company's
consolidated financial position or results of operations.
DEFERRED SERVICE REVENUE
The Company markets and sells service contracts for certain of its
appliances that require the Company to service previously sold appliances for a
specified period of time, usually one to three years. Revenue from these
contracts is billed to customers at the time of sale, but earned ratably over
the life of the service agreement. A corresponding liability reflecting the
unearned revenue is recorded as a current liability, since unearned revenue
relating to service after 12 months is not material.
42
RESEARCH AND DEVELOPMENT COSTS
Costs and expenses that can be clearly identified as research and
development are charged to research and development expenses as incurred.
CONCENTRATION OF CREDIT RISK
Three customers accounted for approximately 45% and 54% of the Company's
total accounts receivable on July 31, 2000 and 2001, respectively, and one
customer accounted for approximately 9% and 7% of the Company's net sales in
fiscal 1999 and 2000, respectively, while another customer accounted for 12% of
the Company's net sales in fiscal 2001. The loss of any one of the Company's
significant customers could have an adverse effect on the Company's business.
NET LOSS PER COMMON SHARE
Basic earnings per share are computed by dividing net loss by the
weighted-average number of common shares outstanding during the period. Diluted
earnings per share are computed by dividing net income by the weighted-average
number of common shares outstanding during the period increased to include the
number of additional shares that would be outstanding if the dilutive potential
common shares had been issued. The dilutive effect of outstanding options and
warrants is reflected in diluted earnings per share by application of the
treasury-stock method.
Due to the net losses in fiscal 1999, 2000 and 2001, no effect is given to
the potential dilution of outstanding stock options. Approximately 367,000,
1,184,000 and 922,000 shares would have been included in the computation of
diluted earnings per share if a net loss had not been incurred in fiscal 1999,
2000 and 2001.
Weighted average number of shares for basic and diluted net loss per share
are calculated as follows:
YEAR ENDED JULY 31,
------------------------------------------
1999 2000 2001
---------- ---------- ----------
Weighted average common shares outstanding
during the period ...................... 11,241,000 11,351,000 12,533,000
Potential dilution ....................... -- -- --
---------- ---------- ----------
Total shares ............................. 11,241,000 11,351,000 12,533,000
========== ========== ==========
STOCK BASED COMPENSATION
The Company measures stock based compensation for option grants to employees
and members of the board of directors using a method which assumes that options
granted at market price at the date of grant have no intrinsic value. Proforma
net loss and net loss per share are presented in Note 10 as if the fair value
method had been applied.
Stock options issued to non-employees are recorded at the fair value of the
stock options at the performance commitment date.
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS No. 141, "Business Combinations," and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001 as well as all purchase method business combinations
completed after June 30, 2001. SFAS 141 also specifies criteria intangible
assets acquired in a purchase method business combination must meet to be
recognized and reported apart from goodwill, noting that any purchase price
allocable to an assembled workforce may not be accounted for separately. SFAS
142 will require that goodwill and intangible assets with indefinite useful
lives no longer be amortized, but instead tested for impairment at least
annually in accordance with the provisions of SFAS 142. SFAS 142 will also
require that intangible assets with definite useful lives be amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets".
The Company is required to adopt the provisions of SFAS 141 immediately,
except with regard to business combinations initiated prior to July 1, 2001,
which it expects to account for using the pooling-of-interests method, and SFAS
142 is effective August 1, 2002.
43
Furthermore, any goodwill and any intangible asset determined to have an
indefinite useful life that are acquired in a purchase business combination
completed after June 30, 2001 will not be amortized, but will continue to be
evaluated for impairment in accordance with the appropriate pre-SFAS 142
accounting literature. Goodwill and intangible assets acquired in business
combinations completed before July 1, 2001 will continue to be amortized prior
to the adoption of SFAS 142.
SFAS 141 will require upon adoption of SFAS 142, that the Company evaluate
its existing intangible assets and goodwill that were acquired in a prior
purchase business combination, and to make any necessary reclassifications in
order to conform with the new criteria in SFAS 141 for recognition apart from
goodwill. Upon adoption of SFAS 142, the Company will be required to reassess
the useful lives and residual values of all intangible assets acquired in
purchase business combinations, and make any necessary amortization period
adjustments by the end of the first interim period after adoption. In addition,
to the extent an intangible asset is identified as having an indefinite useful
life, the Company will be required to test the intangible asset for impairment
in accordance with the provisions of SFAS 142 within the first interim period.
Any impairment loss will be measured as of the date of adoption and recognized
as the cumulative effect of a change in accounting principle in the first
interim period.
In connection with the transitional goodwill impairment evaluation, SFAS 142
will require the Company to perform an assessment of whether there is an
indication that goodwill is impaired as of the date of adoption. To accomplish
this, the Company must identify its reporting units and determine the carrying
value of each reporting unit by assigning the assets and liabilities, including
the existing goodwill and intangible assets, to those reporting units as of the
date of adoption. The Company will then have up to six months from the date of
adoption to determine the fair value of each reporting unit and compare it to
the reporting unit's carrying amount. To the extent a reporting unit's carrying
amount exceeds its fair value, an indication exists that the reporting unit's
goodwill may be impaired and the Company must perform the second step of the
transitional impairment test. In the second step, the Company must compare the
implied fair value of the reporting unit's goodwill, determined by allocating
the reporting unit's fair value to all of it assets (recognized and
unrecognized) and liabilities in a manner similar to a purchase price allocation
in accordance with SFAS 141, to its carrying amount, both of which would be
measured as of the date of adoption. This second step is required to be
completed as soon as possible, but no later than the end of the year of
adoption. Any transitional impairment loss will be recognized as the cumulative
effect of a change in accounting principle in the Company's statement of
earnings.
And finally, any unamortized negative goodwill existing at the date SFAS 142
is adopted must be written off as the cumulative effect of a change in
accounting principle.
As of the date of adoption, the Company expects to have unamortized goodwill
in the amount of $1,140,000, and unamortized identifiable intangible assets in
the amount of $630,000, all of which will be subject to the transition
provisions of SFAS 141 and 142. Amortization expense related to goodwill was
$142,000, $167,000 and $340,000 for the years ended July 31, 1999, 2000 and
2001, respectively. Because of the extensive effort needed to comply with
adopting SFAS 141 and 142, it is not practicable to reasonably estimate the
impact of adopting these statements on the Company's financial statements at the
date of this report, including whether any transitional impairment losses will
be required to be recognized as the cumulative effect of a change in accounting
principle.
In October 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets." SFAS 144 supersedes SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of," and addresses financial accounting and reporting for the impairment or
disposal of long-lived assets. This statement is effective for fiscal years
beginning after December 15, 2001. Adoption of this statement will not have a
material impact on the Company's consolidated financial position or results of
operations.
44
2. INVENTORIES
A summary of inventories is as follows:
YEAR ENDED JULY 31,
--------------------------
2000 2001
---------- ----------
Raw materials ........... $4,225,000 $4,374,000
Work-in-process ......... 255,000 295,000
Finished goods .......... 3,950,000 1,623,000
---------- ----------
$8,430,000 $6,292,000
========== ==========
3. PROPERTY AND EQUIPMENT
A summary of property and equipment is as follows:
YEAR ENDED JULY 31,
-------------------------------
2000 2001
------------ ------------
Computer equipment ................ $ 2,813,000 $ 3,955,000
Furniture and fixtures ............ 1,048,000 1,167,000
Office equipment .................. 1,225,000 1,216,000
Vehicles .......................... 47,000 47,000
Leasehold improvements ............ 297,000 297,000
Land .............................. 7,999,000 8,283,000
Buildings ......................... 6,352,000 7,715,000
------------ ------------
Subtotal ...................... 19,781,000 22,680,000
Less accumulated depreciation ..... (3,747,000) (4,914,000)
------------ ------------
Total ......................... $ 16,034,000 $ 17,766,000
============ ============
Depreciation expense for fiscal 1999, 2000 and 2001 totaled $1,261,000,
$728,000 and $1,166,000, respectively.
4. INCOME TAXES
Loss before income taxes consisted of the following:
YEAR ENDED JULY 31
--------------------------------------------------
1999 2000 2001
------------ ------------ ------------
Pretax loss:
United States .... $ (3,054,000) $ (9,772,000) $(14,032,000)
Foreign .......... (879,000) (1,276,000) (3,518,000)
------------ ------------ ------------
$ (3,933,000) $(11,048,000) $(17,550,000)
============ ============ ============
The components of the provision (benefit) for income taxes for fiscal 1999,
2000 and 2001 are summarized as follows:
YEAR ENDED JULY 31
-----------------------------------------------
1999 2000 2001
----------- ----------- -----------
Current:
Federal ............... $(1,077,000) $(3,064,000) $ (69,000)
State ................. -- -- 7,000
Foreign ............... -- -- 29,000
----------- ----------- -----------
(1,077,000) (3,064,000) (33,000)
Deferred:
Federal ............... 64,000 -- 1,405,000
State ................. (45,000) -- 428,000
----------- ----------- -----------
19,000 -- 1,833,000
----------- ----------- -----------
Provision (benefit)
for income taxes ...... $(1,058,000) $(3,064,000) $ 1,800,000
=========== =========== ===========
45
The following table reconciles the federal statutory income tax rate to the
effective tax rate of the provision (benefit) for income taxes.
YEAR ENDED JULY 31
----------------------------
1999 2000 2001
---- ---- ----
Federal statutory income tax rate .............. (34.0)% (34.0)% (34.0)%
State income taxes, net of federal benefit ..... (1.8)% (2.4)% (2.9)%
Research and development tax credit ............ (4.8)% (4.7)% (3.9)%
State tax rate change .......................... 2.3% -- --
Foreign tax rate differential .................. (3.5)% -- --
Valuation allowance............................. 10.9% 13.8% 39.5%
Purchased research and development ............. -- -- 8.3%
Other .......................................... 4.0% (0.4)% 3.3%
---- ---- ----
Effective tax rate ........................... (26.9)% (27.7)% 10.3%
==== ==== ====
Deferred tax assets and liabilities are summarized below:
YEAR ENDED JULY 31,
-----------------------------------------------
1999 2000 2001
----------- ----------- -----------
Deferred tax assets and liabilities:
State tax ................................. $ (146,000) $ (301,000) $ (569,000)
Depreciation .............................. 66,000 94,000 13,000
Inventory reserves ........................ 338,000 456,000 1,167,000
Reserves for bad debts and returns ........ 614,000 806,000 1,691,000
Stock option exercises .................... 36,000 -- --
Deferred service revenue sales ............ 325,000 152,000 128,000
Research and development tax credit ....... 157,000 876,000 1,559,000
Accrued expenses .......................... 362,000 389,000 270,000
Net operating loss carry forwards - state . 67,000 274,000 524,000
Net operating loss carry forwards - federal -- 172,000 2,117,000
Net operating loss carry forwards - foreign 430,000 853,000 1,974,000
Other ..................................... 14,000 16,000 17,000
----------- ----------- -----------
Total deferred income taxes ............ $ 2,263,000 $ 3,787,000 $ 8,891,000
Valuation allowance ....................... (430,000) (1,954,000) (8,891,000)
----------- ----------- -----------
Net deferred income taxes ................. $ 1,833,000 $ 1,833,000 $ --
=========== =========== ===========
In accordance with SFAS 109, "Accounting for Income Taxes," the Company
has recorded a valuation allowance equal to the net deferred tax assets as it is
more likely than not that the Company will not realize the benefits of the
existing net deferred tax asset at July 31, 2001. The Company claimed no benefit
in the current provision for some $3,518,000 in operating losses at its foreign
subsidiaries. If those subsidiaries generate taxable income in future periods,
the Company may realize a tax benefit for these operating losses.
At July 31, 2001, the Company had net operating loss carryforwards for
federal and state income tax purposes of approximately $6,626,000 and
$11,862,000, respectively, which are available to offset future taxable income,
if any, through 2021 and 2015, respectively. Utilization of the net operating
loss carryforwards may be limited under Internal Revenue Code Section 382.
At July 31, 2001, the Company had tax credit carryforwards for federal and
state income tax purpose of approximately $887,000 and $672,000, respectively.
The federal and state carryforwards are available to offset future tax
liability, if any, through 2021. Utilization of the credit carryforwards may be
limited under Internal Revenue Code Section 382.
46
5. OTHER ASSETS
Other assets consist of the following:
YEAR ENDED JULY 31,
-----------------------------
2000 2001
----------- -----------
Goodwill ............................... $ 1,167,000 $ 2,958,000
Accumulated amortization of goodwill ... (371,000) (710,000)
Other assets ........................... 122,000 11,000
----------- -----------
$ 918,000 $ 2,259,000
=========== ===========
Goodwill relates to two acquisitions completed by the Company in fiscal
1998, two acquisitions completed in fiscal 1999 and one acquisition completed in
fiscal 2001. Goodwill is amortized on a straight line basis over four to seven
years. In fiscal 1999, 2000 and 2001, amortization of goodwill was $142,000,
$167,000 and $340,000, respectively.
6. LINES OF CREDIT AND CONVERTIBLE DEBENTURE
On July 31, 2000, the Company had established a revolving line of credit
with Finova Capital Corporation. The line had been based on a percentage of the
Company's eligible accounts receivable and inventory, up to a maximum of
$10,000,000. In early October 2000, the Company paid off all amounts outstanding
under the Finova line of credit and replaced it with the line of credit with CIT
Business Credit.
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, due and payable upon the Company's finalization of a long-term
mortgage on its corporate headquarters or paid in 12 monthly installments
commencing April 1, 2001, was repaid in May 2001. An initial term loan of $1.0
million, due and payable in 90 days, was repaid on November 1, 2000. The term
loans under the agreement incurred interest at the lender's prime rate (6.75%
per annum at July 31, 2001), plus .5%, with increases if the loan was 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 $2.9 million at July 31, 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 July 31, 2001, no amounts were outstanding
under the various credit arrangements. The lender charged approximately $130,000
for the credit facility which is being amortized as interest expense over the
term of the credit agreement. The line of credit accrues various monthly
maintenance, minimum usage and early termination fees. The line of credit
requires certain financial and other covenants, including the maintenance of a
minimum EBITDA requirement for each fiscal quarter beginning in the quarter
ended January 31, 2001. At July 31, 2001, the Company was not in compliance with
the minimum EBITDA requirement. Although the Company has repaid all amounts
outstanding under the credit facility and does not intend to borrow against the
line of credit in fiscal 2002, CIT may elect to decline making any advances
under the line of credit or may terminate the line. In addition, if advances are
made while the Company is out of compliance with the financial or other
covenants, CIT may charge the Company the default rate of interest (currently
9.0% per annum) on those advances. The Company has initiated discussions with
various other potential financing sources regarding an alternate short-term
working capital financing arrangement. However, no assurance can be given that
the Company will be successful in obtaining any such financing arrangement on
favorable or any terms. The line of credit is collateralized by all of the
assets of the Company.
In addition to the CIT line of credit 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. As of July 31, 2001, the Company owed $531,000 under the flooring
line. The flooring line is collateralized by the specific inventory purchased
pursuant to the flooring commitments. CIT and IBM Credit 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, and the Company was in
compliance with this requirement at July 31, 2001. The flooring line also
requires the Company to represent, at the time it requests advances under the
line, that the Company is in compliance with the terms of the Company's other
loan agreements. Because of the Company's default of the financial covenant of
the CIT credit line, the Company was out of compliance with this portion of the
flooring line at July 31, 2001. The Company has received a waiver from IBM with
respect to the Company's non-compliance with this covenant of the IBM line
resulting from the Company's default of the financial covenant of the CIT
credit line for the year ended July 31, 2001. If the Company was to be out of
compliance with the EBITDA covenant, or any other covenant, under the CIT line
for any quarterly period subsequent to July 31, 2001. IBM could declare an
event of default under its flooring line and decline to make future advances
under the line and or terminate the line.
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 can be adjusted if the Company sells shares of its common
stock at a price less than $22.79 per share while the debentures are
outstanding.
47
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 had the option and elected to pay the investor in cash the
$5.0 million principal amount of the debenture 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 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
statements of operations, 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 the 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 through May 2002, the
last re-set period.
The principal amount of the debenture, net of the remaining unamortized
warrant value is classified as a current liability. At July 31, 2001, the
debenture amount repayable was $10,000,000 and the unamortized warrant value was
$274,000, for a net debenture value of $9,726,000 and is classified as a current
liability. In addition to the warrant cost, approximately $700,000 of debt
issuance costs were incurred in the debt transactions noted above. The
unamortized cost of approximately $529,000 is included in prepaid expenses and
will be amortized as interest expense through May 2002, the last re-set period.
At July 31, 2001, the Company is in default under the financial covenant of the
CIT loan agreement. The investor has advised the Company informally that it will
not declare an event of default under the debenture as long as there is no
amount outstanding under the CIT loan agreement.
In June 2001, the Company completed the sale of 3,800,000 shares of common
stock raising gross proceeds of approximately $34.2 million before offering
costs of $2.7 million. The Company intends to use up to $10.0 million of the
offering proceeds in the future to pay any remaining indebtedness under the
debenture. As a result of this offering, the conversion price of the outstanding
debenture was adjusted to $19.57 pursuant to a weighted average adjustment under
the terms of the debenture. In addition, the completion of the offering resulted
in an adjustment to the exercise price of the warrant and to the number of our
shares issuable upon exercise of the warrant pursuant to anti-dilution
provisions of the warrant. As so adjusted, the warrant exercise price is $27.95
and the number of shares issuable upon exercise of the warrant is 38,333.
In addition to the line 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 July 31, 2001, approximately $8,000 was outstanding under these lines.
In October 2000, the Company repaid the 18 month loan payable to an
investment bank of $10.75 million. The loan, which originally matured in
September 2000 but was subsequently renewed for an additional 6 month period,
carried rates ranging from 6.125% to 7.4%. At July 31, 2000, approximately $11.9
million of the Company's commercial paper portfolio was pledged as collateral
for repayment of this loan.
7. COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENTS
At July 31, 2001, the Company leases facilities under non-cancelable
operating leases in Munich, Germany; Milan and Rome, Italy; Ontario, Canada;
Paris, France and Livingston, Scotland, Great Britain. In addition, the Company
has various operating leases for certain office equipment and vehicles.
48
At July 31, 2001, future minimum lease payments under these leases were as
follows:
OPERATING
LEASES
----------
Fiscal year ending:
2002 .................. $ 382,000
2003 .................. 248,000
2004 .................. 165,000
2005 .................. 47,000
2006 .................. 47,000
Thereafter ............ 114,000
----------
Total minimum lease payments $1,003,000
==========
Rent expense was $1,439,000, $1,412,000 and $458,000 for fiscal 1999, 2000
and 2001, respectively.
FLOORING AGREEMENTS
As is customary in the computer reseller industry, the Company is
contingently liable at July 31, 2001 under the terms of repurchase agreements
with several financial institutions providing inventory financing for dealers of
the Company's appliances. Under these agreements, dealers purchase the Company's
appliances, and the financial institutions agree to pay the Company 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 the
Company 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. The risk of loss is spread over several
dealers and financial institutions. At July 31, 2000 and 2001, the Company was
contingently liable for purchases made under these agreements of approximately
$560,000 and $62,000, respectively. During the three years ended July 31, 2001,
the Company was not required to repurchase any previously sold inventory
pursuant to the flooring agreements.
LITIGATION
The Company is involved in routine litigation arising in the ordinary course
of its business. While the outcome of litigation cannot be predicted with
certainty, the Company believes that none of the pending litigation will have a
material adverse effect on the Company's financial position or results of
operations.
EMPLOYMENT AGREEMENTS
The Company has employment agreements with the Company's President and three
Executive Vice Presidents. Each agreement is for a three-year term with an
automatic renewal provision which provides that the agreement will perpetually
maintain a three-year term unless terminated. Each agreement contains severance
provisions that require the payment of 35 months of base salary in the event of
the termination of the covered executives. Should all four executives be
terminated, the aggregate commitment arising under the severance provisions
would be approximately $2.6 million and, in addition, the Company would be
obligated to pay a pro rata bonus for the year of termination and to continue
for up to two years all life insurance and medical benefits.
8. RETIREMENT PLAN
The Company has a defined contribution plan covering substantially all
full-time employees with more than one year of service. Each participant can
elect to contribute up to 15% of his or her annual compensation. While employer
contributions to the plan are discretionary, during fiscal 1999, 2000 and 2001
the Company elected to make matching contributions equivalent to between 38% and
50% of the first 4% of each eligible employee's contribution. Total expense for
fiscal 1999, 2000 and 2001 was $106,000, $86,000 and $82,000, respectively.
9. RELATED PARTY TRANSACTIONS
During the three years ended July 31, 2001, the Company utilized the
services of Advanced Construction Solutions, Inc. (ACS), an Orange County based
real estate developer and general contractor to (a) locate a suitable facility
for the Company to utilize as its corporate headquarters for approximately 18
months, (b) act as a general contractor to complete a build-out of necessary
tenant improvements for the temporary facility, and (c) locate, and then
negotiate the purchase of, and commence development of, a parcel of land in
Irvine, California for the Company's long-term corporate headquarters. ACS is
owned 50% by a brother of Frank Alaghband,
49
an Executive Vice President and Director of the Company. During the year ended
July 31, 1999, the Company executed an 18 month lease with an unrelated
landlord, calling for approximately $1,050,000 in lease payments, and the
Company purchased an 8 acre site from an unrelated landowner for approximately
$7.3 million. ACS received approximately $357,000 directly from the Company for
the tenant improvement build-out (of approximately 60,000 square feet), $40,200
directly from the Company for services in planning and developing the Irvine
facility, and approximately $142,000 in commissions paid by the temporary
facility landlord and the land owner upon the completion of the transactions
described. The Company had also agreed to utilize ACS in the construction of the
Irvine facility. The Company has expended approximately $7.7 million for
construction costs through July 31, 2001. A majority of the construction costs
were paid to ACS.
10. STOCK OPTION PLAN AND EMPLOYEE STOCK PURCHASE PLAN
During fiscal 1996, the Company instituted the 1995 Stock Option Plan (the
"1995 Plan") for its key employees and reserved 540,000 shares for grant under
the 1995 Plan. Subsequently, the Board and the Company's shareholders approved
the reservation of an additional 3,050,000 shares for grant under the 1995 Plan.
Pursuant to the terms of the 1995 Plan, options to purchase the Company's common
stock may be granted with exercise prices equal to the fair market value of the
stock on the date of grant. Options expire ten years from the date of the grant
and generally vest over a period of four years. In September 1998, the Board
authorized the re-pricing of 374,950 options previously granted with exercise
prices in excess of $4.50 per share. The new exercise price was $4.50 per share,
the fair value of the Company's stock on the date of such re-pricing. Repriced
options are included in the granted and cancelled amounts below.
The following table is a summary of stock option activity for the three
years ended July 31, 2001:
YEAR ENDED JULY 31,
----------------------------------------------------------------------------------
1999 2000 2001
------------------------ ------------------------ ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------- -------- ---------- ------ ---------- ------
Outstanding at beginning of year ......... 502,277 $ 6.53 1,403,449 $ 4.06 1,965,178 $ 8.43
Granted .............................. 1,653,890 $ 4.50 1,085,071 $11.91 735,579 $ 6.54
Exercised ............................ (41,013) $ 3.72 (278,587) $ 4.00 (157,401) $ 5.38
Cancelled ............................ (711,705) $ 6.44 (244,755) $ 5.60 (322,662) $ 9.96
---------- ------ ---------- ------ ---------- ------
Outstanding at end of year ........... 1,403,449 $ 4.37 1,965,178 $ 8.43 2,220,694 $ 7.80
========== ====== ========== ====== ========== ======
Exercisable end of year .............. 99,265 $ 3.43 247,748 $ 4.34 528,647 $ 8.10
========== ====== ========== ====== ========== ======
Weighted fair value per option granted $ 4.11 $ 9.28 $ 5.84
====== ====== ======
JULY 31, 2001
-----------------------------------------------------------------------------------------------------------------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------------------------------------- ----------------------------------
WEIGHTED-AVERAGE
RANGE OF REMAINING WEIGHTED-AVERAGE WEIGHTED-AVERAGE
EXERCISE PRICES NUMBER YEARS EXERCISE PRICE NUMBER EXERCISE PRICE
------------------ ----------------- ----------------- ----------------- ----------------- ----------------
$ 2.50 - 3.00 20,050 4.13 $ 2.50 20,050 $ 2.50
$ 4.50 - 6.48 1,629,731 8.55 $ 5.56 324,813 $ 4.65
$ 8.50 -16.25 570,913 8.58 $ 14.37 183,784 $14.80
-------- -------
2,220,694 528,647
========= =======
During the years ended July 31, 1999, 2000 and 2001, the Company recognized
tax benefits of $71,000, $0 and $0, respectively, from the gains resulting from
exercises by employees of non-qualified stock options. The tax benefit is
recorded as an increase to additional paid-in-capital.
Pro forma information regarding net loss and net loss per share is required
by SFAS 123 as if the Company had accounted for its stock options under the fair
value method of SFAS 123. The fair value of the Company's stock options was
estimated using the Black-Scholes option valuation model. The Black-Scholes
option valuation model was developed for use in estimating the fair value of
traded options, which have no vesting restrictions and are fully transferable.
In addition, the Black-Scholes model requires the input of highly subjective
assumptions, including the expected stock volatility. Because the Company's
stock options granted to employees have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its stock options granted to employees. The fair
value of the Company's stock options granted to employees was estimated assuming
no expected dividends and the following weighted average assumptions:
STOCK OPTION PLAN SHARES
--------------------------
1999 2000 2001
---- ---- ----
Expected life (in years) 4.0 5.0 4.0
Risk-free interest rate 6.0% 6.0% 4.63%
Volatility ............. 0.9 0.91 1.40
50
For purposes of pro forma disclosures, the estimated fair values of the
options are amortized over the options' respective vesting period. The Company's
pro forma information follows:
1999 2000 2001
-------------- -------------- --------------
Pro forma net loss ........................... $ (3,042,000) $ (8,414,000) $ (21,151,000)
Pro forma basic and diluted net loss per share $ (.27) $ (.74) $ (1.69)
In fiscal 1999, the Company adopted an employee stock purchase plan ("ESPP")
that operates in accordance with Section 423 of the Internal Revenue Code
whereby eligible employees may, subject to certain limitations, authorize
payroll deductions of up to 10% of their salary to purchase shares of the
Company's common stock at 85% of the fair market value of the stock on the first
or last date of semiannual purchase periods, whichever is less. The Company has
reserved 250,000 shares of common stock for issuance under the ESPP.
Approximately 6,000, 26,000 and 25,000 shares were issued under the ESPP during
fiscal 1999, 2000 and 2001, respectively.
11. REVENUE BY PRODUCT AREA AND GEOGRAPHIC AREA
REVENUES BY PRODUCT FAMILIES
The Company operates in one principal industry segment: the design,
manufacture and marketing of enterprise-wide data storage and information access
solutions compatible with all major hardware platforms, networks and operating
systems. No one customer accounted for more than 10% of the Company's net sales
in fiscal 1999 or 2000. In fiscal 2001, one customer accounted for approximately
12% of the Company's net sales.
YEAR ENDED JULY 31,
----------------------------------------------
1999 2000 2001
------------ ----------- -----------
Net revenues:
Network attached storage products $ 7,989,000 $17,442,000 $28,376,000
Other data storage products ..... 93,301,000 45,768,000 13,506,000
------------ ----------- -----------
Total net revenues ........... $101,290,000 $63,210,000 $41,882,000
============ =========== ===========
GEOGRAPHIC INFORMATION
Export sales as a percentage of net sales amounted to 33%, 41% and 56% for
fiscal years 1999, 2000 and 2001, respectively. A summary of the Company's net
sales and gross profit by geographic area is as follows (in thousands):
YEAR ENDED JULY 31,
---------------------------------------
1999 2000 2001
--------- -------- --------
Net sales
United States $ 67,549 $ 37,024 $ 18,567
Foreign ..... 33,741 26,186 23,315
--------- -------- --------
Total .... $ 101,290 $ 63,210 $ 41,882
========= ======== ========
Gross profit
United States $ 21,270 $ 11,878 $ 5,001
Foreign ..... 7,017 5,143 10,256
--------- -------- --------
Total .... $ 28,287 $ 17,021 $ 15,257
========= ======== ========
Operating loss
United States $ (4,455) $ (9,909) $(15,993)
Foreign ..... (700) (2,187) (650)
--------- -------- --------
Total .... $ (5,155) $(12,096) $(16,643)
========= ======== ========
International sales were primarily to European customers. As a result of the
Company's February 1998 acquisition of the outstanding stock of Megabyte, and
the subsequent acquisitions of Procom Technology, AG, Procom Technology, SPA and
Scofima, the Company had identifiable assets used in connection with its foreign
operations of approximately $7,054,000, $7,565,000 and $8,447,000 at July 31,
1999, 2000 and 2001, respectively.
51
12. ACQUISITIONS
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 was
not yet determined to be technologically feasible. The Company is currently
completing the software, and expects to release it in the third quarter of
fiscal 2002. 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 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 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)
Common stock issued ......................... (5,760,000)
-----------
Cash consideration paid, net of cash acquired $ 250,000
===========
The following unaudited pro forma information has been prepared assuming
that the acquisition of Scofima Software S.r.l. had taken place at the beginning
of the respective periods presented. The pro forma financial information is not
necessarily indicative of the combined results that would have occurred had the
acquisition taken place at the beginning of the period, nor is it necessarily
indicative of results that may occur in the future.
<Table>
<Caption>
PRO FORMA FOR THE YEAR ENDED
---------------------------------
July 31, 2000 July 31, 2001
------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales $ 63,215 $ 41,884
Operating loss $(12,521) $(12,556)
Net loss $ (8,409) $(15,263)
Net loss per share - basic and diluted $ (0.71) $ (1.20)
</Table>
During fiscal 1999, the Company completed the acquisitions of Procom
Technology, AG and Procom Technology, SPA. In November 1998, the Company
acquired all of the outstanding stock of Procom Technology, AG in exchange for
28,500 shares of stock and $22,000 in cash. Procom Technology, AG is a
relatively small Swiss distributor of computer storage peripherals, and has been
a customer of the Company for more than five years. The Company treated the
acquisition of Procom Technology, AG as a purchase, and recorded goodwill of
approximately $168,000, which is being amortized over seven years.
In January 1999, the Company acquired all of the outstanding stock of Procom
Technology, SPA in exchange for 51,100 shares of stock and $50,000 in cash.
Procom Technology, SPA is a relatively small Italian distributor of higher end
computer storage peripherals. The Company's acquisition of Procom Technology,
SPA, which was initially treated as a pooling-of-interests, has been changed to
reflect the purchase accounting method. As a result of this change, revenue and
net income for the second quarter of fiscal 1999 were reduced by approximately
$3.1 million and $0.1 million, respectively, from that which was initially
reported. The Company recorded goodwill of approximately $286,000, which is
being amortized over seven years.
52
The following is a summary of the net fair value of the assets acquired, the
goodwill on the date of acquisition, and the total consideration paid for the
acquisitions made during fiscal 1999:
PROCOM PROCOM
TECHNOLOGY, TECHNOLOGY,
SPA AG TOTAL
----------- ----------- -----------
Fair value of assets acquired ................ $ 2,094,000 $ 280,000 $ 2,374,000
Liabilities assumed, including lines of credit (1,692,000) (126,000) (1,818,000)
Common stock issued .......................... (436,000) (150,000) (586,000)
----------- ----------- -----------
Cash consideration paid, net of cash acquired $ (34,000) $ 4,000 $ (30,000)
=========== =========== ===========
13. IMPAIRMENT AND RESTRUCTURING CHARGE
As a result of changes to the Company's business operations, as well as
significant operating losses of Invincible Technologies Corporation after its
acquisition, in fiscal 1999, the Company determined it should restructure the
operating activities of Invincible. At the time of acquisition, the Company
sought to utilize Invincible's sales force to market and sell products of both
Invincible and Procom's Netforce products. During the year after the
acquisition, Invincible experienced significant margin pressure on its products
and was unable to increase the sales of Netforce products. From the date of
acquisition through April 1999, the Company had experienced significant
financial losses from its Invincible operations. The restructuring consisted of
closing several field offices, eliminating most of the Invincible product lines
and reducing staff significantly. In connection with the restructuring, the
Company also reviewed the long-lived assets purchased in the Invincible
acquisition. After comparing the carrying value of the assets to the estimated
future undiscounted cash flows from the assets, the Company determined that the
value of the assets were impaired. The Company wrote off the goodwill remaining
from the transaction of approximately $0.8 million, and wrote down the carrying
value of certain Invincible fixed assets by $0.6 million. In addition, the
Company recorded a restructuring charge comprised of approximately $0.2 million
for lease termination and employee severance costs for approximately 10
employees relating to the Invincible operations. Approximately $0.2 million of
the restructuring charge was accrued as of July 31, 1999 and was paid during
fiscal 2000. In addition, the Company recorded, in cost of sales, additional
reserves of approximately $0.8 million to reserve for the ultimate disposal of
much of the Invincible inventory. As a result of the restructuring, the Company
expects to see lower personnel costs and lower fixed charges such as
depreciation relating to Invincible operations in the future.
14. QUARTERLY STATEMENTS OF OPERATIONS (UNAUDITED)
YEAR ENDED JULY 31, 2000
--------------------------------------------------------
Q1 Q2 Q3 Q4
----------- ----------- ----------- -----------
Net Sales ....... 18,909,000 16,327,000 13,811,000 14,163,000
Gross Profit .... 5,241,000 3,806,000 3,333,000 4,641,000
Loss before Taxes (2,170,000) (3,872,000) (3,385,000) (1,621,000)
Net Loss ........ (1,576,000) (2,681,000) (2,481,000) (1,246,000)
Basic EPS ....... (0.14) (0.24) (0.22) (0.10)
Diluted EPS ..... (0.14) (0.24) (0.22) (0.10)
YEAR ENDED JULY 31, 2001
--------------------------------------------------------
Q1 Q2 Q3 Q4(a)
----------- ----------- ----------- -----------
Net Sales ....... 13,264,000 11,722,000 8,002,000 8,894,000
Gross Profit .... 4,882,000 4,614,000 3,173,000 2,588,000
Loss before Taxes (1,485,000) (5,814,000) (2,979,000) (7,272,000)
Net Loss ........ (1,091,000) (5,868,000) (3,040,000) (9,351,000)
Basic EPS ....... (0.09) (0.50) (0.25) (0.64)
Diluted EPS ..... (0.09) (0.50) (0.25) (0.64)
(a) In the fourth quarter of fiscal 2001, the Company's operating results
included an increase in inventory reserves of $1.2 million primarily
associated with the discontinuation of specific product lines and an
increase in accounts receivable reserves of $3.3 million relating to weak
global economic conditions and their impact on the financial stability of
several of the Company's customers.
Item 9. Change and Disagreements with Accountants on Accounting and Financial
Disclosures
Not Applicable.
53
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
There is incorporated herein by reference the information required by this
Item included in the Company's Proxy Statement for the 2002 Annual Meeting of
Shareholders under the captions "Management," "Election of Directors" and
"Section 16(a) Beneficial Ownership Reporting Compliance," which will be filed
with the Securities and Exchange Commission no later than 120 days after the
close of the fiscal year ended July 31, 2001.
MANAGEMENT
OUR DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
The following table sets forth information with respect to our executive
officers, key employees and directors, as of July 31 and October 29, 2001:
NAME AGE POSITION
---- --- --------
Alex Razmjoo.................................... 39 Chairman of the Board, President and Chief Executive Officer
Frank Alaghband................................. 38 Executive Vice President, Engineering and Operations, and Director
Alex Aydin...................................... 39 Executive Vice President, Finance and Administration, Chief Financial
Officer and Director
Nick Shahrestany................................ 38 Executive Vice President, and Director
Jack Bonne...................................... 58 Vice President, Worldwide Sales and Technical Support
Parsa Rohani.................................... 37 Vice President, Marketing and Strategic Planning
Dom Genovese.................................... 59 Director
David Blake..................................... 61 Director
Kevin Michaels.................................. 43 Director
Mr. Alex Razmjoo is one of the founders of Procom Technology, Inc. and has
served as Procom's President, Chief Executive and Chairman since the Company's
inception in 1987. Under his leadership, Procom led in the development of NAS
technology and leveraged its position as world market leader in CD-caching
appliances to address the disk-based data storage needs of workgroup, Internet
and enterprise applications. Prior to forming Procom, Mr. Razmjoo was Director
of Engineering for CMS Enhancements, Inc. from 1984 to 1987. He received his
Bachelor of Science degree in Electrical Engineering from the University of
California at Irvine (UCI) in 1985. He currently serves on the Board of
Directors of UCI's Graduate School of Management and on the Advisory Board of
UCI's Information and Computer Science Department.
Mr. Alex Aydin is one of the founders of Procom Technology and has been an
Executive Vice President and Director since 1987. Previously from 1984 to 1987,
he served as Product Development Engineer for Toshiba America, Inc. He received
dual B.S. degrees in Electrical Engineering and biological science in 1984 from
the University of California, Irvine and an MS degree in biomedical engineering
in 1985 from California State University, Long Beach.
Mr. Frank Alaghband is a co-founder of Procom Technology and has served as the
Company's Executive VP of Engineering and Operations and as a Director since
1987. Mr. Alaghband has been involved in product development in the storage
industry since 1984. He started his career at McDonnell Douglas Computer Systems
Company, where he developed high performance, multi-channel, caching disk
controllers for the company's mini computers. At Procom Technology, he has led
the development of a number of award-winning network storage products. He
received his B.S. degree in Electrical Engineering from the University of
California, Irvine, in 1984.
Mr. Nick Shahrestany is one of the founders of Procom Technology and has served
as an Executive Vice President and Director since 1987. From 1985 to 1987, Mr.
Shahrestany was Regional Sales Manager for CMS Enhancements, Inc. He received
his B.S. in Biological Sciences with a minor in Electrical Engineering from the
University of California, Irvine.
Mr. Jack Bonne is responsible for Procom's worldwide sales and field service and
support. With more than 30 years of experience in IT Sales and Marketing, Mr.
Jack Bonne brings a wealth of knowledge to this key management position at
Procom. He has served as Senior VP, Division General Manager and Board Member of
Sharp Microelectronics; CEO, President and Board Member of Sanyo Icon, a storage
company acquired by EMC; Senior VP of Worldwide Sales Marketing and Field
Service at McDonnell Douglas' Computer System Division and Manager of Corporate
Computer sales at Xerox's Computer System Division. He received his MBA from the
University of Chicago, Graduate School of Business and a B.S. in Mathematics and
Physics from Northern Illinois University.
Mr. Parsa Rohani is responsible for Procom's worldwide product management,
corporate communications, channel marketing and strategic alliances. Prior to
joining Procom, he served in various sales, engineering and marketing management
positions at Microsoft Corporation.
In his last position with Microsoft as an Architectural Consultant, Mr. Rohani
worked closely with key Microsoft executives and customers to drive the adoption
and implementation of Microsoft's strategic products and services. Prior to
joining Microsoft, he served as a Senior Software Engineer for Hughes Aircraft.
Mr. Rohani has a B.S. degree in Electrical Engineering from the University of
Southern California.
54
Mr. Kevin Michaels has been a director since June, 2001. Mr. Michaels is
Senior Vice President, Finance, Chief Financial Officer and Secretary for
Powerwave Technologies (Nasdaq: PWAV). Prior to his current post, he served as
Vice President, Treasurer, for AST Research.
Item 11. EXECUTIVE COMPENSATION
There is incorporated herein by reference the information required by this
Item included in the Company's Proxy Statement for the 2002 Annual Meeting of
Shareholders under the captions "Executive Compensation," "Compensation
Committee Interlocks and Insider Participation" "Report of the Compensation
Committee" and "Stock Performance Graph," which will be filed with the
Securities and Exchange Commission no later than 120 days after the close of the
fiscal year ended July 31, 2001.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
There is incorporated herein by reference the information required by this
Item included in the Company's Proxy Statement for the 2002 Annual Meeting of
Shareholders under the caption "Security Ownership of Beneficial Owners," which
will be filed with the Securities and Exchange Commission no later than 120 days
after the close of the fiscal year ended July 31, 2001.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There is incorporated herein by reference the information required by this
Item included in the Company's Proxy Statement for the 2002 Annual Meeting of
Shareholders under the caption "Certain Relationships and Related Transactions,"
which will be filed with the Securities and Exchange Commission no later than
120 days after the close of the fiscal year ended July 31, 2001.
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) DOCUMENTS FILED AS A PART OF THIS REPORT:
(1) INDEX TO FINANCIAL STATEMENTS
The financial statements included in Part II, Item 8 of this Annual
Report on Form 10-K are filed as part of this Report.
(2) FINANCIAL STATEMENT SCHEDULES
The financial statement schedule is filed as part of this Report.
All other schedules are omitted as the required information is inapplicable
or the information is presented in the consolidated financial statements or
related notes.
(b) REPORTS ON FORM 8-K:
None.
55
(3) EXHIBITS
EXHIBITS TO FORM 10-K
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
on 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 on 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 10.1 in the Form S-1 filed on October 30, 1996)
10.2 Amended and Restated Procom Technology, Inc. 1995 Stock Option
Plan (incorporated by reference to Exhibit 4 in the Form S-8
filed on July 2, 1999)
10.2.1 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
on 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
on 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
on 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
on October 30, 1996)
10.7 Form of Registration Rights Agreement (incorporated by reference
to Exhibit 10.7 in the Form S-1 filed on October 30, 1996)
10.8 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
17, 2001)
21.1 List of Subsidiaries
23.1 Consent of KPMG LLP
56
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, State of California, on the 31st day of October, 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 has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ ALEX RAZMJOO Chairman of the Board,
----------------------------------------------------- President and Chief Executive Officer October 31, 2001
Alex Razmjoo (Principal Executive Officer)
/s/ ALEX AYDIN Director and Executive Vice President,
----------------------------------------------------- Finance and Administration October 31, 2001
Alex Aydin (Principal Financial and Accounting Officer)
/s/ FRANK ALAGHBAND Director October 31, 2001
-----------------------------------------------------
Frank Alaghband
Director
-----------------------------------------------------
Nick Shahrestany
Director
-----------------------------------------------------
Dom Genovese
/s/ DAVID BLAKE Director October 31, 2001
-----------------------------------------------------
David Blake
/s/ KEVIN MICHAELS Director October 31, 2001
-----------------------------------------------------
Kevin Michaels
57
SCHEDULE II
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED JULY 31, 1999, 2000 AND 2001
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
PERIOD EXPENSES OTHER DEDUCTIONS PERIOD
----------- ----------- ----------- ------------ -----------
YEAR ENDED JULY 31, 1999:
Allowance for sales returns ............................ $ 1,044,000 $ 8,326,000 $ -- $(7,431,000) $ 1,939,000
Allowance for doubtful accounts ........................ 508,000 10,000 54,000 (50,000) 522,000
YEAR ENDED JULY 31, 2000:
Allowance for sales returns ............................ $ 1,939,000 $ 5,917,000 $ -- $(5,781,000) $ 2,075,000
Allowance for doubtful accounts ........................ 522,000 360,000 -- (205,000) 677,000
YEAR ENDED JULY 31, 2001:
Allowance for sales returns ............................ $ 2,075,000 $ 4,043,000 $ -- $(4,018,000) $ 2,100,000
Allowance for doubtful accounts ........................ 677,000 3,672,000 -- (37,000) 4,312,000
58
EXHIBITS TO FORM 10-K
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
on 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 on 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 10.1 in the Form S-1 filed on October 30, 1996)
10.2 Amended and Restated Procom Technology, Inc. 1995 Stock Option
Plan (incorporated by reference to Exhibit 4 in the Form S-8
filed on July 2, 1999)
10.2.1 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
on 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
on 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
on 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
on October 30, 1996)
10.7 Form of Registration Rights Agreement (incorporated by reference
to Exhibit 10.7 in the Form S-1 filed on October 30, 1996)
10.8 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
17, 2001)
21.1 List of Subsidiaries
23.1 Consent of KPMG LLP