SECURITIES EXCHANGE AND COMMISSION
WASHINGTON, DC 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): May 22, 1997
ZITEL CORPORATION
(Exact name of registrant as specified in its charter)
CALIFORNIA
(State or other jurisdiction of incorporation)
0-12194 94-2566313
(Commission File No.) (IRS Employer Identification No.)
47211 BAYSIDE PARKWAY
FREMONT, CALIFORNIA 94538-6517
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (510) 440-9600
ITEM 5. OTHER EVENTS
A. PLACEMENT OF DEBENTURES
On May 22, 1997, Zitel Corporation (the "Company") completed the private
placement of $25,000,000 in principal amount of 5% convertible subordinated
debentures due November 22, 1999 (the "Debentures") to a small number of
institutional investors in an offering exempt from the registration requirements
of the Securities Act of 1933, as amended (the "Securities Act"). The Debentures
are convertible into shares of the Company's common stock ("Common Stock") at
any time after 90 days from the date of purchase of the Debentures until
maturity, unless previously redeemed or repurchased by the Company. The
Debentures are convertible into the number of shares of Common Stock equal to
the amount of principal and accrued interest being converted divided by the
lesser of (i) 90% of the market price, or (ii) $26.975. For purposes of the
conversion formula, the market price is equal to the average of the reported
closing bid prices for the Common Stock on the five trading days preceding each
date of conversion. The holders of the Debentures have registration rights with
respect to the Common Stock as set forth in a Registration Rights Agreement
pursuant to which the Company has agreed to register for resale under the
Securities Act the Common Stock issuable upon conversion of the Debentures, on
or before August 20, 1997.
The foregoing description does not purport to be complete and is qualified
by reference to the definitive agreement filed as Exhibits herewith.
B. RISK FACTORS
The Company from time to time makes forward-looking statements that involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including those set forth in the following risk factors and
elsewhere in the Company's SEC filings. In evaluating the Company's business,
prospective investors should consider carefully the following factors in
addition to the other information concerning the Company.
RECENT LEVELS OF NET SALES; DEPENDENCE ON ROYALTY REVENUE
In recent years the Company has not generated net sales sufficient to
produce an operating profit and has relied on a stream of royalty payments under
an agreement with IBM to support its activities. These royalties amounted to
$15,421,000 in fiscal 1995 and $14,473,000 in fiscal 1996. In late 1996 IBM
introduce a new version of the royalty bearing device with substantially greater
capacity and royalty revenue declined to $2,318,000 in the first quarter of
fiscal 1997 and $1,196,000 in the quarter ended March 31, 1997. The Company
believes that IBM is transitioning to a device which does not bear royalty, and
that royalty revenue will continue to decline. In addition, net sales further
declined in the recent quarters to $1,576,000 in the quarter ended March 31,
1997 resulting in operating losses and net losses in the two most recent
quarters. In the most recent quarter the Company realized a negative net margin
on net sales. The Company must generate substantial
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additional net sales of its CASD products in order to restore gross margins on
those products and must generate revenue from its new Solution Services division
or develop other sources of revenue in order to remain a viable operating
entity. There is no assurance that the Company can achieve those objectives.
FLUCTUATIONS IN QUARTERLY RESULTS
The Company's quarterly operating results have in the past varied and may
in the future vary significantly depending on a number of factors, including:
the level of competition, the size, timing, cancellation or rescheduling of
significant orders; product configuration and mix; market acceptance of new
products and product enhancements; new product announcements or introductions by
the Company's competitors; deferrals of customer orders in anticipation of new
products or product enhancements; changes in pricing by the Company or its
competitors; the impact of price protection measures and return privileges
granted by the Company to its distributors and VARs; the ability of the Company
to develop, introduce and market new products and product enhancements on a
timely basis; hardware component costs and availability, particularly with
respect to hardware components obtained from sole sources; hardware supply
constraints; the Company's success in expanding its sales and marketing
programs; technological changes in the market for the Company's products,
product mix and the mix of sales among the Company's sales channels; levels of
expenditures on research and development; changes in Company strategy; personnel
changes; general economic trends and other factors.
Sales for any quarter are not predictable with any significant degree of
certainty. The Company generally operates with limited order backlog because
its products typically are shipped shortly after orders are received. Sales to
a single customer in a quarter have affected and may affect net sales and
operating margins. As a result, sales in any quarter are generally dependent on
orders booked and shipped in that quarter. Sales are also difficult to forecast
because the Company has not as yet generated significant sales of its products
incorporating CASD technology. Due to the typical timing of customer orders,
the Company often ships products representing a significant portion of its net
sales for a quarter during the last month of that quarter. Any significant
deferral of these sales could have a material adverse effect on the Company's
results of operations in any particular quarter. To the extent that the Company
completes significant sales earlier than expected, operating results for
subsequent quarters may be adversely affected. The Company's expense levels are
based, in part, on its expectations as to future sales. As a result, if sales
levels are below expectations, net income may be disproportionately affected.
The mix of the products marketed by the Company has been evolving over the
last three years, and the Company's net sales have declined over that period.
Due to all of the foregoing factors, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as an indicator of future performance. It is possible
that in some future quarter the Company's operating results may be below the
expectations of public market analysts and investors. In such event, the price
of the Company's Common Stock would likely be materially and adversely affected.
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INVESTMENT IN MATRIDIGM
The Company has invested $5,586,000 to acquire an approximately 31%
interest in MatriDigm Corporation, a private company organized to provide
software maintenance and re-engineering services for users of IBM mainframe
computer systems. MatriDigm has initially focused on development of a set of
automated tools to identify and specifically modify dates within IBM COBOL
programs to bring them into compliance with the Year 2000 requirements and to
test the modified programs. MatriDigm in February 1997 announced commercial
availability of an automated tool set for a pac-binary solution for programs
written in ANSI COBOL 85 and, to respond to market demand, has recently
announced commercial availability of a windowing solution. MatriDigm intends to
continue to refine its current tool set and to extend its tool set to modify
other COBOL languages as well as other computer languages widely used to write
programs for IBM mainframe computers. Industry sources report a multi-billion
dollar demand for services such as those being developed by MatriDigm and an
automated tool set should provide greater profit margins than can be realized
using other available methods. However, MatriDigm has not realized revenue as
yet, and there is no assurance that it can successfully market its automated
tool set, develop extensions for other computer languages or generate
substantial revenue and profits. During the course of development, the Company
has made additional investments in MatriDigm and may be required to make
additional investments in the future.
VOLATILITY OF STOCK PRICE
The price of the Company's stock has been subject to extreme volatility
over the past nine months, as the closing bid price has ranged between a low of
$5-1/8 and a high of $61-1/4, with a recent price of $25. The Company believes
that the principal reasons for this volatility are rumored progress of and
rumored problems in the development program of MatriDigm Corporation of which
the Company owns approximately 31%. MatriDigm, which expects to provide an
automated solution to the Year 2000 problem, is a private company and the
principal vehicle for public participation in ownership of MatriDigm is
indirectly through ownership of stock of the Company. MatriDigm has been unable
or unwilling to provide public information on a regular basis about the status
of its development effort, and as a result an opportunity is presented for third
parties to initiate rumors which result in significant swings in the price of
the Company's stock. Until MatriDigm successfully generates significant
sustained revenue, it will remain difficult for investors to apply standard
methods of analysis to the value of the Company's investment in MatriDigm and
the pattern of volatility should be expected to continue.
COMPETITION
The data storage market is intensely competitive, with technological
advances fueling continuous erosion of prices for data storage capacity. The
Company competes with much larger independent companies such as EMC and Storage
Technology Corporation as well as manufacturers of computer systems such as
Unisys Corporation, Sun Microsystems, Inc. and Hewlett Packard
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Corporation. Many of its competitors have substantially greater financial
resources and installed bases than the Company and on account of their
substantially higher level of purchases are able to achieve significantly lower
prices from suppliers of component parts. While the Company believes that its
CASD products are currently superior to competitive products, unless it can
significantly increase the level of net sales and additional cost savings on
component purchases it will be unable to generate adequate gross margins on its
CASD products. There can be no assurance that the Company will be able to
generate the level of net sales to achieve adequate gross margins.
The market for Year 2000 services is intensely competitive, with services
being provided by a number of national, regional and local firms, many of which
have existing relationships and contractual arrangements with customers. Many
of these competitors have substantially greater financial, technical and
marketing resources than the Company and MatriDigm. The ability of the Company
and MatriDigm to compete in this market will depend on the ability of MatriDigm
to develop a successful automated solution and as yet there can be no assurance
that MatriDigm will be successful in this effort. In addition, the Company must
attract and retain qualified personnel in which are also highly sought by its
competition and must successfully leverage its own resources with contract and
partnering relationships with other companies, including companies with are also
competitors.
DEPENDENCE ON NEW PRODUCTS; RAPID TECHNOLOGICAL CHANGE
The markets in which the Company operates are characterized by rapid
technological change, changing customer needs, frequent new product
introductions and evolving industry standards. The introduction of products
embodying new technologies and increased storage capacities by the Company's
competitors and the emergence of new industry standards could render the
Company's existing products obsolete and unmarketable. The Company's future
success will depend upon its ability to develop and to introduce new products,
including products with increasing storage capabilities (including new software
releases and enhancements) on a timely basis that keep pace with technological
developments and emerging industry standards and address the increasingly
sophisticated needs of its customers. The Company has not as yet realized
significant sales of its CASD products. There can be no assurance that the
Company will be successful in generating significant sales of these products.
The failure of the Company to achieve significant net sales from these products
could have a material adverse effect on the Company's business, operating
results and financial condition. There can be no assurance that the Company
will be successful in developing and marketing any other products that respond
to technological changes or evolving industry standards, that the Company will
not experience difficulties that could delay or prevent the successful
development, introduction and marketing of new products, or that its new
products will adequately meet the requirements of the marketplace and achieve
market acceptance. If the Company is unable, for technological or other
reasons, to develop and introduce new products, in a timely manner in response
to changing market conditions or customer requirements, the Company's business,
operating results and financial condition will be materially and adversely
affected.
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PRODUCT LIABILITY
The Company's standard warranty provides that if the system does not
function to published specifications the Company will repair or replace the
defective component without charge. Although to date the Company's suppliers of
hardware components have generally covered the warranty costs associated with
such components, there can be no assurance that such manufacturers will continue
to be willing or able to cover such costs, and their failure to do so would
result in such costs being borne by the Company. There can be no assurance that
the Company's warranty costs will not be significant in the future. Significant
warranty costs could have a material adverse effect on the Company's business,
operating results or financial condition.
The Company's agreements with its customers typically contained provisions
intended to limit the Company's exposure to potential product liability claims.
It is possible that the limitation of liability provisions contained in the
Company's agreements may not be effective. Although the Company has not
received any product liability claims to date, the sale and support of products
by the Company and the incorporation of products from other companies may entail
the risk of such claims. A successful product liability claim against the
Company could have a material adverse effect on the Company's business,
operating results and financial condition.
DEPENDENCE ON PROPRIETARY TECHNOLOGY
The Company's success depends significantly upon its proprietary
technology. The Company currently relies on a combination of patent, copyright
and trademark laws, trade secrets, confidentiality agreements and contractual
provisions to protect its proprietary rights. The Company seeks to protect its
software, documentation and other written materials under trade secret and
copyright laws, which afford only limited protection. The Company has
registered its Zitel, CASD and VAM trademarks and will continue to evaluate the
registration of additional trademarks as appropriate. The Company generally
enters into confidentiality agreements with its employees and with key vendors
and suppliers. The Company currently has issued U.S. patents associated with
its CASD technology. There can be no assurance that these patents will provide
the Company with any competitive advantages or will not be challenged by third
parties, or that the patents of others will not have a material adverse effect
on the Company's ability to do business. The Company believes that the rapidly
changing technology in the computer storage industry makes the Company's success
depend more on the technical competence and creative skills of its personnel
than on patents.
There has also been substantial litigation in the computer industry
regarding intellectual property rights, and litigation may be necessary to
protect the Company's proprietary technology. The Company has from time to time
received claims that it is infringing third parties' intellectual property
rights, and there can be no assurance that third parties will not in the future
claim infringement by the Company with respect to current or future products,
trademarks or other proprietary rights. The Company expects that companies in
the storage systems market will increasingly be subject to infringement claims
as the number of products and competitors in the Company's target markets
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grows. Any such claims or litigation may be time-consuming and costly, cause
product shipment delays, require the Company to redesign its products or require
the Company to enter into royalty or licensing agreements, any of which could
have a material adverse effect on the Company's business, operating results or
financial condition. Despite the Company's efforts to protect its proprietary
rights, unauthorized parties may attempt to copy aspects of the Company's
products or to obtain and use information that the Company regards as
proprietary. In addition, the laws of some foreign countries do not protect
proprietary rights to as great an extent as do the laws of the United States.
There can be no assurance that the Company's means of protecting its proprietary
rights will be adequate or that the Company's competitors will not independently
develop similar technology, duplicate the Company's products or design around
patents issued to the Company or other intellectual property rights of the
Company.
INTERNATIONAL SALES AND OPERATIONS
Sales to customers outside the United States have accounted for significant
portions of the Company's net sales, and the Company expects that international
sales will continue to represent a significant portion of the Company's net
sales. International sales pose certain risks not faced by companies that limit
themselves to domestic sales. Fluctuations in the value of foreign currencies
relative to the U.S. dollar, for example, could make the Company's products less
price competitive and, if the Company in the future denominates any of its sales
in foreign currencies, result in losses from foreign currency transactions.
International sales also cold be adversely affected by factors beyond the
Company's control, including the imposition of government controls, export
license requirements, restrictions on technology exports, changes in tariffs and
taxes and general economic and political conditions. The laws of some countries
does not protect the Company's intellectual property rights to the same extent
as the laws of the United States.
DEPENDENCE ON KEY PERSONNEL
The Company's future performance depends in significant part upon the
continued service of its key technical and senior management personnel. The
Company provides incentives such as salary, benefits and option grants (which
are typically subject to vesting over four years) to attract and retain
qualified employees. The loss of the services of one or more of the Company's
officers or other key employees could have a material adverse effect on the
Company's business, operating results and financial condition. The Company's
future success also depends on its continuing ability to attract and retain
highly qualified technical and management personnel. Competition for such
personnel is intense, and there can be no assurance that the Company can retain
its key technical and management employees or that it can attract, assimilate or
retain other highly qualified technical and management personnel in the future.
The future success of the Company's Solution Services Division will depend
to a significant extent on its ability to attract, train, motivate and retain
highly skilled software development professionals, particularly project
managers, software engineers and other senior technical personnel.
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The Company believes that in the U.S. and elsewhere there is a shortage of, and
significant competition for, software development professionals with the
advanced technological skills necessary to perform the services offered by the
Solution Services Division. The increasing recognition of the scope and
significance of the year 2000 problem has materially increased the competition
for personnel with appropriate skills and salary requirements have increased as
availability of such personnel has decline precipitously. The Company's ability
to maintain and renew existing relationships and obtain new business depends, in
large part, on its ability to hire and retain technical personnel with the IT
skills that keep pace with continuing changes in information processing
technology, evolving industry standards and changing client preferences. An
inability to hire such additional qualified personnel could impair the ability
of the Solution Services Division to manage and complete its existing projects
and to bid for or obtain new projects. Further, the Company must train and
manage its growing employee base, requiring an increase in the level of
responsibility for both existing and new management personnel. There can be no
assurance that the management skills and systems currently in place will be
adequate or that the Company will be able to assimilate new employees
successfully. Accordingly, there can be no assurance that the Company will be
successful in retaining current or future employees.
ANTI-TAKEOVER PROVISIONS
Certain provisions of the Company's Certificate of Incorporation, as
amended and restated, and Bylaws, as amended, California law and the Company's
indemnification agreements with certain officers and directors of the Company
may be deemed to have an anti-takeover effect. Such provisions may delay, defer
or prevent a tender offer or takeover attempt that a stockholder might consider
to be in that stockholder's best interests, including attempts that might result
in a premium over the market price for the shares held by stockholders.
The Company's Board of Directors may issue additional shares of Common
Stock or establish one or more classes or series of Preferred Stock, having the
number of shares (up to 1,000,000), designations, relative voting rights,
dividend rates, liquidation and other rights, preferences and limitations as
determined by the Board of Directors without stockholder approval.
The Board of Directors of the Company has approved the adoption of a
Preferred Share Purchase Rights Plan (the "Rights Plan"). Terms of the Rights
Plan provide for a dividend distribution of one preferred share purchase right
(a "Right") for each outstanding share of common stock, no par value per share
(the "Common Shares"), of the Company. Each Right entitles the registered
holder to purchase from the Company one one-hundredth of a share of Series A
Junior Participating Preferred Stock, no par value (the "Preferred Stock"), at
an exercise price of $69.50 per one one-hundredth of a Preferred Share (the
"Purchase Price"), subject to adjustment, and a redemption price of $.01 per
Right. Each one one-hundredth of a share of Preferred Stock has designations
and the powers, preferences and rights, and the qualifications, limitations and
restrictions which make its value approximately equal to the value of a Common
Share.
The Rights are not exercisable until the earlier to occur of (i) 10 days
following a public
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announcement that a person, entity or group of affiliated or associated persons
(an "Acquiring Person") have acquired beneficial ownership of 15% or more of the
outstanding Common Shares or (ii) 10 business days (or such later date as may be
determined by action of the Board of Directors prior to such time as any person
or entity becomes an Acquiring Person) following the commencement of, or
announcement of an intention to make, a tender offer or exchange offer the
consummation of which would result in the beneficial ownership by a person or
group of 15% or more of such outstanding Common Shares.
The Rights have certain anti-takeover effects as they would cause
substantial dilution to a person or group that attempted to acquire the Company
on terms not approved by the Company's Board of Directors. The Rights should
not interfere with any merger or other business combination approved by the
Board of Directors, since the Rights may be redeemed by the Company at $.01 per
Right prior to the earliest of (i) the twentieth day following the time that a
person or group has acquired beneficial ownership of 15% or more of the Common
Shares (unless extended for one or more 10 day periods by the Board of
Directors), (ii) a Change of Control, or (iii) the final expiration date of the
rights.
ITEM 7. EXHIBITS
(c) The following exhibits are furnished in accordance with the provisions
of Item 601 of Regulation S-K:
Exhibit Number Exhibit
4.1 Form of Convertible Subordinated Debenture
4.2 Registration Rights Agreement
4.3 Securities Purchase Agreement
4.4 Placement Agency Agreement
99.1 Press Release, dated May 23, 1997
The foregoing is a partial summary of certain terms of the Debentures and
the rights of the holders. Reference is made to the Exhibits filed with this
report for the actual terms of the Debentures and such rights.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ZITEL CORPORATION
Dated: May 29, 1997 By: /s/ Jack H. King
---------------------------
Jack H. King
President and Director
Chief Executive Officer
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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
4.1 Form of Convertible Subordinated Debenture
4.2 Registration Rights Agreement
4.3 Securities Purchase Agreement
4.4 Placement Agency Agreement
99.1 Press Release, dated May 23, 1997
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