SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number: 0-8354
nSTOR TECHNOLOGIES, INC.
------------------------------------------------------
(Exact name of registrant as specified in its Charter)
Delaware 95-2094565
------------------------------- -------------------
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10140 Mesa Rim Road
San Diego, California 92121
----------------------------------------
(Address of principal executive offices)
(858)453-9191
-------------------------------
(Registrant's telephone number)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X No____
Number of shares outstanding of the Registrant's Common Stock, par value $.05
per share, as of July 31, 2002: 137,549,920
2
nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Page
Number
--------
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2002
(uaudited) and December 31, 2001 3
Consolidated Statements of Operations
(unaudited) for the three and six months
ended June 30, 2002 and 2001 4
Consolidated Statement of Shareholders'
Equity (uaudited) for the six months
ended June 30, 2002 5
Consolidated Statements of Cash Flows
(unaudited) for the six months ended
June 30, 2002 and 2001 6-7
Notes to Consolidated Financial Statements
(unaudited) 8-19
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 19-23
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 23
Part II. OTHER INFORMATION 23-24
SIGNATURE 24
3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
nSTOR TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
June 30,
2002 Dec. 31,
ASSETS (unaudited) 2001
------ ----------- --------
Current assets:
Cash and cash equivalents $ 654 $ 857
Marketable securities - 4,255
Accounts receivable, net 2,661 1,925
Inventories 292 1,364
Prepaid expenses and other 421 211
------- -------
Total current assets 4,028 8,612
Property and equipment, net of $5,955 and
$5,641 accumulated depreciation 969 1,367
Goodwill and other intangible assets, net of
$842 and $808 accumulated amortization 11,241 1,989
------- -------
$16,238 $11,968
======= =======
LIABILITIES
-----------
Current liabilities:
Bank lines of credit $ 650 $ 2,991
Other borrowings 3,409 1,100
Accounts payable and other 4,211 3,790
Deferred revenue 1,802 -
------- -------
Total current liabilities 10,072 7,881
Long-term debt 3,100 3,600
------- -------
Total liabilities 13,172 11,481
------- -------
SHAREHOLDERS' EQUITY
--------------------
Preferred stock, $.01 par; 1,000,000 shares authorized;
Series L Convertible Preferred Stock, 1,000 and 0
shares issued and outstanding at June 30, 2002
and December 31, 2001, respectively - -
Common stock, $.05 par; 200,000,000 shares authorized;
137,549,920 and 114,603,144 shares issued and
outstanding at June 30, 2002 and December 31, 2001,
respectively 6,877 5,729
Additional paid-in capital 102,143 94,104
Deficit (105,954) (99,346)
------- -------
Total shareholders' equity 3,066 487
------- -------
$16,238 $11,968
======= =======
See accompanying notes to consolidated financial statements.
4
nSTOR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)
Three Months Six Months
Ended June 30, Ended June30,
-------------------- --------------------
2002 2001 2002 2001
(unaudited) (unaudited)
------- ------- ------- -------
Sales $ 2,451 $ 3,953 $ 4,010 $10,171
Cost of sales 2,351 3,050 4,026 7,555
------- ------- ------- -------
Gross margin (loss) 100 903 (16) 2,616
------- ------- ------- -------
Operating expenses:
Selling, general and administrative 1,115 2,808 2,645 6,116
Research and development 650 892 1,387 1,971
Depreciation and amortization 350 368 593 851
------- ------- ------- -------
Total operating expenses 2,115 4,068 4,625 8,938
------- ------- ------- -------
Loss from operations (2,015) (3,165) (4,641) (6,322)
Realized gains (losses) on marketable
securities 206 - (1,123) -
Fair value of option granted to customer - - (670) -
Interest expense (120) (328) (257) (654)
Other (expense) income, net (14) (25) (54) 13
------- ------- ------- -------
Net loss before preferred stock dividends
and extraordinary gain (loss) (1,943) (3,518) (6,745) (6,963)
Extraordinary gain (loss) from debt
extinguishment (net of tax of $0) 137 (362) 137 (362)
------- ------- ------- -------
Net loss (1,806) (3,880) (6,608) (7,325)
Preferred stock dividends - (444) - (629)
------- ------- ------- -------
Net loss applicable to common stock ($ 1,806) ($ 4,324) ($ 6,608) ($ 7,954)
======= ======= ======= =======
Basic and diluted net loss per
common share:
Loss before extraordinary gain (loss) ($ .01) ($ .11) ($ .06) ($ 21)
Extraordinary gain (loss) .00 ( .01) .00 ( .01)
------- ------- ------- -------
Net loss per common share ($ .01) ($ .12) ($ .06) ($ .22)
======= ======= ======= =======
Weighted average number of common
shares used in per share computation,
basic and diluted 120,983,986 35,597,434 117,979,041 35,538,290
=========== ========== =========== ==========
See accompanying notes to consolidated financial statements.
5
nSTOR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(dollars in thousands)
(unaudited)
Common Stock Preferred Stock Additional
---------------------- ------------------ Paid-In
Shares Amount Shares Amount Capital Deficit Total
----------- -------- ------- -------- ----------- --------- -------
Balances, December 31, 2001 114,603,144 $ 5,729 - $ - $ 94,104 ( $99,346) $ 487
Issuance of common stock:
Acquisition of 100% of
common stock of Stonehouse
Technologies, Inc.
("Stonehouse") 22,500,000 1,125 5,850 6,975
Satisfaction of accrued
dividends on Series D
convertible preferred stock 446,776 23 116 139
Issuance of Series L
Convertible Preferred
Stock in connection with
acquisition of Stonehouse 1,000 - 1,403 1,403
Fair value of option granted
to customer 670 670
Net loss for the six
months ended June 30, 2002 (6,608) (6,608)
----------- ------- ------ ------ -------- -------- ------
Balances, June 30, 2002 137,549,920 $ 6,877 1,000 $ - $102,143 ($105,954) $3,066
=========== ======= ====== ====== ======== ======== ======
See accompanying notes to consolidated financial statements.
6
nSTOR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months
Ended June 30,
---------------------
2002 2001
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ($ 6,608) ($ 7,325)
Adjustments to reconcile net loss to net cash
provided (used) by operating activities:
Proceeds from the sale of marketable securities 3,132 -
Realized loses on the sale of marketable
securities 1,123 -
Fair value of option granted to customer 670 -
Depreciation 558 650
Provision for inventory obsolescence 273 -
Extraordinary (gain) loss from debt extinguishment (137) 362
Provision for uncollectable accounts 77 -
Amortization of goodwill and intangible assets 35 201
Amortization of deferred financing costs and other - 242
Changes in assets and liabilities, net of
effects from acquisition:
Decrease in accounts receivable 638 1,154
Decrease in inventories 799 796
(Increase) decrease in prepaid expenses
and other (109) 264
Decrease in deferred revenue, accounts
payable and other 191 (1,024)
-------- -------
Net cash provided (used) by operating activities 642 (4,680)
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (75) (73)
Cash acquired in acquisition 298 -
-------- -------
Net cash provided (used) by investing activities 223 (73)
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments on bank line of credit (2,541) (964)
Additions to other borrowings 1,473 5,641
Issuance of preferred stock - 250
Cash paid for preferred stock dividends - (60)
-------- -------
Net cash (used) provided by financing activities (1,068) 4,867
-------- -------
Net (decrease) increase in cash and cash
equivalents during the period (203) 114
Cash and cash equivalents at the
beginning of the period 857 37
-------- -------
Cash and cash equivalents at the
end of the period $ 654 $ 151
======== =======
See accompanying notes to consolidated financial statements.
7
nSTOR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months
Ended June 30,
-----------------------
2002 2001
----------- -----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during period for interest $ 146 $ 348
======== ========
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES:
Non-Cash Investing Activities:
Acquisition:
Fair value of assets acquired $ 11,027 $ -
Liabilities assumed or incurred (2,947) -
Common and preferred stock issued (8,378) -
-------- --------
Cash acquired ($ 298) $ -
======== ========
NON-CASH FINANCING ACTIVITIES:
Issuance of preferred stock in satisfaction
of borrowings $ - $ 11,870
======== ========
See accompanying notes to consolidated financial statements.
8
nSTOR TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of nStor
Technologies, Inc. and all wholly-owned subsidiaries (collectively, the
"Company"). Significant intercompany balances and transactions have been
eliminated in consolidation.
Basis of Presentation
In the opinion of management, the unaudited consolidated financial statements
furnished herein include all adjustments, consisting only of recurring
adjustments necessary for a fair presentation of the results of operations for
the interim periods presented. These interim results of operations are not
necessarily indicative of results for the entire year. The consolidated
financial statements contained herein should be read in conjunction with the
consolidated financial statements and related notes contained in the Company's
Form 10-K, as amended, for the year ended December 31, 2001.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required for complete financial statements.
Going Concern
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. This contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business. The Company has experienced substantial net losses of $14 million,
$21.9 million and $18.7 million for the years ended December 31, 2001, 2000 and
1999, respectively, and $6.6 million for the six months ended June 30, 2002. In
addition, the Company has negative working capital at June 30, 2002. These
matters, among others, raise substantial doubt about the Company's ability to
continue as a going concern.
However, since 2001 the Company has devoted substantial efforts to: (i)
streamline its operations; (ii) establish the foundation for generating positive
cash flow and operating profits; and (iii) obtain sufficient financing to cover
its working capital needs.
Since 2001, the Company has significantly reduced its direct sales personnel and
related costs as part of its strategy to expand the Company's indirect customer
channel base (original equipment manufacturers (OEMs), resellers and systems
integrators). Further personnel reductions have been implemented to reflect the
Company's lower sales levels and provide certain cost efficiencies.
In July 2002, the Company entered into a contract with Varian, Inc. for
outsourcing the production of the Company's 4000 Series of products. The 4000
product family will be expanded later in 2002 to become the Company's universal
product offering. The Company expects this agreement to result in immediate
improvements in its operating margins by lowering manufacturing costs as well as
reducing overall operating costs. The Company's current manufacturing facility,
located in San Diego, California, is scheduled to be phased out during the third
quarter of 2002.
9
From January 1, 2001 through July 31, 2002, the Company obtained $20.8 million
of equity and debt financing from private investors, principally Maurice
Halperin, the Company's Chairman of the Board since August 15, 2001 and a
principal shareholder, or companies controlled by Mr. Halperin (collectively
"Mr. Halperin"), and H. Irwin Levy, the Company's Vice-Chairman of the Board,
Chief Executive Officer and a principal shareholder, or companies controlled by
Mr. Levy (collectively, "Mr. Levy").
During 2002, the Company's bank lender advised that it did not intend to renew
the Company's credit facility. As of June 30, 2002, the outstanding balance of
this facility had been reduced to $450,000, and as of July 30, 2002, was paid in
full. The Company is currently negotiating with a replacement lender and expects
to be able to complete a new bank credit facility during the third quarter of
2002; however, there can be no assurance that it will be successful in obtaining
such a facility on terms acceptable to the Company, if at all. On an interim
basis, effective in August 2002, the Company has been able to receive financing
based on 80% of qualified accounts receivable.
On June 7, 2002, the Company acquired 100% of the outstanding capital stock of
Stonehouse Technologies, Inc. (see Note 2 to Consolidated Financial Statements).
The Company believes that it has sufficient cash and other financial resources
to effectively operate until it achieves positive cash flows from operations,
which is expected to occur during the second half of 2002; however, there is no
assurance that the Company will be able to achieve positive cash flows in the
future or that additional financial resources will not be required.
The consolidated financial statements do not include any adjustments to reflect
the possible future effects of the recoverability and classification of assets
or the amounts and classification of liabilities that may result from the
inability of the Company to continue as a going concern.
Business
nStor Corporation, Inc., ("nStor"), a wholly-owned subsidiary of the Company, is
a designer, developer and manufacturer of attached and SAN (Storage Area
Network) ready data enclosures and Storage Management Software used in storage
solutions for computing operations. The Company's product line supports a
variety of operating systems, including Windows NT and Windows 2000, Sun
Solaris, Linux, SGI IRIX and Macintosh. Designed for storage intensive
environments such as the Internet or other mission-critical applications, the
Company's products are offered in Fibre Channel, Fibre-to-SCSI (Small Computer
Systems Interface), and SCSI architectures.
In June 2002, the Company acquired Stonehouse Technologies, Inc. ("Stonehouse" -
see Note 2 to Consolidated Financial Statements). Stonehouse provides software
and services solutions that help large enterprises manage their communications
expenses, assets and processes. These solutions include a suite of modular
applications and consulting services, which allow enterprises to manage voice,
data and wireless services by providing a systematic approach to automate order
processing, monitor expenses, manage vendor invoices, track asset inventory and
allocate costs.
Revenue Recognition
nStor
Revenues from the sale of storage products are recognized as of the date
shipments are made to customers, net of an allowance for returns.
10
Stonehouse
Revenues from computer software sales are recognized when persuasive evidence of
a sales arrangement exists, delivery and acceptance of the software has
occurred, the price is fixed or determinable, and collectability is reasonably
assured . Consulting revenues are recognized when services are performed.
Revenues on long-term development contracts are deferred at time of sale and
using the percentage-of-completion method, are recognized based upon hours
incurred as a percentage of estimated total hours. Maintenance revenues for
customer support and product updates are deferred at the time of sale and are
included in income on a straight-line basis over the term of the maintenance
agreement, generally for one year.
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.
Reclassifications
Certain prior year amounts have been reclassified to conform with the current
year's presentation. These reclassifications had no impact on operating results
previously reported.
Net Loss Per Common Share ("EPS")
Basic EPS is calculated by dividing the net loss available to common stock by
the weighted average number of common shares considered outstanding for the
period, without consideration for common stock equivalents. Diluted EPS includes
the effect of potentially dilutive securities. For the periods presented, the
effect of potentially dilutive securities would have been antidilutive.
Accordingly, basic and dilutive EPS for those periods are the same.
Effective January 11, 2002, the Company issued an aggregate of 76,884,122 new
common shares (the "New Common Shares") pursuant to shareholder approval of the
Halco Investment (see Note 3 to Consolidated Financial Statements). The Halco
Investment was completed on November 20, 2001, subject to shareholder approval;
accordingly the calculation of basic and diluted EPS assumes that the New Common
Shares were issued as of November 20, 2001.
Recent Authoritative Pronouncements
In October 2001, the Financial Accounting Standards Board the ("FASB") issued
Statement of Financial Accounting Standard No. 144 ("SFAS No. 144"), Accounting
for the Impairment or Disposal of Long-Lived Assets. SFAS 144 provides guidance
on the accounting for the impairment or disposal of long-lived assets. The
objectives of SFAS No. 144 are to address issues relating to the implementation
of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of", and to develop a model for long-lived
assets to be disposed of by sale, whether previously held and used or newly
acquired. SFAS No. 144 was effective for the Company commencing with its 2002
fiscal year. Upon adoption, this accounting pronouncement had no impact on the
Company's financial position or results of operations.
11
In April 2002, the FASB issued Statement of Financial Accounting Standard No.145
("SFAS No.145"), Rescission of SFAS No.4, 44, and 64, Amendment of SFAS No.13,
and Technical Corrections. SFAS No.145 rescinds SFAS No.4, Reporting Gains and
Losses from Extinguishment of Debt, SFAS No.44, Accounting for Intangible Assets
of Motor Carriers, and SFAS No.64, Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements. SFAS No.145 requires, among other things (i) that the
modification of a lease that results in a change of the classification of the
lease from capital to operating under the provisions of SFAS No.13 be accounted
for as a sale-leaseback transaction and (ii) the reporting of gains or losses
from the early extinguishment of debt as extraordinary items only if they met
the criteria of Accounting Principles Board Opinion No.30, Reporting the Results
of Operations. The rescission of SFAS No.4 is effective January 1, 2003. The
amendment of SFAS No.13 is effective for transactions occurring on or after May
15, 2002. Management is in the process of assessing the effect, if any, of this
pronouncement.
In July 2002, the FASB issued Statement of Financial Accounting Standard No.146
("SFAS No.146"), Accounting for Costs Associated with Exit or Disposal
Activities (effective January 1, 2003). SFAS No.146 replaces current accounting
literature and requires the recognition of costs associated with exit or
disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. The Company does not anticipate the
adoption of this statement will have a material affect on the Company's
financial position or results of operations.
(2) ACQUISITION
Terms of the Acquisition
On June 7, 2002, the Company acquired 100% of the outstanding capital stock of
Stonehouse from Pacific Technology Group, Inc. ("PTG"), a subsidiary of Pacific
USA Holdings Corp ("PUSA")(the "Acquisition"). The purchase price of $8.9
million, including approximately $500,000 in transaction costs, was based upon a
market value of $.31 per share, the average of the Company's closing market
prices for the four days before and after the terms of the Acquisition were
agreed to (April 30, 2002), and consisted of the issuance of 22,500,000 shares
of the Company's common stock and 1,000 shares of the Company's Series L
Convertible Preferred Stock. The Series L Convertible Preferred Stock is
convertible into 4,527,027 shares of common stock, subject to the Company's
shareholder approval. In addition, the Company is obligated to issue up to
8,687,258 shares of common stock based on an Earn-Out provision, as defined.
Under the Earn-Out provision, in the event pretax income (defined in the Stock
Purchase Agreement as "Net Revenues") of Stonehouse exceeds $1 million for the
four consecutive calendar quarters beginning on October 1, 2002, the Company
will be required to issue to PTG that number of additional shares of common
stock equal to the product of 27.027 and the amount of Net Revenues in excess of
$1 million, up to a maximum of 8,687,258 shares of the Company's common stock.
The issuance of such shares is subject to the Company's shareholder approval.
Reasons for the Acquisition
In an effort to improve the Company's financial condition and future sales
revenues, the Company developed a strategic business relationship with Pacific
Electric Wire & Cable Co., Ltd. ("PEWC"), the parent of PUSA. PEWC is a
Taiwan-based corporation, traded on the Taiwan Stock Exchange. As described in
Note 8 to the Consolidated Financial Statements, effective March 1, 2002, the
Company entered into a Reseller Agreement with another subsidiary of PUSA, and
also granted an option to that subsidiary to purchase up to 30 million common
shares at an exercise price of $.40 per share. Subsequently, the Company began
exploring ways to further its relationship with PEWC by combining nStor with
Stonehouse.
The Company believes that the Acquisition will have a positive impact on its
operating results from a cash flow standpoint, and will also contribute to the
Company's operating income during 2002. Further, Stonehouse has an expansive
customer base, including major U.S. corporations and government agencies,
through which the Company believes it will be able to market its computer
storage products, which in turn should have a positive impact on the Company's
operations.
12
In addition, the Company believed that the increase to its shareholders' equity
resulting from the Acquisition would assist the Company in its efforts to regain
compliance with the continued listing standards of the American Stock Exchange
(see Management's Discussion & Analysis, Liquidity and Capital Resources -
American Stock Exchange).
Accounting for the Acquisition
The Acquisition was accounted for under the purchase method of accounting with
assets acquired and liabilities assumed recorded at estimated fair values as of
the Acquisition date in accordance with Statement of Financial Accounting
Standards No. 141 ("SFAS 141"), Business Combinations, and the results of
Stonehouse's operations included in the Company's consolidated financial
statements from the Acquisition date. Allocation of the purchase price has been
made on a preliminary basis subject to adjustment should new or additional facts
about the business become known over the ensuing twelve months after the
Acquisition. Based on a valuation analysis completed by an independent valuation
firm, the allocation of the purchase price included intangible assets with an
aggregate fair value of $3.2 million and goodwill of $6.1 million. Intangible
assets with finite useful lives were identified as follows: (i) customer
relationships ($2.3 million); (ii) software ($660,000); and (iii) non-compete
agreement ($255,000); with corresponding useful lives of ten, five, and four
years, respectively. The excess of the purchase price over the fair value of net
assets acquired (goodwill) will be subject to an annual review for impairment in
accordance with Statement of Financial Accounting Standards No. 142 ("SFAS
142"), Goodwill and Other Intangible Assets, adopted by the Company in 2002 (see
Note 5 to Consolidated Financial Statements).
About Stonehouse
Stonehouse, based in Plano, Texas, provides software and services solutions that
help large enterprises manage their communications expenses, assets and
processes. These solutions include a suite of modular applications and
consulting services, which allow enterprises to manage voice, data and wireless
services by providing a systematic approach to automate order processing,
monitor expenses, manage vendor invoices, track asset inventory, and allocate
costs.
The following unaudited pro forma results of operations assume the Acquisition
occurred at the beginning of the three and six months ended June 30, 2002 and
2001 (in thousands, except per share data):
Three Months Six Months
Ended June 30, Ended June 30,
-------------------------------------- -------------------------------------
2002 2001 2002 2001
-------------------------------------- -------------------------------------
Histor- Pro Histor- Pro Histor- Pro Histor- Pro
ical(b) forma ical forma ical(b) forma ical forma
Combined Combined(a) Combined Combined(a)
------ -------- ------- ---------- ------ -------- ------- ----------
Net sales $2,451 $3,350 $3,953 $5,528 $4,010 $6,824 $10,171 $13,356
Loss before preferred
stock dividends and
extraordinary gain
(loss) ($1,943) ($2,004) ($3,518) ($4,697) ($6,745) ($6,612) ($6,963) ($8,340)
Net loss applicable
to common stock ($1,806) ($1,867) ($4,324) ($5,412) ($6,608) ($6,475) ($7,954) ($9,182)
Basic and diluted net
loss per share ($ .01) ($ .01) ($ .12) ($ .09) ($ .06) ($ .05) ($ .22) ($ .16)
Weighted average number
of common shares used
in per share computa-
tion, basic and
diluted 120,984 143,484 35,597 58,097 117,979 140,479 35,538 58,038
13
(a) The 2001 pro forma combined net loss reflects the implementation of a
revised business plan by Stonehouse, beginning in February 2001, by a
newly-employed business team, which contemplated substantial increases to
marketing, sales and administrative programs, in order to significantly expand
future revenues. Stonehouse subsequently determined that the new plan was not in
its best interests and, as a result, during the fourth quarter of 2001, this
plan was discontinued. Stonehouse's previous top executive reassumed the chief
executive officer duties and the new business team and certain other employees
were terminated in the fourth quarter of 2001 or early 2002. Significant
operating expenses related to the discontinued business plan were incurred in
2001.
(b) Historical amounts include Stonehouse's results of operations for June 2002.
The following table shows the amount assigned to each of Stonehouse's major
assets and liabilities at the date of Acquisition (in thousands):
Cash $ 298
Accounts receivable 1,554
Prepaid expenses 101
-------
Total current assets 1,953
Property and equipment 85
Goodwill 6,113
Other intangible assets 3,174
-------
Total assets $11,325
=======
Borrowings $ 200
Accounts payable and other liabilities 556
Deferred revenue 1,704
-------
Total liabilities $ 2,460
=======
(3) HALCO INVESTMENT
On November 20, 2001 (the "Closing Date"), the Company completed a transaction
in which Halco Investments L.C. (Halco), a company controlled by Mr. Halperin,
acquired a 34% equity interest in, and made certain loans to, the Company for an
aggregate investment of $12.1 million (the Halco Investment). On the Closing
Date, Halco acquired 8,970 shares of the Company's newly created Series K
Convertible Preferred Stock (the "Series K Preferred Stock"), with a face amount
of $8,970,000, and the Company issued a $3.1 million, 5-year, 8% note (the
"Halco Note"). Halco invested $6 million in cash and marketable securities
having a quoted market value of $6.1 million, based on the closing price for
such securities on November 19, 2001.
Mr. Halperin first submitted an investment proposal to the Company on June 26,
2001. The Company subsequently negotiated the terms of the offer from July to
November 2001, during which time, Halco made short-term working capital loans to
the Company in the aggregate amount of $5 million at an interest rate of 8% per
annum. Of that amount, at the Closing Date, $3.1 million was converted into the
Halco Note and the remaining amount was applied to the cash paid by Halco for
the Series K Preferred Stock. In connection with Mr. Halperin's proposal and the
interim financing provided by Halco, on August 15, 2001, the Company's board of
directors elected Mr. Halperin as Chairman, replacing the then Chairman, Mr.
Levy, who became Vice Chairman and who is continuing to serve as Chief Executive
Officer of the Company.
14
In connection with and as conditions to the Halco Investment, it was agreed that
an aggregate of 76,884,122 New Common Shares were to be issued as follows: (i)
the Series K Preferred Stock, owned by Halco, was to be automatically converted
into 39,000,000 shares of the Company's common stock, based upon a conversion
price of $.23 per share, upon approval of the Company's shareholders; (ii) all
of the holders of the Company's other convertible preferred stock (the "Other
Preferred Stock") agreed to convert their shares of preferred stock into common
stock (20,877,432 shares of common stock, including 10,752,527 to Mr. Levy);
(iii) the Company and the holders of the Other Preferred Stock agreed to the
issuance of: (a) 12,993,072 shares of common stock, including 6,651,488 to Mr.
Levy, to induce those holders to convert their shares, all of which were
entitled to periodic dividends, into shares of common stock, which had never
received a dividend (the "Inducement Shares"), and (b) 3,263,618 shares of
common stock, including 1,658,064 to Mr. Levy, (the "Dividend Shares") in
satisfaction of an aggregate of $1.5 million of accrued dividends (including $.7
million to Mr. Levy) on the date of conversion (the Inducement Shares and
Dividend Shares were based upon a conversion price of $.45 per share); and (iv)
Mr. Levy agreed to the receipt of 750,000 shares of the Company's common stock
in exchange for $.3 million owed by the Company to Mr. Levy (the "Note Shares")
based upon a conversion price of $.40 per share.
On the Closing Date, shareholders who owned in excess of 50% of the Company's
voting stock executed proxies to vote in favor of the foregoing transactions.
However, formal shareholder approval of the transactions was required before the
Company could issue the common stock necessary for the conversion of the Series
K Preferred Stock, the Note Shares, the Inducement Shares and the Dividend
Shares, and for an increase in the number of authorized common shares from 75
million to 200 million. On January 10, 2002, shareholder approval was received
and the Company issued the New Common Shares effective January 11, 2002.
Accordingly, to appropriately reflect the financial position of the Company in
the accompanying consolidated financial statements, the foregoing transactions,
as shown in the following table, were assumed to have occurred as of November
20, 2001, the Closing Date of the Halco Investment.
Balances at January 10, 2002 New Common Shares
(Considered Converted to New Common Shares Issued Effective January 11, 2002
at December 31, 2001) (Considered Outstanding at December 31, 2001)
- ---------------------------------------------- -------------------------------------------------
Aggregate Accrued Total
Preferred Number of Stated Value Dividends Conversion Inducement Dividend New Common
Series Shares (in thousands) Shares Shares Shares Shares
- --------- --------- ----------------------- ---------- ---------- --------- -----------
E 3,500 $ 3,500 $ 405 1,166,666 1,166,666 899,665 3,232,997
H 5,100 5,100 383 7,083,333 4,250,000 850,776 12,184,109
I 9,092 9,092 681 12,627,433 7,576,406 1,513,177 21,717,016
K 8,970 8,970 - 39,000,000 - - 39,000,000
-------- ------ ---------- ---------- --------- -----------
$26,662 $1,469 59,877,432 12,993,072 3,263,618 76,134,122
======== ====== ========== ========== =========
Note Shares 750,000
-----------
Total New Common Shares issued effective January 11, 2002 76,884,122
Common shares outstanding at December 31, 2001 37,719,022
-----------
Common shares outstanding at January 11, 2002
(considered outstanding at December 31, 2001) 114,603,144
===========
15
(4) TRADING MARKETABLE SECURITIES
In connection with the Halco Investment (see Note 3 to Consolidated Financial
Statements) on November 20, 2001, the Company received marketable securities
with a quoted market value of $6.1 million, including approximately 434,000
shares of American Realty Investors Inc. ("ARL"), a New York Stock Exchange
listed company, with a quoted market value of $5.2 million. Unrealized losses at
December 31, 2001 on the ARL shares were $897,000.
Due to ARL's low trading volume, the Company's ability to sell or borrow against
the ARL holdings had been extremely limited. From November 2001 through March
19, 2002, the Company had been able to sell only 56,300 shares in the public
market, generating cash proceeds of $442,000. To assist in funding the Company's
working capital requirements, in February and March 2002, the Company and a
company controlled by Mr. Levy, Hilcoast Development Corp. ("Hilcoast"), entered
into agreements whereby Hilcoast purchased 195,000 shares of ARL with an
aggregate quoted value of $1,470,000 on the respective purchase dates for an
aggregate purchase price of $1,240,000. In connection therewith, Hilcoast
granted the Company four-month options to repurchase all or a portion of those
shares based on the price Hilcoast paid plus 10% per annum (the "Options"). In
February and March 2002, the Company sold 183,000 additional shares,
representing all of its remaining holdings in ARL, to Mr. Halperin for an
aggregate purchase price of $1,278,000, which approximated ARL's quoted value on
the respective purchase dates. In April 2002, the Company received $206,000 in
cash proceeds from the exercise of the Options. As a result of the ARL sales in
2002, the Company realized a loss of $1.1 million during the six months ended
June 30, 2002, net of a $206,000 gain during the second quarter.
(5) GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill, representing the excess of the cost of an acquired business over the
fair value of net assets acquired, is carried at cost and, through December 31,
2001, was amortized under the straight line method over seven years.
Effective January 1, 2002, the Company adopted SFAS 142, which requires that
goodwill and certain intangible assets no longer be amortized, but instead be
tested at least annually for impairment. Accordingly, there was no goodwill
amortization recognized during the three and six months ended June 30, 2002, as
compared to $101,000 and $201,000 in the corresponding 2001 periods,
respectively. During 2002, the Company engaged an independent valuation firm to
prepare an impairment analysis of the Company's goodwill, including goodwill
acquired in the Stonehouse Acquisition. Based on this analysis, the Company's
goodwill is not considered to be impaired as of January 1, 2002. The Company
continues to review the impact of SFAS 142 and will make any necessary
adjustments, as appropriate.
As of June 30, 2002, the carrying amount of goodwill and other intangible assets
was approximately $8.1 million and $3.2 million, respectively, of which $6.1
million of goodwill and $3.2 million of other intangible assets were acquired in
June 2002 in connection with the Stonehouse Acquisition (see Note 2 to
Consolidated Financial Statements). Amortization of other intangible assets for
the three and six months ended June 30, 2002 was $35,000.
16
(6) BORROWINGS
Revolving Bank Credit Facilities
At December 31, 2001, the Company had a revolving bank credit facility (the
"Bank Line of Credit"), as amended, which provided for borrowings principally
based on the lesser of $10 million or 85% of eligible accounts receivable, as
defined. The Bank Line of Credit bore interest at prime plus 2.5%, was scheduled
to mature on April 30, 2002, was collateralized by substantially all of the
Company's assets, and provided for certain financial covenants, including
minimum net worth and net income requirements.
Since the fourth quarter of 2000, the Company had not been in compliance with
its minimum net worth and net income requirements under the Bank Line of Credit.
Effective February 4, 2002, the bank increased the interest rate to prime plus
3.5% and advised the Company that it did not intend to renew the Bank Line of
Credit. As of June 30, 2002, the outstanding balance of the Bank Line of Credit
had been reduced to $450,000 and as of July 30, 2002, the entire outstanding
balance was repaid. The Company is currently negotiating with a replacement
lender and expects to be able to complete a new bank credit facility during the
third quarter of 2002; however, there is no assurance that it will be successful
in obtaining such a facility on terms acceptable to the Company, if at all.
Stonehouse has a revolving bank credit facility (the "Stonehouse Revolver")
under which Stonehouse may borrow up to $500,000, payable upon demand, with
interest at prime plus 1% (5.75% at June 30, 2002). Borrowings under the
Stonehouse Revolver are collateralized by accounts receivable and certain other
assets of Stonehouse and guaranteed by PTG and PUSA. The Company has agreed to
use it's best efforts to cause the guarantees to be released by September 5,
2002 and has provided an indemnification to PTG and PUSA on their guarantees. At
June 30, 2002, the outstanding principal balance under the Stonehouse Revolver
was $200,000.
Other Borrowings
The Company's other borrowings consisted of the following (in thousands):
June 30, December 31,
2002 2001
----------- ------------
Current:
Notes payable to Mr. Levy, interest
ranging from 8%-10% per annum,
maturing on various dates from
December 2002 through June 2003 (b) $2,123 $ 650
Other notes payable, interest ranging
from 8%-10% per annum, maturing on
various dates from December 2002
through June 2003 (c) 1,286 450
------ ------
$3,409 $1,100
====== ======
Long-term:
Note payable to Halco, interest at
8% per annum, maturing on
November 20, 2006 (a) $3,100 $3,100
Other - 500
------ ------
$3,100 $3,600
====== ======
17
(a) As a condition to the closing of the Stonehouse Acquisition, the Company
issued an 8% convertible subordinated promissory note (the "New Halco Note") to
Halco in the principal amount of $3.1 million. The New Halco Note replaced the
Halco Note dated November 20, 2001, in the principal amount of $3.1 million (see
Note 3 to Consolidated Financial Statements). The New Halco Note is convertible
at the Company's option at any time prior to maturity on November 20, 2006 and
after the earlier of: (i) May 31, 2002 or (ii) the date on which the Company
receives a notice of delisting from the AMEX, in each case, only to the extent
deemed necessary to maintain the Company's listing on AMEX, at a per share
conversion price equal to 85% of the closing bid price of the Company's common
stock on AMEX on the trading day immediately prior to the date of conversion.
The New Halco Note is convertible at the holder's option at any time after May
31, 2003 and prior to maturity at a per share conversion price equal to 110% of
the closing bid price of the common Stock on AMEX on the trading day immediately
prior to the date of conversion.
(b) Effective June 14, 2002, the Company issued a 10% convertible subordinated
promissory note (the "New Levy Note") to Mr. Levy in the amount of $650,000. The
New Levy Note replaced three previously issued 10% notes, aggregating $650,000
and is convertible at the Company's option at any time prior to maturity on June
14, 2003 and after the date on which (i) the Company receives notice of
delisting from AMEX, and (ii) the New Halco Note has been converted into shares
of the Company's common stock and in each case, only to the extent deemed
necessary to maintain the Company's listing on AMEX, at a per share conversion
price equal to 85% of the closing bid price of the Company's common stock on the
trading day immediately prior to the date of conversion.
(c) The holder of a $450,000 note, payable December 15, 2002, as extended, has
the right at any time prior to maturity, to convert the note into shares of the
Company's common stock based on a fixed conversion price of $.40 per share.
(7) EXTRAORDINARY GAIN (LOSS) FROM DEBT EXTINGUISHMENT
During the three and six months ended June 30, 2002, the Company recognized a
$137,000 extraordinary gain from negotiated discounts with vendors. During the
three and six months ended June 30, 2001, the Company recognized a $362,000
extraordinary loss, representing the unamortized discount on certain notes
payable exchanged for preferred stock.
(8) FAIR VALUE OF OPTION GRANTED TO CUSTOMER
Effective March 1, 2002, the Company entered into a Reseller Agreement with a
wholly-owned subsidiary of PEWC. The Agreement grants the subsidiary of PEWC the
right to market and sell the Company's products for a period of two (2) years in
Mainland China and Taiwan on an exclusive basis, and in the United States and
Europe on a non-exclusive basis. The exclusivity right is conditioned, among
other items, upon minimum purchases by PEWC of $5 million through February 28,
2003 and $10 million during the subsequent year.
In connection with its efforts to develop further strategic business
relationships with PEWC, effective March 1, 2002, the Company granted a
subsidiary of PEWC an option to purchase up to thirty (30) million newly issued
shares of the Company's common stock for a purchase price of $.40 per share,
expiring on November 30, 2002. The option was valued at $670,000 as of the date
of grant based on the Black-Scholes option-pricing model and other provisions of
SFAS 123 and related EITF guidance. This amount was recorded as an expense in
the accompanying Statement of Operations for the six months ended June 30, 2002.
18
(9) INCOME TAXES
The Company accounts for income taxes in accordance with SFAS 109, which
requires recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been included in the financial
statements or tax returns. Under the SFAS 109 asset and liability method,
deferred tax assets and liabilities are determined based upon the difference
between the financial statement and tax bases of assets and liabilities using
enacted tax rates in effect for the year(s) in which the differences are
expected to reverse.
As of December 31, 2001, there were unused net operating loss carryforwards (the
NOL's) for regular federal income tax purposes of approximately $54.8 million
and for California tax purposes of approximately $11.5 million expiring from
2012 through 2021 and 2002 through 2011, respectively. In addition, the Company
has research and development tax credit carryforwards of approximately $1.2
million, which expire from 2002 through 2018 and in conjunction with the
Alternative Minimum Tax (AMT) rules, the Company has available AMT credit
carryforwards of approximately $800,000, at December 31, 2001, which may be used
indefinitely to reduce regular federal income taxes.
The usage of approximately $8 million of the NOL's and approximately $2 million
of the California NOL's is limited annually to approximately $400,000 due to an
acquisition, which caused a change in ownership for income tax purposes under
Internal Revenue Code Section 382.
At June 30, 2002 and December 31, 2001, a 100% valuation allowance has been
provided on total deferred tax assets because it is more likely than not that
the NOL's will not be realized based on recent operating results.
(10) SEGMENT INFORMATION AND SIGNIFICANT CUSTOMERS
Prior to the Acquisition in June 2002, the Company operated predominantly in one
business segment, information storage solutions ("Storage Solutions"). The
Company's customers include end users, OEMs, systems integrators and value added
resellers.
Following the Acquisition, the Company began operating under a second business
segment, Telecommunication Software/Services. Stonehouse offers telemanagement
solutions targeted to large corporations, educational institutions, state
governments and other large public, private and hybrid communications networks.
Financial instruments, which potentially subject the Company to concentrations
of credit risk, are primarily accounts receivable. The Company performs ongoing
credit evaluations of its customers, generally requires no collateral and
maintains allowances for potential credit losses and sales returns. During the
three months ended June 30, 2002, sales to two customers accounted for 40% and
15% of the Company's sales. During the six months ended June 30, 2002, a single
customer accounted for 34% of the Company's sales. In the three and six months
ended June 30, 2001, no single customer accounted for greater than 10% of the
Company sales. Sales to geographic areas other than the United States have not
been significant.
Presented below for the three months ended June 30, 2002 is selected financial
information for the two segments in which the Company now operates (in
thousands). The Storage Solution segment includes all corporate revenues and
expenses except those specifically attributable to the Telecommunications
Software/Services segment. Since the Acquisition occurred in June 2002, segment
information is not applicable for the 2001 periods.
19
Storage Telecommunication
Solutions Software/Services
------------- --------------------
Revenues $ 2,028 $ 423
Gross (loss) margin $ (96) $ 196
Net loss before preferred
stock dividends and
extraordinary gain ($ 1,931) ($ 12)
Net loss applicable
to common stock ($ 1,794) ($ 12)
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
With the exception of discussion regarding historical information, "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
contains forward-looking statements. Such statements inherently involve risks
and uncertainties that could cause actual results of operations to differ
materially from the forward-looking statements. Factors that would cause or
contribute to such differences include, but are not limited to, our inability to
increase sales to current customers and to expand our customer base, continued
acceptance of our products in the marketplace, timing and volume of sales
orders, our inability to improve the gross margin on our products, material cost
fluctuations, competitive factors, dependence upon third-party vendors, our
future cash flows and ability to obtain sufficient financing, level of operating
expenses, conditions in the technology industry and the economy in general,
legal proceedings and other risks detailed in our periodic report filings with
the Securities and Exchange Commission (the "SEC"). Historical results are not
necessarily indicative of the operating results for any future period.
Subsequent written and oral forward looking statements attributable to us or
persons acting on our behalf are expressly qualified in their entirety by
cautionary statements in this Form 10-Q and in other reports we file with the
SEC. The following discussion should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto included elsewhere in
this report
Results of Operations
For the three months ended June 30, 2002 and 2001, we incurred a net loss of
$1.8 million and $3.9 million, respectively. We incurred a net loss of $6.6
million and $7.3 million for the six months ended June 30, 2002 and 2001,
respectively. Included in the net loss for the six months ended June 30, 2002
were $1.1 million in realized losses on marketable securities, a $670,000 charge
for the fair value of an option granted to a customer and a $137,000
extraordinary gain from debt extinguishment. Included in the net loss for the
three and six months ended June 30, 2001 was a $362,000 extraordinary loss from
debt extinguishment.
20
Sales
Sales for the three and six months ended June 30, 2002 decreased to $2.45
million and $4 million, respectively, from $3.95 million and $10.2 million for
the same periods in 2001, respectively. Included in sales for the 2002 periods
was $423,000 attributable to Stonehouse following our acquisition in June 2002.
The significant decrease in sales reflects the economic downturn, which has
caused customer delays in purchasing technology and other equipment. During the
six months ended June 30, 2002, sales revenues attributable to our storage
business, included $1.5 million in direct sales to end users and $2 million in
indirect sales to OEMs, value-added resellers (VARs) and other channel business,
representing 42% and 56%, respectively. During the corresponding period in 2001,
direct, indirect and service revenues represented 27%, 56%, and 17%
respectively, of our sales revenues. In August 2001, we sold substantially all
of our service revenue business; accordingly, service revenues for 2002 are
insignificant.
Cost of Sales/Gross Margins
Gross margins decreased to 4% and 0% for the three and six months ended June 30,
2002, respectively, as compared to 23% and 26% for the same periods in 2001,
respectively. Gross margins for 2002 were positively affected by a 46% gross
margin attributable to $423,000 of Stonehouse revenues for June 2002. The
decrease in gross margin percentage was primarily due to economies of scale
attributable to the level of fixed costs inherent in our operations as well as
the price we paid for materials, coupled with significantly lower sales
revenues. Our gross margins are dependent, in part, on product mix, which
fluctuates from time to time.
See Note 1 to Consolidated Financial Statements regarding expected future gross
margin improvements attributable to a new manufacturing outsource contract
effective in July 2002.
Operating Expenses
Selling, General and Administrative (SG&A)
Selling, general and administrative expenses decreased to $1.1 million and $2.6
million for the three and six months ended June 30, 2002, respectively, from
$2.8 million and $6.1 million for the same periods in 2001, representing a 60%
and 57% decline for each period, respectively. The significant decrease was
primarily the result of the reduction of our overall work force and related
costs (including occupancy) partially offset by an additional $173,000 in SG&A
costs resulting from the Stonehouse Acquisition in June 2002.
Research and Development
Research and development expenses for the three and six month periods ended June
30, 2002 were $650,000 and $1.4 million, respectively, as compared to $892,000
and $2 million for the same periods in 2001. The decrease was primarily
attributable to costs incurred in 2001 as a result of the development of our
4000 Series product line. We believe that considerable investments in research
and development will be required to remain competitive and expect that these
expenses will increase in future periods.
Research and development costs are expensed as incurred and may fluctuate
considerably from time to time depending on a variety of factors. These costs
are substantially incurred in advance of related revenues, or in certain
situations, may not result in generating revenues.
21
Depreciation and Amortization
Depreciation and amortization for the three and six months ended June 30, 2002
was $350,000 and $593,000, respectively, as compared to $368,000 and $851,000
for 2001, respectively. The decrease reflects the discontinuation of
amortization of goodwill pursuant to the implementation of SFAS 142 effective
January 1, 2002 (see Note 5 to Consolidated Financial Statements). During the
three and six months ended June 30, 2001, amortization of goodwill amounted to
$101,000 and $201,000, respectively.
Interest Expense
Interest expense decreased to $120,000 and $257,000 for the three and six months
ended June 30, 2002, from $328,000 and $654,000 for the corresponding 2001
period. This decrease is attributable to lower average borrowings and lower
interest rates.
Preferred Stock Dividends
Preferred stock dividends were $444,000 and $629,000, for the three and six
months ended June 30, 2001, respectively. Effective November 20, 2001, all of
the Company's then remaining convertible preferred stock was converted to common
stock pursuant to the Halco Investment (see Note 3 to Consolidated Financial
Statements). Accordingly, there were no preferred stock dividends in 2002.
The Series L Convertible Preferred Stock issued in connection with the
Stonehouse Acquisition in June 2002 is not entitled to receive dividends.
Liquidity and Capital Resources
The accompanying consolidated financial statements have been prepared assuming
that we will continue as a going concern. This contemplates the realization of
assets and the satisfaction of liabilities in the normal course of business. We
incurred net losses of $14 million, $21.9 million and $18.7 million for the
years ended December 31, 2001, 2000 and 1999, respectively, and $6.6 million for
the six months ended June 30, 2002. In addition, we have negative working
capital at June 30, 2002. These matters, among others, raise substantial doubt
about our ability to continue as a going concern.
However, since 2001 we have devoted substantial efforts to: (i) streamline our
operations; (ii) establish the foundation for generating positive cash flow and
operating profits; and (iii) obtain sufficient financing to cover our working
capital needs. For a description of these efforts, see Notes 1 and 2 to
Consolidated Financial Statements.
Consolidated Statements of Cash Flows
Operating Activities
Net cash provided by operating activities amounted to $642,000 for the six
months ended June 30, 2002. The most significant use of cash was our loss from
operations (before changes in assets and liabilities) of $877,000 (net of $3.1
million of cash proceeds from the sale of marketable securities), which was more
than offset by reductions in accounts receivable ($638,000) and inventories
($799,000). Inventory reductions have been effectuated in connection with our
new manufacturing outsource contract in July 2002 (see Note 1 to Consolidated
Financial Statements).
22
Net cash used by operating activities for the six months ended June 30, 2001
amounted to $4.7 million with the most significant use of cash being our loss
from operations (before changes in assets and liabilities) of $5.9 million. The
operating loss was offset by an aggregate reduction in accounts receivable,
inventories and prepayments of $2.2 million, net of a $1 million decrease in
account payable and other liabilities.
Investing Activities
The most significant component of net cash provided by investing activities for
the six months ended June 30, 2002 consisted of $298,000 of cash acquired in the
Stonehouse Acquisition.
Financing Activities
Net cash used in financing activities for the six months ended June 30, 2002 was
$1.1 million, consisting of a $2.5 million net reduction of our Bank Line of
Credit, partially offset by $1.5 million of borrowings from Mr. Levy.
Net cash provided by financing activities for the six months ended June 30, 2001
amounted to $4.9 million and primarily consisted of borrowings of $5.6 million
from private investors (including $2.7 million from Mr. Levy), of which $4.4
million was satisfied by the issuance of convertible preferred stock in April
2002 and $250,000 from the issuance of convertible preferred stock, partially
offset by a net reduction of our Bank Line of Credit of $1 million.
American Stock Exchange ("AMEX")
On May 28, 2002, we received correspondence from AMEX regarding the potential
delisting of our common stock from AMEX due to our failure to meet certain of
AMEX's continued listing standards, related to minimum shareholders' equity and
our ability to continue operations and/or meet our obligations as they mature.
On June 26, 2002, we submitted a plan and supporting documentation (the "Plan")
to AMEX to demonstrate our ability to regain compliance. On August 13, 2002,
AMEX notified us that it had accepted our Plan and granted us an extension
through June 20, 2003 within which we must regain compliance, subject to
periodic review by AMEX's Staff. Failure to make progress consistent with the
Plan or to regain compliance with the continued listing standards by the end of
the extension period could result in our being delisted. We believe that we will
be successful in regaining compliance, although there can be no assurance that
we will remain listed on AMEX.
Critical Accounting Policies and Estimates
Revenue from the sale of products is recognized as of the date shipments are
made to customers, net of an allowance for returns. Revenues from computer
software sales are recognized upon execution of a contract and shipment of the
software provided that the product is accepted by the customer. Consulting
revenues are recognized when services are performed. Revenues on long-term
development contracts are deferred at time of sale, and using the
percentage-of-completion method are recognized based upon hours incurred as a
percentage of estimated total hours. Maintenance revenues for customer support
and product updates are deferred at the time of sale and are included in income
on a straight-line basis over the term of the maintenance agreement, generally
for one year.
Our preliminary allocation of the Stonehouse purchase price included $6.1
million in goodwill and $3.2 million in other intangible assets in accordance
with SFAS 141. These values were based on a valuation analysis completed by an
independent valuation firm. In addition, we have unamortized goodwill of $2
million that arose from an acquisition in 2000. Goodwill will be tested for
possible impairment at least on an annual basis in accordance with SFAS No. 142
(see Note 5 to Consolidated Financial Statements).
23
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States, 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 these estimates.
Results for the interim periods presented in this report are not necessarily
indicative of results that may be reported for any other interim period or for
the entire fiscal year.
Effect of Inflation
Inflation has not had an impact on our operations and we do not expect that it
will have a material impact in 2002.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Currently we do not have debt that is tied to floating interest rates.
Therefore, at this time we are not subject to risk arising from increases in
interest rates.
Part II - OTHER INFORMATION
Item 1. Legal Proceedings
Not Applicable
Item 2. Changes in Recent Sales of Unregistered Securities and Use of Proceeds
In connection with the Stonehouse Acquisition in June 2002, we issued 22,500,000
shares of common stock and 1,000 shares of Series L Convertible Preferred Stock,
which is convertible into 4,527,027 shares of common stock, subject to
shareholder approval.
All of the foregoing issuances were exempt from registration under section 4(2)
of the Act.
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
24
Item 5. Other Information
Not applicable
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits:
2.1 Stock Purchase Agreement dated June 7, 2002 by and among the Registrant,
Pacific USA Holdings Corp., Pacific Technology Group, Inc. and Stonehouse
Technologies, Inc. (3)
4.1 Certificate of Designation of Series L Convertible Preferred Stock (3)
4.2 Stockholders' Agreement dated June 7, 2002 by and among the Registrant, H.
Irwin Levy, Hilcoast Development Corp., MLL Corp., Maurice A. Halperin,
Halco Investments, L.C. and Pacific Technology Group, Inc. (3)
4.3 Registration Rights Agreement dated June 7, 2002 between Registrant and
Pacific Technology Group, Inc. (3)
4.4 8% Convertible Subordinated Promissory Note for $3,100,000, dated June 7,
2002, between Registrant and Halco Investments, L.C. (3)
10.1 Working Capital Assurance Agreement dated June 7, 2002, by and between
Registrant and Hilcoast Development Corp. (3)
10.2 Employment Agreement dated June 7, 2002, between John E. Gates and
Stonehouse. (3)
10.3 Form of Agreement between Registrant and Hilcoast Development Corp. (2)
10.4 Promissory Note for $750,000 between Registrant and Hilcoast Development
Corp., dated June 14, 2002 (1)
10.5 Promissory Note for $500,000 between Registrant and Hilcoast Development
Corp., dated May 18, 2002 (1)
10.6 Convertible Promissory Note for $650,000 between Registrant and H. Irwin
Levy, dated June 14, 2002. (1)
(1) Filed herewith.
(2) Incorporated by reference to the Exhibits previously filed as Exhibits
to the Registrant's Form 8-K filed April 12, 2002.
(3) Incorporated by reference to the Exhibits previously filed as Exhibits
to the Registrant's 8-K filed June 21, 2002.
(b) Reports on Form 8-K:
A report on Form 8-K dated April 10, 2002 was filed April 12, 2002, reporting
under Item 2 - Disposition of Assets, in which the Registrant reported the sale
of its remaining marketable securities.
A report on Form 8-K dated March 1, 2002 was filed June 21, 2002, reporting
under (i) Item 2 - Acquisition or Disposition of Assets, in which the Registrant
reported the acquisition of 100% of the outstanding capital stock of Stonehouse
Technologies, Inc. on June 7, 2002, and (ii) Item 5 - Other Events, in which the
Registrant reported (a) the grant of an option in March 2002 to an affiliate of
Stonehouse, and (b) an employment agreement in connection with the Stonehouse
Acquisition.
A report on Form 8-K/A dated March 1, 2002 was filed on August 13, 2002,
reporting under Item 7 - Financial Statements, Pro Forma Financial Information
and Exhibits, in which the Registrant reported historical financial statements
of Stonehouse Technologies, Inc. and Pro Forma financial information.
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.
nSTOR TECHNOLOGIES, INC.
(Registrant)
/s/ Thomas L. Gruber
August 13, 2002 ---------------------------------
Thomas L. Gruber,
Acting President, Chief Operating
and Financial Officer